Investors are watching U.S. consumers very closely. Usually shopaholics, Americans are clutching their wallets more tightly these days as they face down a weak economy and rising gas and food prices.
Consumer stocks rise and fall based on where Americans spend their hard-earned money, or, more recently, their government stimulus checks. And so far it's clear that dollars have flowed toward cheaper options.
Above all, that trend has helped Wal-Mart Stores (WMT), the world's largest retailer. Wal-Mart saw its stock jump 24% in the past six months even as the rest of the stock market slid lower. "Wal-Mart has seen a new group of customers come into the fold," says Georges Yared of Yared Investment Research. Middle-class consumers are finally deigning to visit the chain known for its discounts.
Can the High End Hang On?
While consumers continue "trading down"—swapping, for example, brand-name clothes at the mall for discount Wal-Mart attire—Wall Street is trying to figure out which companies will be helped, and which will be hurt, by that trend. Furthermore, investors wonder how long the trend will last. Can higher-end firms find ways to hold on to customers even in a serious downturn?
Expert investors offered advice on these questions, but they also acknowledged that it's difficult predicting where fickle shoppers will spend. For example, in April, Gap (GPS) managed to hold same-store sales steady at its higher-end Gap and Banana Republic stores. However, its low-priced Old Navy stores saw sales plunge 12% from a year ago.
In the world of retail, restaurants, and other consumer stocks, success can be determined less by the economy than a company's product mix, advertising, and other factors.
Quincy Krosby, chief investment strategist at the Hartford (HIG), says that in better times, middle-class families have often stretched to buy "affordable luxuries," expensive but still affordable products from firms such as Coach (COH) and even Tiffany (TIF). But Krosby expects consumers to forgo many luxuries and instead shop at discounters. "When consumers feel really nervous about jobs and/or gasoline prices, you're going to see them hunker down," she says.
Elsewhere in retail, Family Dollar Stores (FDO) shares are up 14% since the start of the year, as investors bet that squeezed lower-income consumers will turn to dollar stores for rock-bottom prices.
Not Feeling So Well-Off
But it's not just poorer Americans who are looking for deals. Consumers have flocked to discount warehouse club Costco Wholesale (COST). Many of the club's members are "relatively well-off people," says John Massey of AIG SunAmerica Asset Management.
Even shoppers at high-end grocery chain Whole Foods Market (WFMI) seem to be cutting back just a bit. Known sometimes as "Whole Paycheck" for its pricey groceries, Whole Foods said on May 14 that same-store sales grew 5.7% in the first four weeks of the quarter. Other chains would be envious of that figure, but it's slower than last quarter's 6.7%.
In tough times, Americans with car trouble try to do the repairs themselves, rather than pay mechanics at an expensive dealership. That's the theory anyway, which suggests auto supply stores such as O'Reilly Automotive (ORLY) should do well. But O'Reilly's same-store sales fell 0.4% last quarter. "Currently, customers are doing the bare minimum to keep their cars running and are deferring all unnecessary maintenance," Cid Wilson, an analyst at Kevin Dann & Partners, wrote recently. However there is hope: "O'Reilly believes that this deferring of maintenance cannot last forever and that the company is well-positioned to capitalize on the pent-up demand."
Frugal consumers may be more likely to settle for secondhand merchandise, and this might help CarMax (KMX), a chain of dealerships specializing in used cars. While the company's new-vehicle sales fell last quarter, used-vehicle sales were up about 13%.
Moving outside retail and into restaurants, McDonald's (MCD) has been a top performer as consumers swap meals at sitdown restaurants for cheaper fast-food options. McDonald's same-store sales rose 2% in April, at the low end of previous estimates. Massey sees a "weakening trend" even at McDonald's. Perhaps, rather than trade down to cheaper restaurants, "people are starting to eat at home more often," he says.
Thomas Nyheim, a portfolio manager at Christiana Bank & Trust in Delaware, is more optimistic. He thinks even casual dining restaurants will do well, as customers migrate from more expensive high-end restaurants, most of which are privately owned. A top performer this year has been Darden Restaurants (DRI), which has seen its stock jump 34%. It owns several chains including Red Lobster, but Darden's Olive Garden chain has done the best, with same-restaurant sales up 5.7% last quarter despite the slowing economy.
All Set for a Stimulus
The key questions for investors may be how stressed consumers really are right now and how much they're willing to give up over the long term. Some investors are optimistic, betting that federal tax-rebate checks will spur Americans to start treating themselves to small luxuries again.
Yared says he suspects the strong sales at Wal-Mart and dollar stores may be a temporary phenomenon. "I don't know if [Wal-Mart's new customers] are long-term and loyal," he says, adding that the dollar store concept has yet to prove itself.
But others worry higher gas prices will eat up much of the benefit from the federal stimulus. The price of oil has risen almost 25% since Apr. 1. High gas prices "serve as a tax on the consumer," Krosby says, giving them "less money to spend on something else." Consumer stocks would get a boost if only oil and gas prices would decline, she says.
But Massey is pessimistic about the consumer's lot. Even if the economy recovers later this year, that's likely to boost demand for oil and push up prices even further. "The consumer faces a difficult time no matter what scenario we're in," he says, whether the economy regains strength or continues to stagnate.
Even as they face stingy customers and a tough economy, companies try to find ways to prosper. For Darden's Olive Garden, that has meant aggressive advertising. Brands as diverse as Coach and Starbucks (SBUX)—which faces tough competition from cheaper coffee outlets—hope to hold customers' attention with new products and innovations.
Investors and company executives may have trouble predicting the macroeconomic environment in the coming year. But at least they can focus on what they do control: making their merchandise so attractive that even cash-squeezed consumers just have to buy it.