3 crucial reasons why investors should be wary of retail shares

I have become increasingly concerned over the outlook for the Australian economy in recent times. At the risk of sounding like the prophet of doom, which is not my intention, my private opinion is that many Australian households are perilously close to insolvent.

Household debt is very high and household savings are very low. I don’t know a single person who could survive more than 1 month of unemployment without selling assets or getting financial aid of some sort. None of this is particularly conducive to discretionary spending, which so many businesses depend on.

Retail shares are already showing some signs of stress, with total retail spending falling in March. Shares in the sector have been hit hard in the last 3 months:

Coca-Cola Amatil Ltd (ASX: CCL) – down 7%

Reject Shop Ltd (ASX: TRS) – down 60%

Harvey Norman Holdings Limited (ASX: HVN) – down 25%

JB Hi-Fi Limited (ASX: JBH) – down 18%

RCG Corporation Ltd (ASX: RCG) – down 52%

Myer Holdings Ltd (ASX: MYR) – down 28%

OrotonGroup Limited (ASX: ORL) – down 18%

In most cases, the above share price falls have followed earnings downgrades. The worrying thing is that if unemployment increases and/or discretionary spending decreases, these falls are really just the beginning – Australia hasn’t seen a serious case of consumer poorness in quite some time. I’m not predicting one, but with the weakness in this area of the economy recently I think it is a very good time for investors to take stock of what they hold, and consider making some changes if their companies would earn a lot less when customers stop spending.

I estimate that about 16% of my personal portfolio will be directly impacted if consumers stop spending. That’s low enough that I recently considered adding some retailers like RCG Corporation, Reject Shop, or Greencross Limited (ASX: GXL). After all, I have no idea if the Australian economy really will deteriorate. Still, if something like 40%-50% (or more) of my investments were directly exposed to consumer spending, I would be concerned.

Other businesses that are potentially vulnerable to a downturn are consumer credit and leasing companies, car sellers, construction companies, furniture companies, and more. Asking yourself ‘would an unemployed person spend money on this?‘ is a straightforward way to decide if a business is vulnerable. For now I would encourage all readers to have a look at their portfolio and consider if they are uncomfortably vulnerable to consumers spending less.

And for investors that share my nerves about the Australian economy, one Foolish expert recently identified 5 reliable dividend stocks that could be right up your alley:

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Motley Fool contributor Sean O'Neill has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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