Retail stocks are stuck. But why?
December’s retail sales surged past estimates, and retailers have been lifting their guidance for the fourth quarter and 2024.
If Wednesday’s retail sales report—up 0.6% from the previous month—was anything to go by, consumers closed out 2023 with a bang. Or, well, maybe a thud. In any case, it wasn’t a whimper.
So why, then, have retail stocks taken the news so poorly, with the
SPDR S&P Retail ETF
(XRT) barely budging this week even as the
S&P 500
and the
Dow Jones Industrial Average
reached record highs?
The question is especially puzzling considering the retail sales report dovetails upbeat commentary from retailers about their projections for 2024.
Lululemon Athletica,
Abercrombie & Fitch,
Urban Outfitters,
and
American Eagle Outfitters
all either reiterated or raised their fourth-quarter guidance in early January, adding that they expected some of their newfound momentum to continue into the new year.
These reports have helped bolster the bull case for the retail sector this year, which has been slowly gaining traction as economists grow confident the Federal Reserve will be able to orchestrate a so-called soft landing.
“We enter 2024 with the most bullish fundamental outlook we have had in the past few years, largely due to several robust and/or improving macroeconomic indicators and the expectation the Federal Reserve will begin to undo its aggressive rate hike campaign,” wrote Loop Capital analyst Anthony Chukumba in a January note.
Yet there’s one group that’s far less sanguine about retail’s prospects in the new year: investors. The retail ETF was down 5% in the first few weeks of the year, while the
S&P 500
is up 1.5%. Valuations have followed suit—the XRT trades at 13.1 times next 12 month’s estimated earnings, below the five-year average of 17.6 and at a roughly 30% discount to the S&P 500. Over the past three years, the ETF has traded at a 17% discount to the S&P.
There’s a couple of things undergirding the market’s pessimism. For one, Wall Street is undergoing a “good news is bad news” cycle, where markets are fretting over the fact that a hot economic report may dissuade the Federal Reserve from cutting interest rates sooner rather than later.
It doesn’t help that the consumer sector got less cheap during 2023. For the year, the XRT gained 24%, outperforming the broader market. A large part of that gain came at the end of the year, in a rare preholiday run-up that saw the ETF surge 19% from the start of October to the end of December.
“We came into the year with the not-so-secret secret being that the market was probably a little bit overvalued for the level of consumer risk and geopolitical risk,” said Kevin McCarthy, managing director and portfolio manager at Neuberger Berman.
To portfolio managers like McCarthy, the surge in price signaled a “bit of a disconnect” between the stock performance, and the outlook for real consumer spending. While spending has held up relatively well despite macroeconomic volatility, many economists and investors still believe 2024 will be a year of moderation for shoppers.
“There’s no more loan forbearance, there’s no more stimulus—a lot of those catalysts that really kind of turbocharged consumer spending over the last few years are fading,” said Emily Roland, co-chief investment strategist for John Hancock Investment Management.
What’s more, while certain economic challenges—notably inflation—are easing their pressure on consumers, others have yet to exert their full weight. Economists and analysts point out that interest rates generally have a delayed effect on consumer spending, and given that the Federal Reserve rose rates at such a fast clip last year, the full impact hasn’t settled in.
“My biggest worry is that we haven’t fully seen, in spending, the effects of the rapid rise in interest rates,” said Brian Nagel, analyst at Oppenheimer, speaking at a press conference last week.
Tack on the possibility that the labor market—which has been the real force buoying spending—may cool off this year, and there’s a real case to be made for the long-forecasted pullback in consumer spending to finally materialize.
Neither Roland, Nagel, nor McCarthy are forecasting a nosedive in consumer spending this year—just that sales growth will slow compared with the explosive levels seen in the last couple of postpandemic years.
“I think [spending] is going to be OK—and OK’s important,” Roland adds.
“OK” spending still translates to less free cash swirling around the economy, meaning that consumers are going to be more picky about how they spend their dollars. Discretionary purchases, for instance, could still be under pressure. And let’s not forget how
Nike’s
guidance cut dragged on the retail sector at the end of last year as the company warned spending would slow down worldwide.
“I think it’s going to be a challenging year with a real focus on value, convenience,” McCarthy said.
“What I’m looking for are brands that can get people off their couches, because I think everyone is going to be fighting for nickels in ‘24,” he added.
Some of McCarthy’s top picks for the year include
McDonald’s
and Nike—even though the latter may still have a few tough quarters to navigate. He also still sees solid consumer demand for travel, and holds
Marriott
International and
Las Vegas Sands.
McDonald’s trades at 23.4 times forward earnings; Nike at 25.1, Marriott 24.1, and Las Vegas Sands 16.7—all lower than their five-year averages.
On his end, Nagel favors discount retailer
Five Below,
as well as furniture retailer
Lovesac.
The former trades hands at 29.2 times forward earnings, and the latter at 11 times earnings. Loop Capital’s Chukumba leans toward stocks that underperformed heavily last year, including
Best Buy,
National Vision,
and
Savers Value Village.
Best Buy’s price to earnings ratio for the next year is 11.6; National Vision’s is 35.2, and Savers Value Village is 23.2.
Compared with other equities, retail stocks are on sale.
Write to Sabrina Escobar at [email protected]
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