Are Retailers Signaling Recovery's End?

May 28, 2014

Should Walmart blame the weather or the economy for its drop in profit?

Retail vs Dow

Walmart, widely considered a bellwether stock for the entire retail industry, disappointed investors last week by reporting a 3.5 percent drop in quarterly profits compared with last year. The company is the biggest holding in the Market Vectors Retail ETF (RTH | B-55), with an allocation of more than 11 percent.

Retailers' profitability is driven by consumer sentiment, which itself is closely linked to employment. Because employment is a lagging indicator of economic growth, the retail industry tends to underperform other industries in the first half of the business cycle and outperform in the latter part.

After a recession consumers, remain cautious in their spending, keeping a tight lid on retail profits. As unemployment slowly recedes, consumer confidence and spending return, lifting the industry's fortunes once again. In the late stages of the business cycle, retailers also regain pricing power, which they use to further boost margins and profits.

The current drop in Walmart's earnings was blamed on the weather. Time will show if this was really a temporary hiccup or a sign of trouble ahead. But for now, the question of whether the second half of the recovery is coming to an end is in focus.

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