Retailers Reflect a Changing Economy

What is good for individuals and for the economy in general is not necessarily good for retailers. For example, it is a good thing when people stop using their home equity as an ATM machine. And it’s a good thing when they increase savings and pay down debt. But these improvements in consumer balance sheets can be a drain on the balance sheets of retailers.

Like it or not, consumer spending accounts for more than two-thirds of U.S. economic activity. And that makes retail earnings an important barometer for the economy. So what are retail earnings telling us… and how can you profit?

The biggest lesson we can take from retail earnings is that our economy is not only slowing (that is obvious), it is also changing. We are moving from an economy based on “what I want” to an economy based on “what I need.”

That is why retailers that sell necessities (like Wal-Mart) will continue to show strength, whereas retailers that focus on luxuries and rely on discretionary spending (think Coach, Tiffany, and Saks) will show weakness.

Two companies that exemplify the shift in consumer buying trends are deep-discount retailers Family Dollar (FDO) and Dollar Tree (DLTR). Market research firm Nielsen recently reported that high-income shoppers (from households making more than $100,000 a year) increased their spending at dollar stores by 18 percent in the second half of 2008 as compared to 2007. Not surprisingly, both of these companies are near their all-time highs, while the rest of the market founders.

And speaking of relative strength, one of my favorite retailers in this market is AutoZone (AZO). When the economy tumbles and money is tight, people are more inclined to fix their old car, rather than buy a new one. Need evidence? AZO is also within spitting distance of its all-time high. Few companies have shown this level of resilience, and in a down market that is what you should be looking for.

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