A Slowdown at Wal-Mart Is a Warning Sign for Retail Stocks

On Friday, Bloomberg broke a story about weak January and February sales trends at Wal-Mart (NYSE: WMT  ) , supported by leaked internal emails. Most notably, a Wal-Mart VP wrote, "In case you haven't seen a sales report these days, February MTD sales are a total disaster. The worst start to a month I have seen in my ~7 years with the company." If this story is true, it bodes ill for most retail stocks, not just Wal-Mart.

Consumer pain
Wal-Mart reports earnings on Thursday, at which point we will learn the full extent of its pain. While the company stated that the emails were taken out of context, it seems quite plausible that Wal-Mart is having a rough time. First, Congress permitted the payroll tax reduction to lapse at the end of last year. Wage earners now see 6.2% of their first $113,700 in earnings deducted for Social Security, up from 4.2% last year. Second, gas prices have climbed by $0.44 in the last month to $3.75, nearly $0.20 higher than at this time last year. Both of these developments reduce discretionary income, with the biggest effects being felt by lower-income workers.

To add insult to injury, automatic spending cuts that Congress delayed last month are now set to go into effect in March. The so-called "sequester" will reduce government spending by $85 billion over the next seven months. Uncertainty about the effects of these cuts on the broader economy has already begun to impact consumer spending. The result of all these problems has been a drop in consumer confidence, which reached its lowest levels in more than a year last month. Lower consumer confidence in turn leads to lower consumer spending.

Next victim?
While Wal-Mart seems to have stumbled in early 2013, the poor economic conditions will probably show up in other retailers' results as well. Upscale retailers like Nordstrom (NYSE: JWN  ) are likely to escape with the least damage, since their average customers have much more discretionary income. Thus, Nordstrom saw a healthy 6.3% increase in same-store sales for its recently ended fourth quarter. Nevertheless, even upscale retailers are unlikely to maintain high-single-digit comps this year; they will just fare better than those lower on the food chain.

By contrast, stores like Wal-Mart that cater to low-income and middle-class consumers are most likely to suffer. Target (NYSE: TGT  ) eked out a meager 0.4% comparable-store sales increase for the fourth quarter, while Kohl's (NYSE: KSS  ) managed a 1.9% gain for the quarter only because it had lots of clearance inventory left in late December and January. Like Wal-Mart, Target and Kohl's generate a large proportion of revenue from customers who are really hurting now from the combination of higher taxes, higher gas prices, and a weak economy.

Watch out!
So what should investors do? My best advice is to avoid retail stocks until after they report earnings this month. Hopefully enough information will come out in the earnings releases and conference calls for investors to better understand the magnitude of the recent slowdown.

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