Don't put too much stock in retail earnings
The market is captivated by retail. Retail earnings encapsulate consumer confidence and, by extension, cut to the quick of the economic environment. At least that's how the conventional thinking goes.
And so, after several disappointing holiday-sales announcements from companies like Best Buy, J.C. Penney and Lululemon, many investors are beginning to doubt the strength of the economic recovery, while others look to the likes of Amazon for signs of a secular shift.
But there are actually a number of important caveats to fourth-quarter retail earnings:
Price increases. You might think that Macy's fourth-quarter earnings from the past five years, for example, would give you a pretty good sense of the company's trajectory, and perhaps even that of consumer spending as well. But what if rising prices actually explained the inflated revenue? You can't just look at revenue and expect to get the full picture.
(Read more: Wal-Mart warns on fourth-quarter earnings)
External factors. It's easy to forget what was happening in the world during the three-month time frame reflected by fourth-quarter retail numbers. In 2013, it was the government shutdown, the fight over Obamacare, and the Target breach. The year before, we had a presidential election and Superstorm Sandy, just to name a couple of things.
Such events can certainly impact retail numbers, either directly or via the context with which we approach them. "When consumers are highly uncertain about their economic prospects and concerned about risk, it can affect their willingness to spend," Edward Fox, director of theJCPenney Center for Retail Excellence at Southern Methodist University, recently told CardHub.
The calendar. The holiday-shopping season can last 26-32 days, depending on where Thanksgiving falls on the calendar. It was 26 in 2013, which means people had nearly 20 percent fewer days to buy stuff than the prior year.
You can't really expect as much spending in such a shortened time frame and that doesn't necessarily indicate that a company or sector is trending downward.
(Read more: A 'tsunami' of store closings expected to hit retail)
The stock market. Consumers spend more when the holiday-shopping season is preceded by a strong year for the stock market, according to Robert Blattberg, professor emeritus of marketing with Northwestern University's Kellogg School of Management. However, market-driven consumer spending isn't guaranteed to last long, especially if there is a correction due to flawed fundamentals.
Customer late fees. Roughly half of the major retailers that offer financing use a feature known as deferred interest. This allows them to retroactively assess finance charges to a customer's entire original purchase amount if they miss a single payment or have the tiniest of balances remaining at the end of the prescribed introductory period.
Practices like deferred interest clearly aren't long for this world as the Consumer Financial Protection Bureau continues its crackdown on opaque, predatory practices across the realm of personal finance. Late last year, the CFPB ordered GE Money to refund $34.1 million to customers who used its CareCredit Card due to the presence of deferred interest.
(Read more: Without rebirth, malls face extinction)
That means companies relying on deferred interest to make their 0-percent financing offers profitable are currently benefiting from artificially-enhanced revenue that is not sustainable in the long term.
— By Odysseas Papadimitriou