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Here’s How the Income Gap Can Impact Retailer Stocks

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October 27, 2015
Income gap's effect on retail sector

Income inequality—the gap between rich and poor—has grown wider in recent decades. Does this gully have ramifications for retailer stocks, especially a retail-heavy lineup of Q3 earnings that’s right around the corner?

Investors and traders might contemplate this longer-running trend against shorter-term economic signals as they monitor upcoming retailers’ earnings for signs of consumer health. This includes the job market trends that drove the unemployment rate to a seven-year low of 5.1% in August and September.

But what about the big picture and its meaning for stocks?

High End versus Low End

Data from U.S. tax returns reveals that the top 1% of households received 8.9% of total pre-tax income in 1976. By 2012, the top 1%’s share had more than doubled to 22.46%, according to research by the Institute for Policy Studies.

"People talk about income inequality. The wealthy are getting wealthier. Or, there are those having trouble just finding work and they’re watching their pennies or their wages aren't going up as much as other costs,” says Efraim Levy, equity analyst at S&P Capital IQ.

The gap translates to the stock market.

"We are seeing a continuation of a bifurcated market in the retailing sector," says Levy.

He says we’ve seen activity in stocks at the high end, “like Nordstrom [JWN] and Tiffany [TIF], and at the low end, like Dollar Tree [DLTR],” he says. “People are either flush with cash and wealth, or they have to watch every penny. The middle market, like Sears [SHLD] and J.C. Penney [JCP], is being squeezed.”

JJ Kinahan, chief market strategist at TD Ameritrade, agrees: "We are at a real crux in the retail space. Everyone is fighting for market share."

Now, analysts do point to cheaper gasoline prices as potentially opening up spending elsewhere. The national average for gasoline has dropped 83.9 cents from a year ago to $2.20 per gallon, according to gasoline price website GasBuddy.com. "This especially makes a difference on lower-end income. If you save $10 on a fill-up and you are making $25,000 a year, that makes a difference, versus if you save $10 and you are making $250,000 a year," says Levy.

Q3 Outlook

Even with this push and pull, the retailing sector is one of the brighter spots in the stock market universe of late. While the S&P 500 (SPX) is expected to show an overall decline of 4.44% in Q3 earnings per share (EPS), the consumer discretionary sector is expected to show the best growth of the SPX’s 10 sectors with a 13.38% projected EPS rise, according to S&P Capital IQ. Auto sector EPS is expected to be up 43.7%; consumer durable and apparel EPS is expected up 3.1%; consumer services up 12.6%; media up 1.8%; and retailing up 14%, the research firm says.

Looking ahead, S&P Capital IQ pegs Q4 EPS growth for the retailing sector at 14.1%; for fiscal year 2015, EPS growth is estimated at 11.84%; and for fiscal year 2016, at 17.10%, says S&P Capital IQ.

Other Gaps, Too

There’s another shift in retail that could color Q3 results and more—the widening performance between brick-and-mortar stores versus the online space. According to a recent survey from the National Retail Federation, 46% of holiday shopping will be done online, up from 44% last year.

Kinahan pointed to the division between Amazon.com (AMZN) earnings, which revealed a positive earnings trend in Q3, versus warnings from Wal-Mart (WMT). "Basically, [the latter] is reorganizing their business in a way they hope will help make them profitable," Kinahan says.

WMT, still the world's largest retailer, surprised investors earlier this month with a nasty earnings warning for next year, predicting EPS could decline between 6% and 12%. The warning was in stark comparison to AMZN’s $79 million in the black in Q3, its second straight profitable quarter. Sales in its quarter were up 23% from the year-ago comparison.

The health of the economy, the labor market, and consumer confidence are all critical factors that drive consumer spending. "If we are seeing the economy improve, that also means people are presumably moving up the economic ladder, which could benefit stores including Target [TGT], Costco [COST], and high-end stores like Tiffany, but could hurt stores like Wal-Mart," says Kinahan.

The real test for retailers comes in the next two months, says Kinahan. "Shares of high-end stores like Tiffany and Coach [COH] are up since the end of September, but the holiday season will be the key," he says. "What are the CEOs saying about the state of the economy going forward? Are they going to be in the camp with Wal-Mart, warning about a reorganization? Or, will they be in the Amazon camp, where everything is seemingly firing on all cylinders?"

Stock screener and retailers

FIGURE 1: SCREEN YOUR RETAILERS.

Drill down on the stocks that may fit your investing criteria. Log in to tdameritrade.com, then go to Research & Ideas > Stocks > Select Sector, Industry & Sub-Industry. This example shows the selections Consumer Discretionary > Specialty Retail > Specialty Stores. Not a recommendation. For illustrative purposes only. Past performance does not guarantee future results.

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