Why You Might Consider Retail Stocks Soon

by George Leong, B. Comm.

The retail sector has been rallying in recent weeks on optimism that the U.S. economy will pull out of its recession later this year. There have been some bright spots in consumer confidence, but we are still not where we believe consumers are ready to spend.

The Conference Board reported that consumer confidence in April came in at 39.2, well up from the estimate of 29.5 and a 26.9 reading in March. But, while the reading still points to weakness, it was the highest since November 2008. It appears that consumers may be gaining some confidence that the worst is over; although, in my view, I would want to see improvement in the distressed jobs and housing markets before we are confident.

The weak condition of the U.S. economy was confirmed by a weaker-than-expected first quarter GDP report that pointed to a decline at a 6.1% annual rate, much worse than the 4.9% estimated by economists. The GDP contraction has occurred for three straight quarters. The last time this happened was in the 1974 to 1975 period. A positive was a 2.2% increase in the key consumer-spending portion of the report.

In an advanced retail sales report, the April total retail sales fell 0.4% and 0.5% when excluding autos, which fell short of consensus estimates. A positive was the decline in April was a sequential improvement over the 1.4% drop in March total retail sales.

Department sales continued to be poor, as shoppers continue to head to the discounters and big-box stores. These stocks have been on a nice uptrend. There continue to be declines in non-essential items such as clothing and specialty stores.

Over the past year, I have been cautious and warning readers about the risk of investing in retail stocks given the declining consumer confidence, major job losses, and the weak housing market, which has negatively impacted household wealth and has created a poverty effect. Given the decline in overall material wealth, we are clearly seeing a decline in consumer spending.

Companies like Costco Wholesale Corporation (NASDAQ/COST) and Wal-Mart Stores, Inc. (NYSE/WMT) continue to benefit from the thrift spending.

Retailers that sell non-essential goods at regular prices will continue to struggle and will be forced to sell at discounts to eliminate inventories. When this happens, profit margins are squeezed and companies make fewer sales and earnings.

My view on the retail sector remains the same. The ripple effect from the housing and jobs areas will continue to impact the spending patterns of consumers. People need to feel confident about their jobs and housing values before they will consider spending on non-essential goods. The travel industry has been hard hit and, according to recent data, fewer Americans are expected to take vacations this summer.

My advice is to continue to tread carefully in retail. The economic slowdown and recession will continue to impact retail stocks, although you should also look at buying on extreme weakness with brand name retail stocks. Sometimes the best time to buy is when there is chaos.