Target's troubles lead to pain for all The whole retail recovery story has wandered perilously off script over the past quarter. The start of the year held the promise of green shoots at the discretionary spending end. But as we near the close of the financial year, the fragile recovery appears to have been nipped in the bud. It would not be surprising to see some retailers provide updates over the coming weeks that reflect the fact that the market is still soft and second-half earnings will be below what was previously indicated. The prospect seems bizarre given investors have waded into the retail shares over the past six months anticipating this recovery, aided by the heart-starter stimulus from the Reserve Bank which has pushed interest rates to historically low levels. Still, consumers are not buying. Citi analyst Craig Woolford says sales trends have slowed by 2 per cent to 3 per cent in the past three months. Last week, the black sheep of Wesfarmers' retail family, Target, took investors by surprise when it lowered its second-half forecast earnings before interest and tax to between a loss of $8 million to a profit of $12 million - representing a massive downgrade in earnings. The company told the market a few weeks back that it was having troubles with its inventory levels and its chief executive had been replaced. Clearly the problems were significantly larger than had been expected. (A reasonable portion of its inventory writedown involved "shrinkage." Exactly how Target management could lose this stock brings into question its accounting practices and systems.) The trouble is that Target's problems have a contagion effect. Even one large retailer with a giant excess inventory problem will send ripples through the market. Target will need to discount heavily to get rid of stock and competitors will need to undertake some degree of discounting. Thus Big W and Kmart will get caught in the crossfire. Myer also shares some of its customer base with Target and will have to discount selectively. Because Myer competes with David Jones and specialty fashion companies like Just Group, all will wear some pain from Target's mishaps. But Target can't take the blame for the widespread issues in discretionary retailing. Consumers are not in the right psychological frame of mind for buying, other than on products that are particularly enticing. They have also become addicted to discounts and one of the features of the retail environment over the past six months is that stores have been attempting to wean customers off the discounting drip. It's a tricky time to undertake this manoeuvre. Consumer sentiment, which was improving for the first few months of the year, has now hit a wall. Retraining customers to buy more and pay for for it is a tall order in this environment. The consumer response has been something of a protest and this will put pressure on retail sales in the current half. The retailers have come to the conclusion that they can't keep discounting to attract sales and have instead started to focus on gross sales margin - the different between the cost of goods bought from wholesalers and the price the goods are sold to consumers. The key to working this strategy well is to reduce inventory levels in order to avoid getting stuck with excess stock at the end of the season that would need to be sold at a discount. David Jones has been heralding its tight inventory control for six months. Its sales revenue may be under pressure but it should avoid the inventory trap. And when it comes to buying apparel the warmer start to autumn/winter is not helping. Retailers tend to exaggerate the weather effect and analysts have all manner of data on what a one degree change in the temperature has on sales. It is a factor, but one that is rarely mentioned when the industry is booming. The most recent buzz in retail is how the potential fall in the dollar will affect the various players in the retail space. There is a dividing line between those that are primarily private label retailers and those that are not. A fall in the dollar is net disbenefit to those that manufacture private label goods offshore (mainly in China) but it is a benefit for those that need to compete with cheaper imports from offshore (in particular those that compete with online imports from the US.) Thus stocks like Pacific Brands and Just would be disadvantaged by the lower dollar, and David Jones would benefit. The fall in the dollar last week had a negative impact on Myer, for example. It rebounded on Monday morning as the Australian dollar firmed but medium to longer term movements in the currency are hard to predict. Finally, retailers got nothing positive out of last week's budget. If anything the budget promised to take money out of the hands of consumers in the lead-up to an election - which is traditionally a time when caution takes over.