Despite disappointing March sales data, consumer spending and retail stocks are above their lows of late last year. Can this rally continue?
Three months after the worst holiday sales season in recent memory, there have been signs that retailers are beginning to pick themselves off the mat. First, stocks in the hardest-hit retail industries rallied, and it looked as if consumers had finally stopped slashing spending. Then on Apr. 14, new retail sales data came in well below expectations. The March data, which showed a 1.1% decline in sales, don't completely refute the optimistic case for investing in retailers. But the U.S. Census Bureau report is the latest reminder that there will be no easy comeback for the retail sector.
According to Standard & Poor's (MHP), department store shares dipped 2.6% on Apr. 14 in response to the March numbers. But in the previous 13 weeks, department stores had rallied 22%—quite a recovery from their 50% decline through 2008. Other retail industries battered last year have shown surprising strength. Apparel retailers were up 28% in the last 13 weeks, S&P says, following a 42% drop in 2008. Internet retailers advanced 36% after falling 49% last year.
The best performers recently—since the broader market hit bottom in early March—were the worst performers during the bear market, says Rochdale Research analyst Jaison Blair. "We believe we are in the early-to-mid stage of the bottoming process in the retailing sector," he wrote on Apr. 9.
Wal-Mart (WMT) has been a recession favorite of investors for its focus on discount merchandise. But Wal-Mart shares are up just 4.5% since the Mar. 9 market low, while shares of upscale department store Nordstrom (JWN) have rocketed 72% higher. After such a strong rally for retailers, Blair said he was cautious about the possibility of future gains in the near term. But overall, analysts and investors have sounded much more optimistic about retailers recently. On Apr. 13, for example, JPMorgan (JPM) analysts raised earnings estimates for Wal-Mart, JCPenney (JCP), Nordstrom, Target (TGT). and Macy's (M).
"The patient is still bleeding"
Despite the disappointment in March, economic data have also raised hopes.
From the first quarter of 2008 to the first quarter of 2009, total retail sales are down 8.8%, the Census Bureau estimates. However, the steepest declines occurred in the second half of 2008, when retail spending fell off sharply. Since yearend, consumer spending has actually inched higher. Before March's 1.1% drop-off, retail sales actually rose 1.3% in January and inched up 0.3% in February. "It looks like the rate of decline is diminishing," says Keith Hembre, chief economist at First American Funds. Michele Gambera, chief economist at Ibbotson Associates, a subsidiary of Morningstar (MORN), agrees that "the intensity of the bleeding has decreased." But, he adds: "The patient is still bleeding."
Several economists warn that retail sales data can be volatile and unreliable from month to month. Increases in Social Security, unemployment payments, and tax refunds may have boosted spending in the new year, while it's hard to predict the effects of Easter's calendar shift from March in 2008 to April this year. "The information we're getting [on retail sales] is not sufficient" to make a prediction, Gambera says.
So investors, analysts, and economists are left to comb over the scant evidence, with an outlook for the rest of the year that could go in several different directions.
Oppenheimer (OPY) analyst Robert Samuels notes that "mall traffic has certainly picked up." While it could be some time before stores see positive sales figures, profit margins are widening, he wrote Apr. 14, amid "evidence that companies are appropriately planning for the 'new normal.'"
"less wealth in the economy"
KDV Wealth Management Chief Executive Dave Hinnenkamp says cheap share prices for many consumer discretionary stocks make them attractive to patient investors. As long as you have a long investing time frame of six months, a year, or more, he says, "consumer discretionary offers some very good upside potential."
However, Michael Yoshikami, president and chief investment strategist at YCMNET Advisors, warns that consumer spending is set to shrink significantly as a percentage of the U.S. economy. This is primarily due to the rapid drop in real estate values and secondarily because of the rise in joblessness. "What we're beginning to see is the natural consequence of less wealth in the economy," Yoshikami says. Most disturbing for those waiting for retail stocks to bounce back, he believes the shift could take place slowly, perhaps over the next five years.
Recent tax cuts and the refinancing of mortgages could put more money into Americans' pockets in the near term, says Ryan Sweet, an economist with Moody's Economy.com. However, "the major question mark is the second half of this year," Sweet wrote on Apr. 14. "It could be dreadful for spending if the labor market does not quickly turn, because these temporary supports to income will fade." Hembre suspects that most of the decline in consumer spending has already occurred. But he warns: "I don't think we rapidly rebound from here. It's going to be a very slow process of getting to the level we were at."
An unemployment rate of 10% or more by next year should take its toll, Hembre says. And with so many out of work, American wages are likely to grow very slowly—if at all.
Investors considering retail stocks are thus left with the same dilemma that faces those observing the broader stock market. After steep declines in 2008, conditions appear to have stabilized for now. But that's no guarantee of a quick rebound anytime soon.