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By Brian Sozzi

If we were to make two columns on a chalkboard, one titled "Mr. Frown" and the other "Ms. Smiley Face," the former would undoubtedly contain more tally marks as it pertains to reads on the U.S. consumer. Mr. Frown has countless soft consumer-related data points and dour 2Q11 earnings outlooks (dating back to 1Q11 conference calls) to his credit, while Ms. Smiley Face has holiday 2010, and the majority of 2007, to brag about. Roller coaster trends in monthly retail sales have become the norm in this economic recovery cycle, and is consistent to my boom and bust theory expressed coming into the year.

In such a feast and famine environment, retailers will put up juicy sales numbers in the weeks prior to specific holidays or when promotions are just right. Furthermore, purchases that would be classified as discretionary are done at the time of need, meaning warm weather gear is not bought well in advance. The result of all these crosscurrents in retail is consistent volatility because outside of high income earners, the spending recovery is far from consistent. June, in which 15 of the retailers from the total of 17 I monitor for monthly sales, was a great example of the boom and bust theory. Weather and holidays lured consumers from their bunkers (following a weak May) and promotions sealed the deal. One other explanation for the strength: investment in essentials, either back to school merchandise or consumables, due to the expectation of higher ticket prices down the road.

That being said, I think it's important to mention the plight of the low income consumer. When we hear that wage growth is not keeping pace with inflation it's the sub $50,000 annual income households, and even the "squeezed middle" earning $60,000 to $80,000, that are feeling it disproportionately. The quarterly earnings from Dollar General (DG) and Family Dollar (FDO), and the June sales from Bon-Ton (BONT) and Fred's (FRED) and its earnings warning, shed a floodlight on the weekly spending volatility of households that only dream of buying something at Nordstrom (JWN) and Saks (SKS).

Tour of the Month

  • Mum was the word on 2Q11 earnings for the majority. Fred's warned on 2Q11, and JC Penney (JCP) had a month that implies a shortfall relative to consensus is possible. Macy's (M) took the bull by the horns and once again raised 2Q11 sales guidance (thank you Bloomies and online).
  • Continuing to receive poor reads on furniture sales throughout the department store sector and branded retailers. The commentary is in line to trends I found unfolding in the government retail sales data a couple of months ago.
  • Average transaction value is inflated...by inflation. Consumers are demonstrating that they will pullback on units per transaction.

Investment Strategy

The key word of the day is leverage. Put simply, the June performances were so strong on the top line that the market will reason consensus estimates are justifiably too low. Remember, the concern entering 2Q11 was that weak top lines would expose inflation in transposition, inventory, etc. With better than expected leverage over these inflationary line items at this point in the quarter, and July unlikely to show a significant drop in consumption due to back to school buying, tourism, etc., the short-term thesis in retail that has materialized is that margins will not be at super depressed levels in the quarter, just somewhat depressed. A vital distinction has now been made.

I continue to say to be very selective in retail names, preferring to be 100% sure on a specific call rather than loading up on stocks that tend to have tight correlation. It's a high-end and very low end long thesis, with targeted shorts on those names catering to the middle income by selling high ticket items, like furniture (where obviously there is no pricing power at this moment).

Temperature of the Industry

There continues to be more mixed reads on the state of the U.S. consumer than there are alcohols in a Long Island Iced Tea (that would be five depending on recipe used). There is this divergence in viewpoints amongst investors between allocating funds to those names benefiting from what is actually happening in so many households throughout the U.S. at the present (careful spending; long the low-income plays, short the middle of the market) and being positioned for the potential of brighter days as we transition into the peak of back to school and yes, the holiday season.

If one is inclined to listen to the market's sweet nothings, than it would appear that the outlook for the consumer has improved nicely from the 1Q "soft patch" (where personal consumption expenditure growth tailed off dramatically compared to 4Q) and slow beginning to 2Q (in a normal recovery, retailers are not offering gas gift cards and discounting shirts by 40%). The S&P Retail Index is a mere seven points shy of its early May highs (different than last year's sell off where the index broke the 200-day moving average in late June and held below there until early September), and across the consumer discretionary space there are stocks that are leading the broader risk on rally that has ensued amidst the Greece mess. However, if one prefers to operate on cold hard facts, the government data and countless survey measures suggests all is not well in consumer land.

Conference Board Consumer Confidence-June

  • All components lower.
  • Although inflation fears eased, it failed to be reflected in a bounce in confidence from May's decline.

Personal Income & Spending-May

  • Savings rate ticked up month to month.
  • There has not been any real disposable income growth for consumers since January.

Miscellaneous Views

  • Talk on the topic of U.S. spending centers on a "zombie" consumer base. In a world of zombies, the consumer simply goes to work to pay off debts incurred from yesteryear. There is a focus on doing what it takes to pay more for needs, with wants assuming a backseat.
  • Dollar store sales growth is not decelerating, and continues to be healthier than gains at Wal-Mart (WMT) and Target (TGT). Discount retailing is now comparable to a train track instead of one subset of retailing. The dollar stores and traditional discounters are on opposing sides of the track.
  • Not yet seeing a consistent ramp in consumption from gasoline prices some 10% lower from 2011 peak and signs of inflation moderation in the food aisles. It took a few months for the consumer to adjust their spending habits in response to higher prices earlier in the year, perhaps we are enduring that same adjustment process as the coast becomes clearer on inflation (see June).
Source: The Consumer Spending Recovery Is a Giant Roller Coaster