While the economy continues to tread water, many investors have grown increasingly bearish on the retail sector, assuming that consumers will cut back on discretionary purchases in the difficult current environment. This seemed to be the case in the early summer when monthly retail sales declined in both May and June, but sales have been rising since then and recently posted a 1.2% gain for the month of October. This turnaround has led some to believe that a retail recovery is underway and could continue into the important holiday season.
Despite this uptick, which included a 0.2% gain for department stores and big chains, some analysts are not quite as bullish for the overall retail sector, citing sluggish demand in the lower end of the market. “The wealthy are back and willing to spend conspicuously, while the majority of households continue to stick to necessities and shop for deals,” Diane Swonk, chief economist at Mesirow Financial, wrote in a research note. Due to this disconnect, today’s earnings report from Wal-Mart (WMT), the largest retailer in the world, looks to be a critical indicator and could help to show how the lower end of the retail market has been faring during this modest summer recovery period [read ETF Plays For A Retail Recovery].
The Bentonville, Arkansas firm is projected to post earnings of 90 cents a share on revenues of $102.25 billion, a sharp increase in earnings from the year ago period but only a modest uptick in revenues; last year the company reported EPS of 84 cents on revenues of $99.41 billion. Of particular concern to investors should be the ability of the company to keep costs down despite surging commodity prices across the board but especially in key products such as cotton–which drives the vast majority of the company’s sales–and oil, which is a key driver of transportation costs and thus a critical component in the company’s just-in-time inventory system. “We note several themes that investor continue to focus on, including overall consumer spending trends, sourcing costs (cotton, in particular), freight and transportation costs, concerns on inventory levels and heightened promotional activity, and the overall outlook for the 2010 holiday season,” said Barclays Capital analyst Bob Drbul. “For each individual company will be the ability to pass the cost impact through to customers via price increases at retail so as to protect their margins from price increases at the vendors.”[see ETF Stock Exposure Tool]
With the earnings report from an industry bellwether on tap, the iShares Dow Jones U.S. Consumer Index Fund (IYC) should be active in Tuesday trading. The fund allocates its top holding to the retail giant and also gives a big weight to Home Depot, which is also reporting earnings later today. Thanks in part to this surge in retail optimism over the past quarter, IYC has shot higher, posting gains of 16.6% over the past 13 weeks. If Wal-Mart Home Depot post solid quarters and give quality guidance for the holiday season, investors could see a strong end to the year for IYC and the consumer sector as a whole [also see Which ETFs Would Benefit From Lower Oil Prices?].
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Disclosure: No positions at time of writing.