Early Signs Point to Upcoming Storm for Retail Sector This Holiday Season

Retail SectorIt’s that time again. I haven’t heard the holiday music ring through the stores and malls yet, but it‘s coming, and I can tell you that retailers across America are nervous.

Black Friday is less than two weeks away, and I sense there’s increasing nervousness in the retail sector. For some, this weekend of spending accounts for over 50% of annual sales.

Macy’s, Inc. (NYSE/M) reported a strong fiscal first quarter in which it beat the Thomson Financial earnings-per-share (EPS) consensus estimate by $0.08 per diluted share or 20%. But while Macy’s offers investors some hope, the good news was short-lived, as the stock’s results may have had more to do with the company’s own success than a strong retail sector.

Wal-Mart Stores, Inc. (NYSE/WMT) and Kohls Corporation (NYSE/KSS) followed suit with soft reports that left investors worried about the strength of the holiday shopping season.

In the case of Wal-Mart, the world’s largest retailer reported a 0.1% decline in comparable U.S. store sales (without fuel) for the 13 weeks ended October 25, down from 1.7% growth a year earlier. For the 39 weeks ended October 25, Wal-Mart saw its U.S. sales contract by 0.4%, versus 2.4% growth in the year-earlier period. The result from Wal-Mart raises some red flags for the retail sector as we head into what is the most critical shopping time of the year.

Mike Duke, president and CEO of Wal-Mart, noted in the company’s quarterly report that the retail sector is “competitive.”

Wal-Mart also doesn’t appear to be too optimistic going forward and that makes me nervous, since the company is a good barometer for the global retail sector.

Even more worrisome is the impact of lower consumer spending and retail sales on gross domestic product (GDP) growth. Retailers may be heading for a storm. We saw the red flags in the advance reading of the third-quarter GDP that pointed to soft personal spending and the continued weakness in the jobs market, especially given that more than half of the jobs created in October were in low-skilled and low-paying sectors. And while all jobs are important, the creation of low-paying, low-skilled jobs does not exactly instill in me any confidence in the U.S. economy.

The reality is that the early signs of a potentially weak holiday shopping period could drive retailers to offer heavy discounts in an effort to move inventory. Of course, this would not be good, as it would pressure profit margins and kill growth in same-store sales.

The end result could be a weak retail sector and poor fourth-quarter results.

The area of the retail sector that I see as having the most immunity to a slowdown in consumer spending is the discount retail area and big-box stores, such as Family Dollar Stores, Inc. (NYSE/FDO) and Dollar General Corporation (NYSE/DG). Otherwise, it may be tough-going in the retail sector for the next several months. (See “My Two Favorite Discount Retail Stocks” for two top picks for investors to watch in the discount retail sector.)