3 Reasons Retailers May Face Uphill Battle

 Although many retailers reported first-quarter earnings results which beat Wall Street’s expectations, an ambiguous recovery in consumer spending and confidence will likely put a strain on near term growth and profitability.

On one hand, retail giant Target (TGT) recently announced that in the month May its same-store sales jumped 1.3%, a hair ahead of expectations and witnessed a rise in credit card sales, suggesting consumers are more willing to extend themselves.  On the other hand, clothing retailers, which are a good indicator of consumer discretionary spending, Abercrombie & Fitch (ANF) and Hot Topic (HOTT), reported sales that fell short of expectations.  Additionally, warehouse giant Costco Wholesale (COST) recently saw an uptick in sales of food, an essential item, and a decrease in the volume of televisions sold in May. 

These trends indicate that once again, consumers are starting to penny-pinch and only spend on necessities.  A retailer like Target, which many consumers visit to purchase food, toiletries and other household essentials, is less likely to feel the revenues stream impact from a decline in consumer discretionary spending than a retailer like Abercrombie & Fitch-a trend that was seen in May.

This erratic consumer sentiment is primarily being driven by a job market which fails to improve and remains weak.  According to data from the U.S. Labor Department, the unemployment rate in 78 percent of the metropolitan areas covered by the Labor Department was higher in April than a year ago.  Additionally, the April report indicated that year-over-year decreases in nonfarm payroll employment was seen in 300 metropolitan areas.  To make things even more challenging, a study conducted by the payroll giant ADP and consulting firm Macroeconomic Advisers suggests that the four-week moving average of initial claims for jobless benefits increased in the last week of May.

The nation’s overall unemployment rate continues to hover around 10 percent, and is likely much higher than this because the data that is used to derive the percentage comes from household surveys and not actual payroll data.  With elevated unemployment rates, it is difficult to sustain an increase in discretionary spending.

A second force that could hinder retailers is personal disposable income.  In many ways this force goes hand-in-hand with unemployment rates, and declines in disposable income trend to decline in discretionary spending.  According to the Labor Department’s most recent reports, real compensation, adjusted for inflation, remained flat.  A good illustrator of this is U.S. productivity is on the rise while unit labor costs are declining, indicating that workers are producing more for the same, or possibly even lower, wage. 

Lastly, the stability and health of the overall global economy could play a role in hindering domestic consumer spending.  The geopolitical tensions around the world combined with the sovereign debt crisis in the Euro Zone have put a damper on consumer confidence, amplified fear in the markets and are likely to result in penny-pinching at the consumer spending level.

Some ETFs that are primarily driven by consumer discretionary spending and could be influenced by these forces include:

  • PowerShares Dynamic Consumer Discretionary (PEZ), which closed at $22.31 on Thursday.
  • Vanguard Consumer Discretionary ETF (VCR), which closed at $52.27 on Thursday.
  • SPDR S&P Retail (XRT), which closed at $40.66 on Thursday.

If invested into the retail sector, a good way to mitigate the risks involved is through the implementation of an exit strategy which identifies specific price points at which these ETFs could start trending downward.

According to the latest data at www.SmartStops.net, the price points for the mentioned ETFs are: PEZ at $20.84; VCR at $49.35; XRT at $38.53.  These price points change on a daily basis and are reflective of market conditions and volatility.

Disclosure: No Positions

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