Retail Sector—It’s Make or Break Time

Consumer spending drives gross domestic product (GDP) growth. And with Black Friday several weeks away, the market focus will be on the retail sector. As is the case each year, the next few months will be a make or break for the retail sector. In October, the key same-store retail sales increased 3.7% in October, which is good, but was short of the 4.3% estimate.

The key Christmas shopping season could be a struggle for the retail sector, as we know retailers are nervous about the ability of consumers to want to spend. How consumers spend will likely tell us how the economy will fare in 2012. With consumer spending accounting for about 70% of the GDP growth in this country, it will be critical.

As we found out last week, job creation continues to be a struggle. The non-farm payrolls showed the creation of 80,000 jobs in October, below the 85,000 estimate and the upwardly revised 158,000 (+55,000) in September. While the new jobs were the lowest in four months, a positive was the upward revision and a drop in the unemployment rate to nine percent.

My concern is that the lack of jobs negatively impacts consumer confidence, spending, and growth in the retail sector. When consumers feel less optimistic, there is a tendency to cut back on spending, specifically on major purchases such as homes, vehicles, furniture, appliances and travel, to name a few.

Consumer Confidence continues to be extremely weak. October saw another weak reading at 39.8, well below the estimate of 46.0 and the revised 46.4 in September. The subpar readings clearly indicate the nervousness of consumers and cannot be good for the retail sector.

To give you an idea of how bad the readings are, economists say that a reading of 90 indicates a healthy economy, something that has not happened since December 2007, when the recession began. It looks like it will be some time until the confidence reading heads back towards the pre-recession level of 90.

Moreover, add in the fact that the U.S. housing market remains in a mess after prices declined to below the lows of 2006, and you’ll understand my concerns going forward for the retail sector.

To drive the economy, consumers need to spend. We have interest rates at historic lows and quantitative easing. It is working, but not as fast as I would like to see.

A strong housing market is also critical for the retail sector, as homeowners tend to buy new furnishings, including many big-ticket items. This is not happening, as home prices continue to decline, dragged down by continued high foreclosures and short sales where homes are dumped below the mortgage value. The key Case-Shiller 20-city Index show that prices on average declined another 3.80% across the 20 largest U.S. cities in August, following a 4.21% decline in July. The reality is that foreclosures are driving the buying and this does not bode well for housing price appreciation. It may not be until 2013 that prices steadily rise.

Jobs, confidence, and higher home prices are needed to drive spending in the retail sector. Only under this scenario will there be sustained spending and economic growth.

I continue to sense that stocks will face difficult resistance and remain vulnerable to a downside reversal, but you can protect via put options, as I discussed in Today’s Stock Market: Managing Your Risk.

While spending is an issue domestically, the Chinese continue to spend, as I talked about in The Chinese Economy: What You Need to Know Right Now.