Investors care about retail spending because most of U.S. gross domestic product is derived through consumption. Consumer spending is a measure of economic health and corporate profits. A decline in the growth rate of consumer spending (or even a contraction) is a precursor to recessions. For those reasons, the declines in some big retail stocks has put traders on edge this quarter.
With all the bad news about retail stocks this earnings season, is consumer spending as bad as it sounds?
The short answer to that question is “no.” Retail spending and consumer activity look good, but understanding why that seems to be contradicting so many headlines is important.
The obvious red flags this quarter have been the price-performance among traditional retail stocks. As you can see in the next chart, stock prices (and margins) have been in decline among many of the major names.
It is easy to assume that if retail stocks and earnings are falling, then consumers must not be spending. If that were true, we would be very concerned. Fortunately, retail spending is on the rise, but traders often confuse spending with profits when spending is actually equal to sales (or revenue).
For example, in the next chart you can see the price performance of Nordstrom, Inc. (NYSE:JWN) compared to its revenue trend (positive) and its earnings trend (negative). What this shows is how traders can be fooled into assuming that sales are falling when they are actually rising because they over-focus on earnings.
According to Zacks, even the earnings picture isn’t so bad for retail once you include Wal-Mart Stores Inc (NYSE:WMT). Within the S&P 500, the consumer discretionary sector grew profits 1.7% versus the same period last year, and revenues (total spending) are up 3.2%.
We believe there are two primary factors creating a misperception about consumer spending:
- Trader myopia: Investors think retail spending is in decline because they are over-focused on a limited pool of “traditional” retailers and their earnings. They have neglected to properly weight revenue — which is the real measure of spending — across the entire sector.
- Consumer-spending shifts: Consumers are buying more products online all the time. However, the so-called “Amazon effect” isn’t entirely to blame for the poor performance among consumer stocks. Consumers are also buying different things at this stage in the cycle. Housing is still very strong, and hiring continues to rise, which means durable goods like furniture and appliances are doing great this year. And last year marked the all-time high for auto sales.
The Bottom Line
There are three important things to remember about current spending trends.
First, although we can show that spending is still rising, that does not mean that valuations for retail stocks are reasonable. Stock prices are really high, which may increase the potential for volatility in the near-term. However, if spending continues to rise, it means we are more likely to experience corrections than recessions and bear markets.
Second, tracking what consumers are buying (and what they aren’t) should provide attractive long (and short) trading opportunities this quarter. Currently, retail apparel and department stores look good for bearish trades at resistance, while furniture, appliances and electronics are attractive for bullish positions at support.
Finally, while consumer spending is on the rise, consumer prices aren’t. This divergence has created a situation where it will be less likely for interest rates to rise, which could keep financials flat or in decline through 2017.
InvestorPlace advisers John Jagerson and S. Wade Hansen, both Chartered Market Technician (CMT) designees, are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news.
John and Wade have now launched Turbo Trader Live — a live, interactive trading room service that focuses on technical analysis, long options and vertical spread strategies to help investors like you lock in fast and consistent profits with less risk.
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