Your favourite retail stocks may be in deeper trouble than you think

The retail sector is entering a winter of discontent even as our economy is growing strongly. This could be a time to be underweight on the sector with Citigroup recommending three stocks to sell now.

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Don't be fooled by the share market run and the stronger-than-expected economic growth in our economy. Not every sector is poised to do well and the divide between the "haves" and "have nots" is widening.

The market-beating Gross Domestic Product (GDP) growth figure for the March quarter and positive overnight leads have pushed the S&P/ASX 200 (Index:^AXJO) (ASX:XJO) index up 0.6% in late afternoon trade and just about every sector is trading in the green.

But the reality is that yesterday's 1% GDP growth for the March quarter is showing that parts of our economy are continuing to lag.

There are few sectors where this is more obvious than in retail even as consumer spending grew by a respectable 4.5% in the quarter.

But it's non-discretionary spending that is propping up the figure and that includes spending on groceries.

This should whet investors' appetites for our supermarket stocks Woolworths Group Ltd (ASX: WOW) and the owner of Coles supermarkets Wesfarmers Ltd (ASX: WES) as the era of food deflation appears to be dead.

But that won't be enough to save Wesfarmers, according to Citigroup as the broker reiterated its "sell" recommendation on the stock.

Wesfarmers is spinning off Coles and its department stores Target and Kmart are under increasing pressure.

The latest data from the Australian Bureau of Statistics (ABS) shows householders are using their savings to help pay for price rises in electricity, medical and insurance.

"The annual household savings rate sits at 2.1%. A year ago it was 3.9%," said Citigroup. "Without a reduction in household savings, retail sales growth would be half the rate it is today. Savings are typically inversely correlated with household wealth."

Wesfarmers knows it needs to do more. The conglomerate said today that it was looking to expand Kmart's reach overseas. Kmart currently distributes products to retailers in Thailand and it wants to sell products directly to consumers, possibly through small-format stores with local partners, according to the Australian Financial Review.

Management is also looking to shrink Target's store network by around 20% and to reposition the mid-market retailer as a fast fashion outlet that competes with the likes of H&M and Zara instead of its traditional rival Big W.

It will be interesting to see if the strategy will help overcome the challenge of stretched household budgets and falling house prices. Home prices are correlated to consumer spending, so the retreating residential market is adding a further headwind to low wage growth and record household debt.

But Wesfarmers isn't the only consumer stock that Citigroup is urging investors to dump. The broker has also slapped a "sell" recommendation on furniture and electrical franchise Harvey Norman Holdings Limited (ASX: HVN) and its rival JB Hi-Fi Limited (ASX: JBH).

The retail sector is entering a winter of discontent. I think investors are better off being underweight on consumer discretionary stocks.

Given how close we are to the end of the financial year, these stocks will no doubt be on the list of tax-loss selling candidates for investors looking to offset their tax liabilities by booking a capital loss on such laggards.

If you are looking for a new home for your capital, the experts at the Motley Fool have a suggestion. Click on the link below to see what stocks they believe will outperform in 2018 and beyond.

Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Wesfarmers Limited. 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 Scott Phillips.

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