Retailers Make a Surprising Comeback

You may be hearing a lot of bearish commentary centering on the premise that the market's advance is unsustainable because it has benefited so much from government spending.

But one big swath of the rise in stock prices has come from retailers, and it's hard to make a direct link between fiscal spending and chain store sales.

When the government pays for things like more highways and military goods, more people gain employment and then their families go out and purchase things at companies like Family Dollar Stores Inc. (NYSE: FDO) - a position in our Strategic Advantage portfolio that is fast on the rise. But that's really a "second-derivative" concept, as the statisticians say.

Employment and wage improvements have been the big catalysts.

Left for dead a year ago, recent data shows that the U.S. consumer is bouncing back in a big way as the economy finally starts generating jobs. That has resulted in a boom in retail sales that has taken even optimists by surprise. So let's look more closely at the numbers.

Household employment has increased at a rate of 371,000 jobs a month, on average, over the past three months - the strongest run in over three years. And retailers surveyed by the economists at the ISI Group Inc. expressed the most positive sentiment seen in six years.

But how does this mesh with the broad measure of unemployment still at nearly 17%?

My research suggests that a nascent wage-inflation spiral might be to blame. Fully 44% of the nation's 15 million unemployed workers have been out of work for more than six months. Such a long period of unemployment erodes useful skills. And many of the long-term unemployed are members of industries that are no longer a big part of the economy - think of all those extra mortgage brokers and real estate agents.

But after cutting payrolls far deeper than the decline in gross domestic product (GDP) would historically suggest, businesses are scrambling to lock up high-quality employees before their competitors do. As a result, the ISI Group's survey of temporary employment agencies indicated wage pressures are building. In fact, they've returned to levels not seen since mid-2004 - a time of economic recovery and low interest rates similar to the one we're experiencing now.

A renewed sense of confidence is encouraging spending among those that possess skills employers demand and are lucky enough to be in growing industries. This increase in spending encourages retailers to order new stock, which encourages wholesalers to place new orders, which causes manufacturers to increase production. Throughout the supply chain, new jobs are created. This increase in employment further lifts spending, and thus continues the cycle.

This so-called "positive feedback" loop is what powers economic expansions. And it's the main driver behind the SPDR S&P Retail (NYSE: XRT) exchange-traded fund (ETF) and individual retail stock positions.

The reality is that the stronger economy has improved confidence, and people who had been putting off purchases are finally feeling good enough about the future to book travel to Las Vegas on Southwest Airlines Co. ( LUV), reserve a Memorial Day weekend at an MGM Mirage (NYSE: MGM) casino, and buy something pretty for the occasion from Limited Brands Inc. (NYSE: LTD). And a portion of those purchases could end up going to American Express Co. (NYSE: AXP), which just broke out to a new one-year high.

An 8.7% jump in same-store sales for an index of 29 retailers tracked by Retail Metrics was 2.6 percentage points above expectations -- a level of new consumption that economist Jeremy Siegel says demonstrates that the recovery is "on a self-sustaining path."

One reason for the significant advances in chain store stocks in the past week was a very positive monthly report by the Census Bureau on monthly sales for retail and food services. Courtesy of analyst Jason Blair at Rochdale Securities, here were the highlights:

  • Retail sales rose 1.6% from February to March, compared to the consensus 1.3% gain. Sales are up 7.6% year over year.
  • Most retailing categories were up, which shows consumer spending is gaining momentum.
  • Auto sales rose 6.7% month-over-month, largely driven by the decline in auto finance rates to the lowest level since 2002.
  • Furniture and home furnishings rose 1.5% month-over-month, reflecting a surge of pent-up demand and big-ticket purchases.
  • Sales of building materials and garden equipment increased 3.1% month-over-month, the biggest increase since November 2007. This is seasonal of course, reflecting a warming trend, but retailers have said in their reports that they worry about not having enough inventory.
  • Apparel sales jumped 2.3% month-over-month, continuing the surge seen since 2009.

So what's next?

I agree with the Rochdale analysis that sees an acceleration of consumer spending, as

a) pent-up demand starts to unwind (e.g. autos and appliances); b) the inventory cycle turns positive and drives production and employment growth; c) credit markets continue to improve; d) consumers feel less bad given the wealth effect of the stock market rally and employment upturn; e) corporate profits surge; and f) personal income growth accelerates.

Chain-store sales in March were up 9% year-over-year and vehicle sales were up 21.3% year-over-year. Throw that together with the rise in temporary employment surveys and mix in a regression formula, and it appears to ISI Group analysts that U.S. household employment is now rising at a 3.3% annual pace, which would actually be as fast or faster than employment growth in supposedly stronger emerging markets in Taiwan and Chile, as well as smaller developed nations like Australia and Canada.

The bottom line for U.S. investors: It's too extended now, but look for opportunities to own SPDR S&P Retail Exchange-Traded Fund (NYSE: XRT) on pullbacks.

[Editor's Note: As this article underscores, Money Morning Contributing Writer Jon D. Markman uncovers significant new profit opportunities well ahead of the crowd. That's because Markman's experiences have provided him with a unique view of both the world economy and the global financial markets. With uncertainty the watchword and volatility the norm in today's markets, low-risk/high-profit investments will be tougher than ever to find.

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