Retail stocks sold off to multi-month lows last week, defying strong consumer spending driven by a surging U.S. economy and the lowest unemployment rate in decades. The twin headwinds of rising wages and falling margins are to blame, dropping this recently resurgent group into an intermediate correction. Unfortunately for shareholders, adverse forces are likely to grow well into 2019, affecting sector leaders and laggards alike.

China tariffs will rise from 10% to 25% at the start of 2019, while the Trump administration has threatened to expand surcharges into all imports from the Asian nation. Those goods comprise a majority of all items sold at many retailers, including Walmart Inc. (WMT), forcing companies to raise prices or lower margins. Higher pricing isn't an option for low-cost leaders, predicting reduced earnings per share (EPS) in coming quarters. (See also: Walmart Stock Could Test 2018 Low Without China Deal.)

Last week's decision by, Inc. (AMZN) to raise the employee minimum wage to $15 per hour has amplified industry shock waves, adding to concerns generated by an exceptionally tight job market. The retail trade employs the highest number of workers in the American private sector, raising fears that competitors will be forced to match the internet juggernaut, regardless of the negative impact to the bottom line. 

The SPDR S&P Retail ETF (XRT) fell to an all-time low at $7.41 in 2008 and turned higher, returning to the mid-decade high in 2010. A 2011 breakout caught fire, lifting the broad-based sector fund into a graceful series of higher highs and higher lows that ended in 2015 just above $50. The ETF sold off into the upper $30s in January 2016 and tested that level in August 2017, completing a long-term double bottom reversal, ahead of a recovery wave that reached the prior high in June 2018.

An August breakout made little progress, posting an all-time high at $52.96, ahead of a reversal that failed the breakout last week. This price action has set off bearish signals, indicating a potential long-term top. The decline reached the 200-day exponential moving average (EMA) on Friday, but testing at this critical support level is likely to continue in coming weeks, with a breakdown generating aggressive sell signals. (For more, see: The Four Rs of Investing in Retail.)

Shares of Costco Wholesale Corporation (COST), the fourth largest retailer by capitalization, stalled at $157 in 2015 following a multi-year uptrend and eased into a rising channel that posted nominal new highs into January 2018. It then broke channel resistance and went vertical, lifting into September's all-time high at $245.16. A September downgrade triggered an orderly pullback, ahead of last week's fiscal fourth quarter earnings report.

The quarterly release added to sector woes, meeting Wall Street expectations but including a warning that "material weakness in internal controls" could affect the fiscal 2018 annual report. The news triggered a nasty sell gap and a 5.44% decline, dropping the stock through support at the 50-day EMA for the first time since April. The sell-off is now approaching new channel support near $210, which should slow or stall the downside.

Quarterly sales remain brisk, and the big box giant made no mention of the potential 2019 tariff impact, but its shelves are also filled with Chinese goods. Admittedly, Costco is better positioned than Walmart to raise prices due to higher income demographics, but that could affect profits as well because its rival's goods could become more attractive, generating a loss of market share. (See also: Why Costco's Bull Run Will End Soon: Piper Jaffray.)

The Bottom Line

Retailers have entered an adverse period despite strong consumer spending, driven by tariffs and wage increases. Investors have taken note, dumping sector stocks at an aggressive pace. (For additional reading, check out: Analyzing Retail Stocks.)

<Disclosure: The author held no positions in the aforementioned securities at the time of publication.>