The Retail Feedback Loop: When It Rains, It Pours

by: Skyler Greene

On news of the dismal hiring report a little over a week ago, I made the following prediction:

Even large S&P 500 companies sitting on cash piles have been slow to hire, because the whole thing is essentially one giant vicious feedback cycle. The end retailer doesn't hire because they don't want to train employees only to have to let them go because there isn't enough demand. Consequently, their supplier doesn't want to hire because THEY'RE now afraid there won't be enough demand -- and this effect continues on up the supply chain. It's a catch-22/chicken-and-egg argument: I won't hire because you won't hire.

No hiring and jobs means consumers have less money to spend. As a result, June retail sales dropped, along with economic forecasts for the remainder of 2012:

Retail sales in the U.S. unexpectedly fell for a third month in June as limited employment gains took a toll on consumers.

Analysis for Investors

Understanding the cause of the drop is important.

Retail sales and employment are in a feedback loop. Businesses refuse to hire because they don't have customers. The unemployed who can't find jobs are reluctant to go out shopping, leading to less sales for retailers, and less incentive for businesses to hire. This leads to no reduction in unemployment, which perpetuates the issue.

While the cycle will eventually be broken, in the meantime, investors should position themselves defensively. Certain companies may actually be in a position to benefit. According to Bloomberg,

Spending decreased 0.7 percent at department stores, 0.8 percent at furniture outlets and 0.6 percent at motor vehicle and parts dealers. [...]

Demand at Target rose 2.1 percent last month, falling short of the average projection for a 2.8 percent gain from analysts surveyed by Retail Metrics.

While high-end retailers are likely to see slowing sales, Jim Cramer thinks investors should focus on low-cost "dollar stores." These include Family Dollar (NYSE:FDO), Dollar General (NYSE:DG), and Dollar Tree (NASDAQ:DLTR). Other retailers poised to benefit from consumer spending cutbacks include low cost retail giants Walmart (NYSE:WMT) and Target (NYSE:TGT), as well as wholesaler Costco (NASDAQ:COST). Stores that derive revenue mostly from consumer staples are obviously better-positioned than stores who rely mostly on discretionary spending to turn a profit.

Ironically, another likely winner in the consumer spending slowdown is the credit card industry. Consumer credit jumped in May more than it has in almost five years, increasing by $17 billion. As many Americans struggle to make ends meet, they're increasingly turning to their plastic friends American Express (NYSE:AXP), Mastercard (NYSE:MA), Discover Financial (NYSE:DFS), and Capital One (NYSE:COF) for help. Economic malaise may perpetuate credit card borrowing in the near term.

On a brighter note for the economy, auto dealers sold 1.3 million cars in June, up 22% year-on-year. However, unless the employment situation improves soon, consumer spending may remain lackluster from now through the holiday season.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.