Chances are, if you are like most US citizens, you find yourself shopping quite a bit less.  The retail sales data for July released this morning showed an unexpected decline.  The sharp drop is in contrast to data seen from June in which buyers helped businesses work through inventory levels and sparked optimism in the retail sector.

Demand for goods aside from cars took a large tumble last month, with big declines for housing-related retailers and electronic stores ~Wall Street Journal

The news should not be extremely surprising given the weakness we continue to see in employment numbers.  ZachStocks has continued to avoid retail names as weak employment will continue to lead to weak spending and should eventually cause a significant drop in many retail stock prices.  Even though you might have heard that employment numbers are improving, the fact remains that employment numbers continue to get worse – they’re just getting worse at a slower rate than before.

Investment Commentary You Can’t Afford to Miss

Sign up for the ZachStocks Newsletter: Email:

Concurrent with the retail sales data, the Labor Department reported that the number of new unemployment claims for the past week came in at 558,000.  Analysts had been expecting this number to drop a bit to 545,000 so the data is obviously a disappointment.  But a silver lining appears to be getting more attention as the “continuing claims” or number of workers continuing to receive unemployment benefits, actually dropped slightly.

We have talked several times in the past few months about how continuing claims doesn’t necessarily accurately represent the employment picture.  If workers are unable to secure a new position over a period of several months, eventually benefits run out and they are no longer eligible to receive benefits (and thus drop off the unemployed tables).  At the same time, if a laid off middle manager takes a job delivering pizzas to feed his family, he is no longer considered unemployed even though his income is only a fraction of what he used to make in his former job.

As I write just before the market close Thursday, equity markets appear to be willing to overlook the weakness.  Of particular note is the fact that Wal-Mart increased its earnings guidance for the full year.  However, the good news out of Wal-Mart is not due to an increase in sales – or even a bump in the broader economy, but due primarily to cost cutting initiatives.  In actuality, same store sales took a hit in the last quarter which should raise eyebrows of any investors counting on an increase in spending to play into an economic recovery.

Ironically, the cash-for-clunkers program could actually end up hurting the majority of retail companies as consumers allocate dollars to vehicle purchases which might otherwise have gone to other purchases such as eating out, buying household goods, apparel purchases and more.  Another area that is competing for consumer dollars is the mortgage category as rising rates have most recently begun hitting adjustable rate mortgages and requiring larger monthly payments.

Since consumer spending continues to make up a large majority of our GDP (roughly 68% to 70%), it has a broad, and often spiraling effect on our broad economy.  Over the past 18 months, weakness in employment has led to lower spending.  This leads to lower profits for businesses who have to cut costs.  As companies such as Wal-Mart cut costs (read: lay off employees), this results in further unemployment.  On top of that, laid off employees now have little ability to pay for excessive housing which has led to a devastating drop in homeowner wealth.

Investors have been counting on this spiral hitting a bottom over the last few months and beginning to recover.  But today’s data appears to point at least to the fact that the recovery is not in place – and more likely to the fact that we will continue to spiral down.  Only this time the spiral looks more like a “slinky” (circles dropping only slightly each revolution) instead of a corkscrew (more vertical distance covered).

So what are we supposed to do?  My recommendation is to watch retail shares carefully and pick out a few targets.  Similar to my recent comments on Blue Nile, I think it makes sense to follow prices with a trailing stop.  So each time your favorite retail short candidate makes a new high, increase the price at which you are willing to short.  At some point when the new trend actually begins and retail stocks begin to drop, you will be ready with a handful of vulnerable stocks – and can make serious profits as these stocks plummet.  But until the trend actually begins, your capital will be safely on the sidelines.

The market continues to be strong, but the danger is real.  Continue to look behind the headlines in order to accurately gague the risk in your investments.  Remember, successful investing is 90% damage control.

Enjoy this article? Sign up for the ZachStocks Newsletter,
Your source for Sound Market Commentary, Growth Stock Analysis and Successful Investment Strategies