Wall St. analysts believe the retail sector can withstand US-China trade war issues

From Teresa Rivas: Worries about increased tariffs were pushing stocks down across the board on Monday, and retail was no exception, with renewed investor fears about how this trade-sensitive sector would fare if the next round of duties is imposed after previous delays.

The back story. The SPDR S&P Retail ETF (XRT) hasn’t quite kept pace with the market in 2019, but it has risen nearly 11% and held fairly steady this year. However, as we saw in 2018, the retail revival has proven fragile, and easily dampened by various worries, from economic growth to trade, even as consumer confidence remains near record highs amid low unemployment.

The concerns about trade are understandable though: Many retailers’ supply chains include China, while still others are counting on the country’s emerging middle class to provide the next leg up in sales growth. Certainly, some companies would simply raise prices to pass along costs to consumers, but that option may not be available to retailers struggling with weaker demand, and even well positioned players could take a hit if consumers–who remain cost conscious–suffer from sticker shock.

What’s new. Given this backdrop, it’s not surprising that retail (and other) stocks were falling on tweets from the White House, saying it will go ahead with the next round of tariffs that had been put on hold previously amid negotiations–especially as recent reports had hinted that U.S.-China talks were progressing.

The Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite all opened down more than 1% before recovering some of those losses by late Monday morning. The XRT was down 0.9% to $45.41 in Monday morning trading.

Analysts are already handicapping this latest development, and while it might not be as bad as some investors fear, it’s not great either.

Credit Suisse’s Seth Sigman notes that, given that the trade war has been dragging on for some time, a number of retailers have already made moves to diversify their supply chains. Yet the rush to get goods into the U.S. ahead of deadlines has led to port delays and product shortages. And he warns that this is “not a great scenario for the consumer and many of the cyclical stocks that have moved this year…While many consumer indicators have been positive, most importantly wage growth, higher retail prices broadly would not be welcomed,” and renewed tariff fears won’t help stocks rally.

It’s not just retail of course. “The news comes at a time when the U.S. equity market has already become vulnerable to bad news again (and more at risk for a correction in the months ahead) due to excess euphoria among institutional investors and overvaluation,” writes RBC Capital Markets’ Lori Calvasina. She cautions that there are “eerie similarities between current conditions in the stock market” and those before the S&P 500’s peaks in September and January. Yet while misery loves company, that’s cold comfort to retail investors today.

Looking ahead. The platitude that “everything will work out” may not always be accurate, but it’s popular for a reason, as optimism can be a balm for uncertainty. The market’s double-digit year-to-date rally appears to have drawn some strength from that belief; the idea that it’s only a matter of time before a tariff agreement is reached fueled hopes of ongoing economic growth and allayed worries about the sustainability of the long bull market. So it’s not surprising that a threat to the smooth and imminent resolution of the trade war is causing the market to fall. That’s not to say that a deal is out of the question–there’s still incentives on both sides to come to an agreement–but it shows how much the market already assumed it was a done deal, and what risks remain from a delay.

Not all retail is created equal, however, and UBS’s Michael Lasser predicts that in a 25% tariff scenario, the home improvement, food retailers, and auto-parts companies would be most insulated from the move. While as much as 40% of auto-parts retailers’ products are traceable to China, “the largely inelastic nature of the demand” should allow them to pass along costs to consumers. Among some of most exposed are Dollar Tree (DLTR), although the company has already accounted for the next tariff round in its guidance, and home furnishings, including Bed Bath & Beyond (BBBY), RH (RH), andWilliams-Sonoma (WSM), although the latter has also factored tariffs in its forecast.

To end on a hopeful note, Credit Suisse’s Michael Binetti writes that retailers that sell products like handbags, which have already been hit with tariffs, saw “minimal effects”; he cites Tapestry (TPR) and Capri Holdings (CPRI), formerly Coach and Michael Kors, respectively. That could be a comfort to other retailers that would be subject to the next round of tariffs. Binetti suggests that “the cost of goods for most companies in our softlines Retail coverage likely wouldn’t see much impact.”

The SPDR S&P Retail ETF (XRT) was trading at $45.40 per share on Monday afternoon, down $0.44 (-0.96%). Year-to-date, XRT has gained 0.77%, versus a 9.60% rise in the benchmark S&P 500 index during the same period.

XRT currently has an ETF Daily News SMART Grade of A (Strong Buy), and is ranked #4 of 41 ETFs in the Consumer-Focused ETFs category.

This article is brought to you courtesy of Barron’s.