Wednesday, January 22, 2014

Broader Implications Of A Weakening Retail Sector

It has been a while since I have seen so much written about the weakness impacting a particular segment of the market. In the recent case much is being written about the retail/discretionary sector of the market and its recent underperformance. This comes on the heals of the sector generating strong returns since the bottom of the financial crises in 2009.
  • Amazing run for consumer discretionary stocks (Charts etc.)
  • Q4 retail sales frozen by polar vortex (AlphaNow)
  • Caution: XRT underperformance puts retailers in focus (See It Market)
  • The first domino to fall: Retail-CRE (oftwominds)
The first chart below details the return of several discretionary segments of the market relative to the S&P 500 Index since 2006. The contraction in consumer spending that occurred through 2008-2009 is evident on the chart as well as the recovery from 2009 until today. In the second chart below the two retail/discretionary sectors are displayed, but over a shorter two month time period. The weakness within the discretionary/retail sector is clearly evident.

From The Blog of HORAN Capital Advisors

From The Blog of HORAN Capital Advisors

Thomson Reuters recently noted the weakness within the sector and the subsequent reduced earnings guidance. A number of retail stocks have exhibit market weakness: L Brands (LB), Abercrombie & Fitch (ANF), Best Buy (BBY) and Family Dollar Stores (FDO) to name just a few.

From The Blog of HORAN Capital Advisors

One concern associated with the weak performance of this sector is the potentially broader implications to the health of the overall consumer. The consumer (consumption) accounts for about 70% of of the economy or GDP. If the consumer is pulling back does this portend further weakness in the overall economy and hence the equity market? As the below chart displays, there is a high correlation with the retail sector price movement and the overall S&P 500 Index.

From The Blog of HORAN Capital Advisors
Source: See It Market

On the other hand, if the pervasive market sentiment is the consumer has rolled over, vis-à-vis the market and the economy, the efficient market hypothesis would imply this type of news is factored into current stock prices. We have written a number of posts on our blog regarding some of the weaknesses of the efficient market hypothesis as well as modern portfolio theory, but suffice it to say that significant stock price moves, up or down, suggests the markets are not fully efficient.

Concluding, the retail sector performance is a potential canary in the coal mine as it relates to the health of the consumer and the economy. The mixed financial and economic data we have cited in the recent past continues to be reported. As an example, Norfolk Southern (NSC) reported stronger earnings than expected today and the stock jump 4.7%. NSC is transporting materials and products for consumption. On the other hand, CSX (CSX) reported earnings last week and provided cautious guidance. CSX stock fell over 6% on the report. This mixed data picture is confounding investors at the moment. At HORAN, we do believe the consumer may have gotten ahead of itself; however, as one of the links in the introduction to this article notes, the wide spread cold weather could have had a negative impact on a number of brick and mortar retailers. The weaknesses in some consumer stocks is certainly worth paying attention to; however, the market/investor already knows a lot about this weakness and a majority of this bad news may be factored into stock prices. The question for investors is to evaluate specific company valuations relative to their anticipated growth expectations. The stocks that will fall the hardest on a missed earnings report are those that are trading at premium valuations.

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