This morning, the weekly ICSC/Goldman Sachs chain store sales poll showed a 3.4% gain in comparable store sales, year over year. ICSC expects a 3.5-4.5% gain in comp store sales for the month of August, excluding drug stores. This provides a positive data point ahead of Thursday's sales reports from various major retailers (although many have been abandoning the practice of reporting monthly sales figures in recent years). I expect major department and discount stores like Macy's (M), Kohl's (KSS), and Target (TGT) to post good numbers on Thursday. However, I think that the sector as a whole is overbought and investors should considering selling on any bounce.
Retail stocks have performed well over the past few months, with the exception of a few basket cases like J.C. Penney (JCP). Many retailers are now sitting just shy of 52-week highs. Macy's, Kohl's, Target, and Dillard's (DDS) all fit that description. Those four stocks also appear to be attractively valued, with forward P/E ratios between 10 and 13. (Data sourced from Yahoo! Finance.) However, I expect to see a particularly weak fall selling season due to high gas prices and uncertainty about the U.S. economy as the "fiscal cliff" comes back into focus. If retail sales start to falter, shares in these bellwethers will most likely be punished severely.
One negative indicator is falling consumer confidence. On Tuesday morning, the Conference Board reported the lowest consumer confidence index in nine months (60.6). Consumer confidence is being driven down in part by rising gas prices. Whereas prices usually fall towards the end of the summer driving season (Labor Day), gas prices have recently been on the rise after correcting lower through June and July. As of Monday, the average price of a gallon of regular gasoline was $3.756 (nearly 30 cents higher than the previous month and 15 cents above last year). Depending on how long oil producers and refiners have to remain closed due to Hurricane Isaac, gas prices could jump even higher this week. While I am bearish on oil in the medium-long term, gas prices tend to be pretty sticky, and will likely remain elevated through much of the fall.
It is true that changes of 20-30 cents in gas prices have only a modest effect on the amount American consumers spend at the pump. For most families, it will be less than $5 extra per week. However, that small increase can have a disproportionate spillover effect on spending for stores catering to the middle class. With gas prices close to $4 nationwide (and above that psychological level in many cities), consumers will start to cut their fuel consumption and discretionary expenditures. The indirect impact of consumers skipping a weekend shopping trip to save gas can be more important than the direct effect of people shifting some spending from discretionary purchases to fuel.
A potentially bigger long-term drag on U.S. consumer spending is the government's inability to negotiate a reasonable debt-reduction bill. As Paul Krugman has been persuasively arguing in recent years, cutting back government spending in a period of weak growth will make things worse (as would raising taxes). However, U.S. leaders seem to be inexorably headed in that direction, with Republicans and Democrats merely arguing over how to restore fiscal austerity. As the Economist explained last week, even if Congress manages to avoid the automatic cuts built into last year's legislation to raise the debt ceiling, there are still a host of smaller budget cuts and tax raises coming on line next year.
In short, the U.S. economy is most likely headed for a rough patch this fall, and there is no guarantee that things will improve next year. I think Congress will wait until the very last minute (late December or January) to agree on a deficit reduction package, which will raise anxiety this fall and could crimp holiday spending. Analyst estimates for retail stocks do not seem to be reflecting the strong possibility of stalled growth or recession for next year. If current estimates turn out to be too optimistic, middle class-oriented retailers could suffer a severe correction over the next 6-12 months despite their apparently reasonable valuations. I would urge investors to avoid these stocks, even though many have performed well recently. If retail stocks continue to rise in the coming weeks, they may even offer an attractive short opportunity for risk-tolerant investors.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.