Retailers see earnings growth ahead, but investors are lukewarm

Retailers and retail-related stocks are among the best performers in the sector SPDR fund for selected consumer discretionary sectors NYSEARCA: XLY. However, this is faint praise: Retail stocks have lagged the broader market and their sector.

Walmart Inc. New York Stock Exchange: WMT AND Costco Wholesale Corp. NASDAQ: COST are among the top 10 largest gainers in large-cap consumer staples companies in January, but the sector has posted only lackluster returns since the start of 2024.

The S&P 500 Index rose 2.61% this month, while the Consumer Staples sector gained 0.35%.

Consumers freely opened their wallets, spurring economic growth and defying economists’ recession predictions.

Clothing retailers see big gains ahead

Clothing retailers like it Lululemon Athletica Inc. NASDAQ: LULU, Abercrombie & Fitch Co. New York Stock Exchange: ANF, Urban Outfitters Inc. NASDAQ: URBN AND American Eagle Outfitters Inc. NYSE:AEO driving towards strong earnings performance, continuing their momentum from 2023.

Within this group, mid-cap Abercrombie & Fitch is the only one in rally mode, while the others show slight sell-offs, with support at or above the 50-day moving averages.

THE SPDR S&P Retail ETF NYSEARCA:XRT fell 3.77% in January after returning to 21.54% in 2023. This ETF tracks an index of large-, mid-, and small-cap stocks from nine sub-sectors within retail.

This index uses a modified equal-weighted approach, meaning that it’s not just the giants that drive the index’s performance, as is the case with the market-cap-weighted S&P 500.

For example, within the XRT retail ETF, Abercrombie’s January return of 16.14% means it has raced to pole position.

Consumer confidence is at a two-year high

But retailers’ overall performance points to a disconnect between consumer confidence, which hit a two-year high in January, and retail inventories.

In theory, retailers should be among the market leaders, as earnings expectations are high and under upward revision.

Oppenheimer’s Brian Nagel said he doesn’t believe consumers will feel the effect of interest rate increases when it comes to making purchases, although that’s certainly true for the housing market.

In a Jan. 19 research note, Bank of America analysts said, “Ignore retail sales; the economy is cooling.”

Analysts at B of A wrote: “We expect a reversal of December’s strength into January. Consumer spending may be healthy, but it’s not up or down, and we don’t think the report says much about the capacity of Fed to cut rates starting in March as we expect.”

Analysts expect retail sales growth in 2024

With large and mid-sized retailers forecasting earnings growth this year and analysts agreeing, there is no hint that retail sales will fall off a cliff.

According to market researcher Insider Intelligence, in 2024, e-commerce retail sales will grow 10.1% compared to 2023, while non-e-commerce sales will grow 2%.

The financial services sector may offer a clue to what’s to come: When it reported fourth-quarter results, Discover financial services NYSE:DFS said it was increasing the default reserve on credit cards and that the rate of payments 30 days or more delinquent increased in the fourth quarter. The charge-off rate for personal loans is also increasing.

This could indicate that higher rates are finally reaching consumers, causing investors to be more cautious.

Factors behind the sell-off in retail stocks

A look at the chart of retail ETFs shows that selling volume increased in the first three weeks of January before buyers took control in the week ending January 26.

This could signal a few things.

First, investors could make some profit from retail stocks after the rally that began in October.

Additionally, investors may pull back on retail stocks as the market is less certain about the Federal Reserve’s interest rate cuts anytime soon. On the other hand, developments such as strong consumer spending dampen investor enthusiasm for short-term cuts.

Finally, as data from Discover Financial shows, there’s a growing sense that consumers may start to cut back and that even a pause in rate hikes will take time to work through the system.

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