Strong Consumer Sector Will Support Retail Stocks

Strong Consumer Sector Will Support Retail Stocks

When investors think back to the financial crisis of 2008, one of the primary concerns for most economists was the prospect of massive unemployment over an extended period of time.  These concerns were of critical importance in the decisions made at the US Federal Reserve to ease monetary policy and cut interest rates to historically low levels.  But now that we have conclusive evidence that these initial fears were unwarranted, it is time for investors to start looking for new opportunities in growth stocks that are poised to capitalize on the better than anticipated spending power for the American consumer.

One sector that should be on the radar of investors in this current environment is retail, which was one of the first sectors to meet heavy selling pressure when stock declines started building in momentum.  But now that consumer spending has reached its pre-crisis levels, it starts to become clear that there is solid value in the sector for those that are able to identify which stocks are best positioned for sustainable growth over the long-term.  Here, we will look at some of the reasons investors should be bullish on the sector and then outline some of the best positioned stocks that can be found in the space.

Signs of Macro Strength

To support this positive outlook, it is a good idea to identify the broader trends that are in place to help support the sector.  The first factor to consider is the falling unemployment rate, which is now seen holding just above the 5% mark:

In this chart, we can see that the total unemployment rate has been cut almost in half relatively to the highs that were seen toward the beginning of 2010.  From the standpoint of the Federal Reserve, the national unemployment rate is arguably the most important single factor in determining the monetary policy outlook going forward.  The initial increases in the unemployment rate were commonly cited as the primary concern for the Federal Reserve during the period of financial collapse -- and this was one of the biggest reasons for cutting interest rates to historic lows.  Low interest rates make consumer credit costs much cheaper and this opens the way for sustainable strength in discretionary spending:

The positive trends in the unemployment rate have had far-reaching peripheral effects that should be viewed as added positive because at the same time, wage growth and consumer spending have been on the rise.  The chart above shows the meteoric rise in consumer spending that has been seen since 2009.  It shouldn’t be a complete surprise, as this come in line with the steady improvement that has been seen in the unemployment rate over the same period.  But if it seems as though this type of activity is unsustainable, then we can also look at the supportive trends that are now being seen in consumer wage growth:

While we can see that there was a small dip in 2012, average hourly wages have been on a steady upswing in the time since.  This shows that there is more to the strength in the unemployment rate than more workers simply finding new jobs.  It also shows that those jobs are of higher quality.  So when we look at the potential for strength in the consumer sector, there are some clearly defined macro trends that support the outlook.

Chart Source:  CornerTrader

Add to this the fact that interest rates are still at historic lows and that oil prices are now seen trading at their lowest levels in more than five years.  In the chart above, we can see that oil has shown a consistent inability to overcome the $100 mark and the result has been a massive drop back below $50 per barrel.  “Low oil prices suggest that consumers have extra money to spend on consumer items that would not be considered necessities,” said Michael Carney, market analyst at TeachMe Trading.  “Since saving rates have held relatively steady, the ultimate conclusion is that consumers are likely to continue putting their money back into the economy with the purchase of large items.”  Cheap credit adds to this outlook and this is an environment is likely to continue at least until the Federal Reserve raises interest rates back to normal levels.  The process is raising interest rates is generally a slow one, so it is clear that investors should benefit from looking for ways that can capitalize on all of these trends in an efficient fashion.  

Stocks to Watch

One of the best ways of doing this is to take another look at the retail sector and to identify companies that are positioned to rise in valuation based on the supportive underlying elements.  There are many excellent possibilities that can be used to engage in this type of investment strategy, and the list includes some well-established names that are likely to perform in a stable manner over the long-term.  

First on the list is Best Buy, Inc. (NYSE:BBY), which is an electronics retailer that has received several major analyst upgrades over the last few months.  Most of the optimism has been based on encouraging trends in forward P/E which could rise as high as 16 times earnings over the next year.  The company has implemented cost savings strategies that could reduce costs by as much as $1 billion and support the company’s bottom line.  Improved vendor relationships with outfits like Amazon and Google add to the bullish outlook as both of those organizations have opened kiosks in many Best Buy locations.

Next on the list is Foot Locker, Inc. (NYSE:FL), which has posted some very strong gains  recently (32% in 2014).  There is an increased possibility that the positive momentum will continue, as supportive earnings have created a strong floor under which the stock price is unlikely to fall.  Foot Locker owns Champs Sports and is one of the last full-price destinations that can be found in the mall.  Stronger demand in shoes and athletic apparel has created earnings growth as high as 39% in recent quarters.  All of this points to continued gains in the stock, making it a strong buy at current levels.

For those looking to balance a blue chip portfolio with stocks that have the potential for long term growth, another interesting selection can be found in JunkieDog, Inc. (OTCMKTS:JKDG) which has a highly diversified asset portfolio and the ability to generate revenues from a number of different businesses.  JunkieDog has recently enacted new marketing strategies with consulting firm Brewer and Associates that could bring large increases to its distribution opportunities around the globe.  The company has established product distribution routes through a number of different channels (ie. liquidated merchandise sold as wholesale and through its e-commerce units focused on consumer retail).  JunkieDog is another example of a company with established relationships with Amazon and has recently added relationships with eBay that have increases the company’s existing sales numbers.

Last, we look at CVS Health Corp. (NYSE:CVS), which is a company that is focused more on consumer staple sorts of items when compared to some of the other names on our list.  CVS is the second largest pharmacy in the US and its earnings have actually been improved by its recent decision to stop selling tobacco items.  Tobacco is generally considered to be a low-margin product so the decision to start placing the focus on other areas of the business have so far proven to be beneficial for stock prices.  In the last year, valuations increased by roughly 40%, putting its performance well ahead of key competitors like Walgreen’s and Rite Aid.  CVS stock is still trading well below the average target of most commonly watched analysts on Wall St., so there is still excellent opportunity for those looking to add the company to a diversified portfolio.

In all, the broader outlook supporting all of these companies stems from the positive trends in both unemployment and in average hourly earnings.  The trends in both of these areas are relatively clear and when we add in additional factors like low interest rates and declining oil prices, it starts to become clear that bullish trends in consumer spending should continue well into next year.  For the most part, the retail sector has been largely overlooked by the financial media -- and this is something of a surprise given the strong moves that have already been seen.  In any case, there is little reason to believe these trends will be ending any time soon and there are still some strong opportunities that can be identified for those looking to add exposure in the retail sector.