Retail Sector Faces More Downside From Struggling Consumers

Authored by Simon White, Bloomberg macro strategist,

Retail stocks are exposed to tighter credit and consumers facing rising non-discretionary costs. Their expected underperfomance also makes them a candidate as a portfolio hedge for an increasingly likely equity-market correction.

(Nominal) retail sales were released this week, with January showing an improvement on December’s data. However, this should not detract from the strong downward trend leading indicators anticipate for retail consumption.

As the Fed’s rate hikes increasingly bite, credit conditions are tightening. A key demand support for consumption comes from consumer credit. But banks are tightening lending conditions across the board, from company loans to consumer credit. Fewer banks are willing to make consumer loans, which points to much weaker retail sales through this year.

Consumers are also having to tighten their belts. Inflation has ensured the cost of virtually all goods and services has risen over the past two years. Wages are not keeping pace with price rises, and certain essential outlays, such as rent and mortgage payments, cannot be readily cut.

Therefore discretionary consumption, which retail sales mainly captures, suffers.

My self-explanatory (but not catchily titled) Consumer Non-Retail Essentials Index shows that retail sales are going to face continued headwinds this year from consumer retrenchment.

The index is a little off its highs (brown line in the chart above; NB it is reversed), but the costs of essential services remains very high, and this will continue to force consumers to prioritize their spending.

This leaves retail stocks exposed. Retail is one of the most cyclical sectors, and as growth continues to weaken (as multiple leading indicators point towards), the sector will face increasing resistance.

After being one of the best sectors year-to-date thus far, retail is likely to soon begin underperforming as it becomes apparent discretionary consumption will weaken more.