As consumer confidence plummeted in late 2008 through early 2009, retail stocks naturally got hammered. Well-known names such as Ruby Tuesday, Office Depot
While the retail outlook was pretty dire in March, the tide has turned, reviving retail to a degree that Lazarus would envy. Since March 9, Ruby Tuesday is up 750%, Office Depot an incredible 1,040%, and Borders 280%.
The reasoning behind the rally? We've seen more positive economic data, which has seemingly convinced the market that the worst is over for both consumers and retailers.
Don't believe the hype
Let's not get ahead of ourselves here. It's true that economic indicators are pointing higher, but these year-over-year growth rates are based on pretty dire figures from the previous year and they remain well below what economists consider healthy.
The biggest issue remains the suffocating level of existing debt on consumers' balance sheets. A 2009 article in the Harvard Business Review found that, among other things, "It would take consumers 1.3 years to pay down existing debt with their current after-tax income, provided they spent that income on absolutely nothing else." An optimist might note this figure is down slightly from 1.33 years in the first quarter of 2008, but I find that little reason to celebrate. It's still a long way from being a good figure -- by comparison, this measure stood at 0.6 years in 1975.
Compounding this problem, the employment picture has only gotten "less bad" and has shown few signs of gaining positive traction. Recent layoff announcements by UPS
Not only is job competition higher, but unemployment is lasting longer, too -- the median length of unemployment was 20.5 weeks in December, which is the highest since the U.S. Bureau of Labor of Statistics began tracking the data in 1967. Until the jobs picture improves, consumer spending will stay under pressure.
Finally, to round out the consumer maelstrom, both demand for and availability of consumer credit remains low. These two factors have forced American consumers to rethink their budgets and increasingly put whatever cash they can spare into savings and paying down existing debts. All of this makes a return to pre-recession consumer spending habits highly unlikely.
What to buy
None of this means that you should avoid the entire retail sector, or that American consumers won't continue to spend. Quite the contrary, actually. According to Nielsen market research, U.S. consumers are indeed shopping, but are still very price conscious. That's why warehouse stores like Costco Wholesale
This trend toward thrift will be lasting, too. Even with historically low interest rates and trillions of dollars worth of government stimulus and incentives to encourage spending, American consumers remain hesitant or unable to justify large discretionary expenditures. Until consumers can adequately deleverage -- which, as the Harvard study made very clear, could take years -- a sustainable recovery in discretionary spending simply cannot take place.
Foolish bottom line
If you're going to buy a consumer stock today, focus on companies that offer value over style and needs over wants. One retailer we've admired at Motley Fool Pro is Tractor Supply, a "rural-lifestyle" retailer that sells a wide range of goods, from livestock and pet supplies to garden tools to, yes, tractor supplies. Despite the significant changes in consumer behavior during this recession, Tractor Supply has increased sales by focusing on "consumable, edible, and usable" products that people need in their everyday lives.
While there are a few retailers, like Tractor Supply, that we would consider buying (and only then at the right price), we continue to be concerned about the state of the consumer, and we're skeptical of the recent rally in retail. Fortunately, in our $1 million real-money portfolio, we can use options and ETFs to take advantage of a downward move in retail stocks -- and we have. If you'd like to learn more about what we do at Motley Fool Pro, simply enter your email address in the box below.
