From Walmart Inc. to Home Depot Inc., the largest retailers in the US are set to take center stage in the upcoming earnings season. These earnings reports will provide valuable insights for stock investors into consumer spending, which is a crucial driver of the US economy. Last quarter, many retailers expressed caution about the future, but recent months have shown a resilient economy, with wage increases outpacing inflation and retail sales staying strong. Even consumers are beginning to believe that inflation is decreasing, and economists have abandoned recession predictions.
With the Federal Reserve signaling the end of its aggressive tightening campaign, Barclays Plc analyst Adrienne Yih expects US retail shares to perform well in 2024 as pressure on shoppers from inflation and higher borrowing costs eases. This is a significant shift from three months ago when Yih raised concerns about recession risks for the retail sector.
The ratio between an equal-weighted index of discretionary stocks, which includes companies like Amazon.com Inc., and staples stocks has traditionally been an indicator of Wall Street's view of the economy and investors' appetite for risk. This ratio has been steadily climbing in 2023, suggesting that traders believe the economy will avoid a recession in the next year.
"This ratio tells us that investors see brighter times ahead and want to increase risk in their portfolios," said Thomas Martin, senior portfolio manager at Globalt Investments. The S&P Retail Select Industry Index, which includes retail giants like Amazon, Costco Wholesale Corp., and Dollar Tree Inc., has outperformed the broader S&P 500 Index with a 16% rally since the end of May. The strength in retail sales has further bolstered the bullish case that Americans are still willing to spend. Walmart's stock has climbed 9.8% since then, while Macy's and Home Depot have both seen double-digit gains.
Investors are keen to gauge the health of the consumer, as this has been a major driver of optimism and confidence in the economy. The upcoming US retail sales data for July, due on Tuesday, will provide additional clues about the state of consumer demand. Home Depot's results, also released on Tuesday, will reveal if homeowners are scaling back on discretionary spending.
Other prominent retailers like Target, Walmart, Kohl's, Macy's, Nordstrom, and Lowe's will also be reporting their earnings in the coming weeks. This quarter is particularly important for Target, as it aims to regain momentum amid a modest sales forecast and struggles in the apparel and footwear sectors. Analyst Adrienne Yih has raised her ratings on companies like American Eagle Outfitters Inc., Bath & Body Works Inc., Gap Inc., and Tapestry Inc., as part of a proactive stance for next year.
However, both discretionary and staples retailers face the challenge of margin pressure from rising prices. Bloomberg Intelligence predicts that price pressures will continue to be a key headwind for retailers in both sectors. While inflation has impacted discretionary spending, Yih notes in a client note that price moderation has been observed.
Furthermore, the impact of higher borrowing costs takes time to ripple through the economy, so investors will be interested in companies' outlooks on inflation and profit margins.
"Retailers probably won't paint a rosy picture for the upcoming quarters," says Brooke May, managing partner at Evans May Wealth. "But it's typical for expectations to be set low in order to surprise on the upside."