Can Retail Sustain Its Gains?

The retail sector as a whole is in an uptrend, pushing prices near 52-week highs, but spending and consumer confidence remain wary, making these gains somewhat fragile.

Most recently, home improvement giant Home Depot (HD) posted its first quarterly profit growth in more than three years, beating analyst expectations and painting a rosy picture. To make things even more appealing, the Atlanta-based company boasted an increase of 1.2% in same-store sales for the fourth quarter, driven primarily by growth in international markets. As for the future of the retailer, the expected expiration of the homebuyer tax credit is likely to have an impact on future earnings.

In the department store subsector, Macy’s (M) swung to a quarterly profit, beating analyst expectations. However, the profitable quarter generated by the second largest department store chain was driven via cost-cutting measures and not revenue growth. In fact, sales slipped by 1% for the quarter and 6% for the year, indicating that consumers are still reluctant to spend. A similar story was seen in the latest quarterly earnings reports from Sears Holdings (SHLD). The department store beat analyst expectations, but continued to witness a decline in sales, due in large part to dampened demand for home appliances, lawn and garden goods, and electronics.

The trend of beating analyst expectations continued on to Internet retailers as Amazon’s (AMZN) first-quarter profits rose 69%, with sales increasing nearly 40%. Amazon’s Kindle contributed significantly to the company’s sales growth and is likely to continue to do so.

Another major retail outfit to witness both revenue and earnings growth was Target (TGT). The company boasted earnings growth of 54% from a year ago, revenue growth of 3%, and same-store sales growth of 0.6%. As for the future of Target, the company’s outlook seems relatively promising, especially due to its recent announcement of being the first brick-and-mortar retailer to sell Amazon’s Kindle and the fact that consumers are still reluctant to spend, boosting the appeal of discount retailers.

This recent outperformance and uptrend in the sector can truly be seen in the performance of the following ETFs:
 

• Retail HOLDRs (RTH), which boasts Home Depot, Amazon, and Target in its top holdings. RTH is up 37% over last year and is flirting with its 52-week high. The ETF closed at $104.27 on Wednesday.
  
  
• Consumer Discretionary Select Sector SPDR (XLY), which also holds Home Depot, Amazon, and Target in its top holdings. XLY is up 57% over the last year, is trading close to its 52-week high, and closed at $34.79 on Wednesday.
  
  
• PowerShares Dynamic Retail (PMR), which holds retailers such as Nordstrom (JWN) and Gap (GPS), two companies that have performed relatively well. PMR is up 32% over the last year and closed at $18.94 on Wednesday.

Although most retailers are outperforming Wall Street’s expectations, the sector is highly dependent on consumer confidence and consumer spending. A recent study conducted by the Reuters/University of Michigan Consumer Sentiment Index for April illustrated that retail spending is weak and will likely remain weak. The study suggests that personal financial conditions for consumers are deteriorating rather than improving at a ratio of 2-to-1, a trend that will likely put a damper on the retail sector.

Other potential threats that face the sector are unstable labor and credit markets. As long as these potential threats are present, a sustainable uptrend in the retail sector remains questionable.

A good way to protect against these threats is through the implementation of an exit strategy that identifies price points at which an upward trend could come to an end.

According to the latest data at SmartStops.net, these price points are: RTH at $102.66; XLY at $34.43; PMR at $18.85. These price points change on a daily basis and are reflective of market volatility and both macro and micro economic factors. Updated data can be found at SmartStops.net.