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Retail Stocks Show Declines in May, Though The Tide May Turn

Retail shares didn’t fare well in May, with stocks showing declines in the month over tariff concerns and earnings reports that pointed to a slow start to the second quarter. But the tide could turn in June if the reasons for Tuesday’s market gains continue over the near term.

Tuesday’s trading sessions began with a pop in the markets after investors started believing that there was a greater chance that the Federal Reserve might lower interest rates, and in fact the bond markets have factored in at least one, if not two, cuts by year-end. That fueled the day’s trading, which led to substantial gains in all three key U.S. indices.

The Dow Jones Industrial Average ended the day’s trading session up 512.40 points to 25,332.18, the S&P 500 up 58.82 points to 2,803.27 and the Nasdaq Composite was up 194.10 points to 7,527.12.

Retail shares declined in May as investors made trading decisions based on news of the trade wars and fears of tariff hikes. Other reasons were more sector-related. First-quarter earnings results for many retailers, as well as quarterly reports from several apparel, accessories and footwear firms, left much to be desired. And many also indicated a slower start to the second quarter. That in turn has led several companies to revise their guidance for the upcoming quarters and fiscal year.

The impact for investors was that many punished companies that met Wall Street’s estimates for the quarter so long as revised projections for the next quarter and beyond was lower than they had expected. And as analysts took in the possibility of a hike in tariff rates, they also pondered what the impact would be for the sector, whether from a consumer spending standpoint or what else companies can do to mitigate what’s expected to be lower profits ahead. That led some to lower price targets for the stock of many retail and apparel firms. Adding to the concerns are general questions over how much growth is really viable given the possibility of a recession ahead, and even speculation on the need for continued store closures.

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Still, retail and apparel companies managed to see gains Tuesday as the overall markets rose.

The top retail gainers were shares of J.C. Penney Co. Inc., up 17.03 percent to $1.03; Ascena Retail Group, up 12.2 percent to $1.09; Chico’s FAS Inc., up 6.6 percent to $3.73; Urban Outfitters Inc., up 4 percent to $23.74; Qurate Retail Group, up 3.9 percent to $12.95 and Target Corp., up 3.5 percent to $85.85.

Among the fashion firms, the top performers were shares of L Brands Inc., up 5.5 percent to $24.03; G-III Apparel Group, up 4.9 percent to $27.05; Nike Inc., up 4.7 percent to $81.62; Ralph Lauren Corp. was up 4.4 percent to $111.99; Tapestry Inc., up 4.3 percent to $30.05; Levi Strauss & Co., up 4.1 percent to $21.48 and Capri Holdings, also up 4.1 percent to $35.40.

The question now is: how much longer can the optimism continue?

The stock rebound was fueled by hope of a near-term Fed Rate cut following St. Louis Fed President James Bullard’s remarks in a presentation Monday to the Union League Club of Chicago. Bullard said the U.S. economy is expected to grow more slowly going forward, adding that there’s some risk the slowdown could be sharper than expected because of the uncertainty with respect to the ongoing global trade regime.

What investors were focused on was his comment that “both inflation and inflation expectations remain below target, and signals from the Treasury yield curve seem to suggest that the current policy rate setting is inappropriately high.” Bullard also said a “downward policy rate adjustment may be warranted soon to help re-center inflation” and noted that the move could also “provide some insurance in case of a sharper-than-expected slowdown.”

Federal Reserve Chairman Jerome Powell was also in Chicago Tuesday morning speaking at the “Conference on Monetary Strategy, Tools and Communications Practices.” In his presentation, Powell said while the Fed doesn’t know how or when the trade issues will be resolve, it is “closely monitoring the implications of these developments for the U.S. economic outlook and, as always, we will act as appropriate to sustain the expansion,” while maintaining a strong labor market and in keeping with its inflation target of 2 percent.

Also, Fed Vice Chairman Richard Clarida said in a CNBC interview from the Chicago conference, “We will put in policies that need to be in place to keep the economy, which is in a very good place right now, and it’s our job to keep it there.”

But even if the economy is good right now, as Clarida noted, there could still be storm clouds ahead.

In fact, the second half could be one long roller coaster ride as investors continue to grapple with what potentially weaker-than-expected earnings data, the potential impact from trade wars and continued fears of a recession. Retailers and apparel companies will start reporting their next quarter’s results in August, but companies from other sectors will begin a month before that.

Mike Wilson, Morgan Stanley’s chief investment officer, said in his weekly “Thoughts on the Market” podcast on Monday, that economic and earnings data have “come in weaker than most were expecting,” noting too that the data was for periods “unaffected” by the recent rise in trading tensions. He concluded from that data point, “Trade is not the primary risk for U.S. companies.”

The chief investment officer explained that the U.S. suffers from three excesses that resulted from the tax cuts and tariffs that were implemented in 2018. The first was excessive capital spending by most companies, particularly after several repatriated overseas cash back home. The second involved the building of excess inventory over the past 12 months as companies doubled orders to offset tightness in the supply chain. The third center on the strong labor market, which may be good for workers, but not for companies that have to pay higher wages, Wilson noted.

Wilson said although there are many bulls citing to a strong labor market and consumer confidence as reasons why an index such as the S&P 500 could go higher, the two factors are lagging indicators, and there’s risk of a “more protracted” slowdown ahead.

A recession would lead to lower capital spending, inventory burn and a weaker employment market as “companies decide to protect margins and cash flow.” All of that, Wilson said, would “weigh on economic growth.”

According to the chief investment officer, the biggest risk and one to keep an eye on is what companies do on the employment front, which could determine whether the U.S. can avoid a recession. Companies may start to adopt a more conservative stance in rhetoric by later this summer or early fall, and when they do, the “news flow could be quite negative,” he said, adding that the “market [later on] may seem more unsettled than it is today.”