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Consumers Power Retail Stocks to New Highs

There has been a lot of fear in 2013 about how Washington will affect consumer sentiment, what with the fiscal cliff and the payroll tax cuts and the sequester. But so far, those fears seem to be much ado about nothing.

Take last week’s retail sales number for February. The 1.1% surge was the biggest gain in five months and blew away expectations of a 0.5% increase. As Bill McBride of Calculated Risk pointed out, “Excluding gasoline, retail sales are up 23.5% from the bottom, and now 11.0% above the pre-recession peak (not inflation adjusted).”

This is just the latest data point in a longer narrative of improving consumer behavior — ultimately resulting in new highs for consumer stocks.

The SPDR S&P Retail ETF (NYSE:XRT) set a new 52-week high last week and continues its outperformance with a roughly 13% gain so far in 2013.

Sure, some of that is due to a huge pop in component Hot Topic (NASDAQ:HOTT) thanks to Sycamore Partners’ buyout plan. But other constituent stocks from outdoors retailer Cabela’s (NYSE:CAB), grocer Safeway (NYSE:SWY), e-commerce photo shop Shutterfly (NASDAQ:SFLY) and discounter Big Lots (NYSE:BIG) have all hit new highs in the last week or so and are up between 25% and 50% year-to-date.

Strength in retail stocks obviously is a positive sign for the economy and the broader stock market. The million-dollar question is whether consumer stocks can keep this up.

That’s a complex question, but here are some data points to consider:

Jobs: The 7.7% unemployment rate we printed for February was the lowest in four years. And growing job openings as well as declining layoffs means the trend could continue. Obviously without jobs, spending is impossible.

Inventories: Looking forward, the Commerce Department reported this week that business inventories were up from December to January in anticipation of strong sales for the rest of the first quarter. You don’t order more goods if you don’t expect to move them, and businesses are stocking up in anticipation of continued sales.

GDP Forecasts Improving: Some experts like those at Deutsche Bank and BofA/Merill Lynch believe we are in a virtuous cycle here where consumers help businesses that help employee hiring that helps consumers again. This has led to a few upgrades in GDP outlooks, hinting the gains will stick and momentum will continue.

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Massive deleveraging:
Paying down debt over the last few years has not just made households more stable, but freed up cash that was once spent on debt service. Check out this chart from Federal Reserve Data covering the last 20 years, showing what percentage of disposable income has been dedicated to debt service. Hints that consumers are taking on a bit more debt and spending more now that they have repaired household balance sheets are already starting to emerge.

Wealth Effect: The major indices keep hitting new records. The housing market is strong again, as foreclosures are down and home values are at five-year highs. These things make people feel rich — and if trends continue, it will continue to feed confidence across 2013. This is reflected in the the monthly Spending Monitor from Discover Financial (NYSE:DFS), which showed an increase in confidence, with all age groups seeing an improved outlook on the economy and at the very least keeping spending trends steady. Confidence is key to continued spending, and the “wealth effect” of higher markets and home values is vital, too.

This is not to say there aren’t risks. In conflict with recent data, the preliminary University of Michigan consumer confidence reading for March plummeted to its lowest point in a year. Is this noise or a trend? Investors will have to watch closely.

Furthermore, don’t forget that higher gas prices account for a decent chunk of the retail sales increase, and that as economic activity picks up, the demand for energy will push fuel prices even higher. CPI data just showed consumer prices rising at 0.7% in February, the highest pace since 2009, and any significant uptick in inflation could eat into consumer behavior.

Still, the outperformance of retail and consumer stocks is noteworthy. If you believe the economy is getting its groove back, then discretionary plays are the place to be.

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Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here

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