Looting at Macy’s, Target and other retailers is not the only reason to avoid retail stocks

The retail stock rally looks crazy overdone.

Looters ransacking retail stores such as Target, Macy’s and Nordstrom (as seen below in one of many Twitter posts) amidst the George Floyd protests is far from retail’s biggest problem at the moment. No, that’s actually one of many major red flags. Take the large sums of money it will take to repair the destroyed stores (and the time needed to repair consumer confidence around the stores) and combine it with minimal business happening inside the stores anyway due to the aftershock of COVID-19, and you have a retail space in for brutal second and third quarters.

“The whole thing going on in America right now, we have moved from lockdowns to looting. What is going on in retail, it’s extremely difficult out there,” said former long-time Chairman and CEO of the American Apparel & Footwear Association Rick Helfenbein on Yahoo Finance’s The First Trade.

Veterans of the retail space like Helfenbein point to a host of issues in retail outside of the rampant looting at high-profile retailers. For one, renewed trade tensions between the U.S. and China could mean higher costs for hurting retailers that rely on the emerging market to source a majority of their goods.

Secondarily, the consumer spending backdrop continues to be weak with more than 40 million people having filed for unemployment in recent months because of the pandemic. The rising unemployment rate in the country has sent the U.S. savings rate skyrocketing to an astronomical 33% as consumers save their new stimulus checks.

And lastly, closed stores amidst mandatory COVID-19 state lockdowns has meant a serious pile-up in retail inventories. That will have to be aggressively worked down at margin busting prices ahead of the fall. Not helping matters here are noteworthy retail bankruptcies and store closures by J.C. Penney, Tuesday Morning, Pier One and others that will pressure product pricing and margins.

An empty parking is visible outside the J.Crew store, closed due to the COVID-19 virus outbreak, in Tilton, New Hampshire, Monday, May 4, 2020. The owner of J.Crew is filing for bankruptcy protection, the first major retailer to do so since the pandemic forced the closing of most stores in the United States. More retail bankruptcies are expected in coming weeks with the doors of thousands of stores still locked. (AP Photo/Charles Krupa)

“We’re fully anticipating it will be a promotional environment, given the inventory that’s out there,” cautioned Kohl’s CEO Michelle Gass on the company’s first quarter earnings call in late May. “And so we’re planning for that to create margin pressure as we look ahead.”

As a result of the seemingly dire situation, investors trying to pick the bottom in the retail space may be in for another rude awakening soon in the form of a fresh round of earnings warnings. And boy, have the bottom pickers come out in force of late in retail.

The SPDR S&P Retail ETF is up 18% in the past month, while the Consumer Discretionary Select SPDR has tacked on 13%. Macy’s — despite a hefty new debt issuance (on top of weak balance sheet to begin with) and horrendous first quarter due to COVID-19 —shares have rocketed 29% inside of a month. Nike is up 18%. Struggling Dillard’s is up 8%.

The list of retail advancers in four weeks is almost endless.

“In the short-term, I would probably sit on the sidelines [in retail],” said Tematica Research chief investment officer Chris Versace on The First Trade, adding he is more optimistic on winning retailers such as Walmart and Costco than secularly challenged names in The Buckle.

Brian Sozzi is an editor-at-large and co-anchor of The First Trade at Yahoo Finance. Follow Sozzi on Twitter @BrianSozzi and on LinkedIn.

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