By Amey Stone The outlook for the holiday shopping period is quickly going from good to great. When the National Retail Federation put out a forecast on Oct. 21 for 5.7% growth this year over last year, it struck a lot of analysts as overly optimistic. But with many companies reporting strong same-store sales for September and knock-your-socks-off economic numbers being reported near-daily, that kind of heady growth is starting to seem well within reach.
The recovering economy is certainly doing its part to spur sales. On Oct. 28, the Conference Board's Consumer Confidence index came in at 81.1 for October, up from 77 in September. The housing market is still breaking records: Sales of existing single-family homes rose 3.4% in September, to a record 1.89 million. Then, Oct. 30 brought the fabulous gross domestic product report, which showed the economy growing at a blistering 7.2% in the third quarter. That's up from 3.3% in the second quarter and the strongest growth since 1984.
Even the stalled labor market may be starting to perk up. First-time claims for unemployment benefits came in below the important 400,000 threshold for the fourth week in a row on Oct. 30. And Oct. 31 capped off the week with personal income growth at 0.3%, vs. an expected at 0.2. Reasons for caution -- and a few remain -- are rapidly falling by the wayside.
CAVEAT EMPTOR. For investors in the retail sector, this is good news -- provided you pick the right companies. The market has moved ahead of strong economic news throughout this recovery, and equity returns have already been quite robust. Names like Gap (GPS), Men's Wearhouse (MW), and Lowe's (LOW) have nearly doubled in the past year. Standard & Poor's consumer discretionary sector is up 31% this year -- 10% of that in October alone.
"Most any retailer worth its salt is near its 52-week high," says Eric Jemetz, a senior equity analyst at New Amsterdam Partners. S&P's consumer discretionary sector is starting to look pricey, with a forward price-earnings ratio of 20 -- higher than the S&P 500's p-e of 18.
Another reason to choose your picks carefully: Some early signs indicate that consumers are entering a phase where they care more about cutting back on debt than upgrading their lawn mower, dishwasher, or car, says Richard Hastings, retail-sector analyst for retail advisory firm Bernard Sands in New York. According to an Oct. 31 government report, consumer spending actually slipped 0.3% in September, mostly due to a 5.1% drop in purchases of durable goods -- big-ticket items that last five years or longer. Sales of general merchandise like food and clothes climbed 0.3% in the month.
HIGH, LOW, IN BETWEEN. On the upside, "consumers are spending well on very discretionary, seasonal items, like clothing, fashion, footwear, cosmetics, and jewelry," Hastings says. But without as many big-ticket items, total sales may not be as robust as consumers' upbeat mood might indicate, especially looking ahead into 2004.
For now, "they've gone from an obsession about their house to an interest in what they look like personally," Hastings says. Best-selling holiday items are likely to be apparel, especially suits, as workplaces grow more formal. All things digital (TVs, cameras, phones) remain popular. Gift cards are also expected to be hot sellers this year, says Hastings. Many analysts see e-tailers doing particularly well (see BW Online, 11/3/03, "Web Synergies Pay Off").
Analysts further note that consumers seem to be embracing a few high-end brands they perceive as being worth the extra money, while at the same time shopping at discount stores that they believe offer the best values. This trend is explored in Michael Silverstein's Trading Up: The New American Luxury (see BW Online, 11/3/03, "Shopping for Gratification"). "We're seeing an increasing polarization of the consumer," says Dan Trott, an analyst at Jefferies & Co. "Retailers with a strong value franchise will do well. On the other hand, more upscale merchants will probably also do very well," he says.
STOCKING STUFFERS. Jemetz likes department stores, especially Nordstom's (JWN). Many other names, including Federated (FD), have revamped their stores and are performing surprisingly well lately (see BW Online, 11/3/03, "Federated's Focus: Fashionable Females"). "Last year, people were weary and didn't go to department stores as much," Jemetz says, due to factors like the weak economy and geopolitical worries. This year he thinks they'll be back.
Jemetz also expects luxury retailers like Tiffany (TIF) and Coach (COH) to do well. But he thinks discounters like Wal-Mart (WMT) and Target (TGT) may not grab as large a share of holiday shopping dollars this year as they did last. "Relatively speaking, in good times people tend to be more confident and spend less at discounters," he says (see BW Online, 11/3/03, "Hoping for a Feliz Navidad at Kmart").
Maira Thompson, senior portfolio manager at Clark Capital Management Group in Philadelphia, continues to like Wal-Mart but says she has been disappointed by Target. She is lately adding Dollar Tree Stores (DLTR), which is a great place to buy stocking stuffers, she says, and also has strong company fundamentals.
HIRING SOON? As strong as the holiday shopping period looks, investors must also keep an eye on 2004. Much of the third-quarter economic growth was fueled by tax rebates and government spending. Some of this stimulus will wear off next year, and if hiring hasn't kicked in to generate a self-sustaining recovery, consumer spending could stall.
"What happens to the retail sector going forward is not just a function of Christmas," says Jemetz. "People are going to start obsessing about the second half of 2004. For strength to continue, we'll want to see job growth."
The good news is that the growing strength of the underlying economy should soon result in more hiring. "If employment recovers as expected, we ought to continue to grow consumer spending at an above-trend pace," says John Lonski, chief economist at Moody's Investors Service. That should means investors in retail stocks can look forward to a strong holiday shopping period -- as well as cash registers clanging well into next year. With reporting from Amy Tsao in New York
Stone is a senior writer for BusinessWeek Online