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Canadian retail stocks look expensive at a time when consumer spending is sluggish at best. Household debt has hit record levels of over 97 per cent of GDP, and even though current debt loads appear sustainable at low interest rates, at some point a Canadian credit deleveraging will create huge headwinds for the retail sector.
This chart (also at left) shows the year-over-year change in Canadian retail spending against the performance of the S&P/TSX retail sector. Retail stocks drove higher through 2012, while at the same time, growth in spending slowed significantly.
At 19.2 times trailing earnings, the sector is expensive relative to its history. The average P/E since 2005 is almost five points lower at 14.4. If I take out 2008 as a one-time only anomaly, the average P/E is still lower at 17.9.
Analysts expect earnings growth of 21 per cent for the next twelve months, but it's hard to see what the drivers of this growth might be. This is particularly true if the housing market slows further and the wealth effect (consumers feeling more flush as their home prices rise) fades away.
Importantly, there are only four companies in the retailer index – Canadian Tire Corp. Ltd., Rona Inc., Reitmans (Canada) Ltd. and Dollarama Inc. – so we're looking at a very small sample. Still, it's hard to be overly optimistic about the sector for the medium-term given record consumer debt levels.
Scott Barlow is a contributor to ROB Insight, the business commentary service available to Globe Unlimited subscribers. Click here to read more of his Insights, and follow Scott on Twitter at @SBarlow_ROB.