Fiscal Cliff & Retail Stocks: 2 to Buy, 2 to Sell

by Dan Burrows | December 7, 2012 12:37 pm

The so-called fiscal cliff might really be more of a slope, but if the U.S. does roll over it next year, automatic tax hikes are indeed going to take a bite of consumers’ discretionary income.

All told, the expiration of income tax cuts and the 2% payroll tax holiday will suck about $265 billion out of consumers’ pockets in 2013 alone. The poorest Americans will be hit hardest on a relative basis, the richest will pay the most on a dollar and percentage basis and the middle class will get squeezed in between.

It used to be that recessions and their aftermaths created a sort of hourglass shape when it came to where folks spent their money at the retail level. The luxury names at the top of the hourglass tended to hold up well, thanks to their well-off clientele, while the discounters and dollar stores at the bottom benefited from more middle-class shoppers pinching pennies and trading to more downmarket options.

But now we’re starting to see more of a pyramid shape taking form, where traditionally redoubtable high-end names are starting to show vulnerabilities, too, and discounters and dollar stores only continue to gain steam.

It’s almost as if everyone is trading down — and if those automatic tax hikes take place … well, we could see an acceleration of the trend.

Consider that if the U.S. economy does indeed stall out as expected after going off the cliff, the total wealth of the richest Americans would contract by about $240 billion[1], according to consulting firm WealthInsight. At the same time, the middle class and upper-middle class will see their taxes jump anywhere from 3.8 to 4.2 percentage points[2], according to the Tax Policy Center.

If such a scenario does indeed come to pass, we expect next year’s share performance in some of the top luxury names, dollar stores and discounters to echo that of 2012.

With that in mind, here are two retail stocks to buy and two to sell if the U.S. is hit with the automatic tax hikes and spending cuts known as the fiscal cliff:

Buy

Walmart (NYSE:WMT[3])

The world’s largest retailer has its “always low prices” mojo back. Shares are up more than 20% year-to-date, beating the broader market by 8 percentage points. The discounter isn’t exactly counter-cyclical, but it does benefit from a more cash-strapped middle class.

Furthermore, if the economy contracts because of higher taxes and lower spending, that could lead to lower energy and gas prices, which disproportionately hurt Walmart’s lower-income shoppers. Less cash going into the tank could mean more traffic and spending at the discount chain.

Dollar General (NYSE:DG[4])

The nation’s largest dollar-store chain rode the recession and its aftermath to huge share-price gains, for obvious reasons. Persistently high unemployment and stagnant wages means practically everyone is shopping for bargains.

The stock is up more than 13% in 2012, beating the S&P 500 by about a percentage point, and that outperformance should widen if higher taxes pinch consumer spending. A member of InvestorPlace’s Real America Index[5], Dollar General is already expected to enjoy a long-term earnings growth rate of more than 17%. That might be too conservative if the fiscal cliff accelerates traffic to its stores.

Sell

Tiffany (NYSE:TIF[6])

TIF shares have slumped 11% for the year-to-date, lagging the broader market by about 23 percentage points. This once-sterling name has missed Wall Street’s earnings forecast in four consecutive quarters as high-end shoppers both here and abroad have become tighter with their pursestrings.

In the most recent period, TIF missed by a whopping 14 cents a share and cut its outlook. Expect more of the same if the richest Americans see $260 billion in wealth go poof.

Coach (NYSE:COH[7])

The handbags and accessories maker has held up better than TIF, but shares still are off nearly 5% for the year-to-date, lagging the S&P 500 by 17 percentage points. Like Tiffany, Coach is highly cyclical and dependent on discretionary income — something that will take a further hit if taxes go up.

Although the company has a long track record of beating analysts estimates, its growth trajectory is slowing down. It also doesn’t help that COH is in a cage match with Michael Kors (NYSE:KORS[8]). If discretionary income becomes more scarce, that will only intensify Coach’s competition with Kors for the remaining luxury scraps.

As of this writing, Dan Burrows did not hold positions in any of the aforementioned securities.

Endnotes:
  1. would contract by about $240 billion: http://www.cnbc.com/id/100270710/More_than_300000_Millionaires_Would_Go_Off_039Cliff039
  2. taxes jump anywhere from 3.8 to 4.2 percentage points: http://www.taxpolicycenter.org/publications/url.cfm?ID=412666
  3. WMT: http://studio-5.financialcontent.com/investplace/quote?Symbol=WMT
  4. DG: http://studio-5.financialcontent.com/investplace/quote?Symbol=DG
  5. Real America Index: http://investorplace.com/real-america-index/tennessee-dollar-general-dg-a-booming-bargain-store/
  6. TIF: http://studio-5.financialcontent.com/investplace/quote?Symbol=TIF
  7. COH: http://studio-5.financialcontent.com/investplace/quote?Symbol=COH
  8. KORS: http://studio-5.financialcontent.com/investplace/quote?Symbol=KORS

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