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Have Consumers Made a Comeback?

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"The American consumer's back and ready to spend, spend, spend!" You've probably noticed this joyful sentiment bubbling up around many retail stocks -- and their euphorically rising prices.

But even if recovering American shopaholics have busted out of rehab for now, their celebration could be short-lived. Now more than ever, prudent retail investors should proceed with caution.

Hurray, the consumer's back!
Throughout April, I spotted headlines crowing about resurgent American consumers, who appear to be loading up on new clothes, jewelry, and cars.

Consumers are indeed spending more now than they were this time last year. March same-store sales were impressive, with overall comps surging 9.1%. First-quarter earnings reports from companies like Starbucks (Nasdaq: SBUX  ) and Coach (NYSE: COH  ) imply that many folks have rediscovered the urge to splurge.

A few days ago, The Wall Street Journal reported that many restaurants are also seeing customers return, citing data from companies like Brinker International (NYSE: EAT  ) , Panera (Nasdaq: PNRA  ) , and Chipotle (NYSE: CMG  ) . Restaurants are particularly good indicators of consumers' financial health, since eating out is one of the easiest expenses to strike from budgets.

With the coast apparently clear, luxury retailers have even begun to raise prices again. Saks (NYSE: SKS  ) is retreating from the highly promotional pricing it embraced last year to move merchandise, while Tiffany (NYSE: TIF  ) has raised prices on its high-end baubles. That strategy seems a poor fit with a recent warning from Bain & Co. Although sales of luxury goods are emerging from the trench they occupied during last year's "worst year ever" for luxury, Bain said they won't return to 2007 levels until 2012.  

I can see why resurgent spending can seem exciting after such a long period of Puritanical penny-pinching. After all, consumer spending represents a whopping 70% of the U.S. economy. However, many investors should still prepare themselves for the possibility of a reality check.

... But for how long?
While it was exciting to see March's same-store sales surge, the month included Easter this year, and it faces very easy prior-year comparisons. A year ago, the sky was falling, and consumers maintained a death grip on their wallets.

Despite our recent euphoria, dark sentiments still lurk beneath retail's surface. According to a Reuters/University of Michigan index, consumer confidence unexpectedly fell to 69.5 in April, from 73.6 in March.

High unemployment and the ailing housing market continue to constrain consumers' ability to spend. Meanwhile, American consumers' efforts to reduce their indebtedness are proceeding slowly. Total household debt remained at 94% of gross domestic product in the fourth quarter, a measly improvement from 96% when the recession began. Egad!

In the short term, consumers reloading their credit cards would certainly provide a remedy to the "paradox of thrift" that punishes the economy for shoppers' frugality. However, it's dangerous to rely entirely on spending-happy consumers for an economic recovery -- a lesson we should have already learned.

More troubling twists ahead?
Investors need to navigate the retail landscape carefully. Beyond unemployment and shoppers' personal debt, the recently passed health-care reform law now raises a big question mark for retailers.

The National Retail Federation has already warned that the law will result in retail job losses. The industry's reliance on part-time workers, and its high employee turnover, will make conforming to the new law difficult, at least at first. That promises yet another challenge for long-term retail stock investors.

Foolish investors will reduce risk in uncertain times by sticking with quality. Seek retailers with the most solid brands, the strongest balance sheets, and the smartest management teams. The across-the-board retail rally implies that many investors are loading up for the here and now. Their high-priced, low-quality stocks could soon plummet back down to earth.

Are overly euphoric investors about to get creamed from an unsustainable retail stock rally? Are consumers really resurgent, or is the recent positive data simply a short-lived anomaly?

Leave your two cents on consumer confidence and the retail industry in the comment box below.

Chipotle is a Motley Fool Rule Breakers pick and a Motley Fool Hidden Gems recommendation. Coach and Starbucks are Stock Advisor choices. The Fool owns shares of Chipotle. Try any of our Foolish newsletters free for 30 days.

Alyce Lomax owns shares of Starbucks. The Fool has a disclosure policy.

Read/Post Comments (1) | Recommend This Article (8)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On April 28, 2010, at 5:11 PM, Patbubblebuster wrote:

    Hello good read,I watched the Nova special last night about how irrational people are with money and a year ago the sky was falling while now it is a mini boom times.However the employment problem is just as bad as it was and some demand comes from a real need for some itmes like cars,clothes and repairs on home items.The BIGG problem is still real estate,the old merry-go-round of jacking up the prices and taking out money to pay off redit card bills is over.How much growth the last 30 years of the US economy comes fron this is hard to say but I believe it was a majority.Even after the crash of 1929 it took years for finacial reform and a war to create real demand.The Voo-Doo (supply-side) economics of the last thirty years still has years to go to correct itself.The free money for buying a house program ends on Apirl 30 and how much demand has been stolen fron the future is unclear now but it should be alot.The up coming elections should keep any new goverment handouts from coming and we had been living off the fumes of an empty tank for a long time.

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