From Home Depot Inc. to Walmart Inc., the biggest US retailers are about to grab the earnings spotlight, providing investors crucial insight into consumer demand, the trajectory of economic growth and Corporate America’s profitability.
The group doesn’t have nearly the heft of Big Tech in terms of sway over the broader market. But these earnings announcements set to hit starting next week bear watching for a key reason: Consumer-discretionary shares are the year’s top-performing cohort in the S&P 500 Index, after getting battered in 2022 as soaring inflation and swollen inventories crimped profits.
The announcements ahead will go a long way to determine whether the rebound is just a temporary mean-reversion play to start the year or a green light to keep buying, given the fierce debate over whether the economy will skirt a recession. Surprising strength in retail sales is bolstering the bulls’ case, even as concerns remain about margin-shredding inflation pressures.
“We’re looking to buy great discretionary companies at a discount,” said Nancy Tengler, chief investment officer of Laffer Tengler Investments, who’s using pullbacks in the market this quarter to pick up discretionary shares. “Purchasing power remains strong.”
Investors will read the first tea leaves on Tuesday, when Walmart, which is labeled as a consumer staples company given its high percentage of grocery sales, and Home Depot deliver results before the market opens. Target Corp., Lowe’s Cos. and Dollar Tree Inc. follow the next week.
When combined, the S&P 500’s consumer discretionary and staples firms, excluding technology-leaning megacap growth stocks like Amazon.com Inc. and Tesla Inc., amount to the third-biggest S&P 500 sector when it comes to weighting, even though the grouping isn’t quite half the size of the information-technology universe.
But their link to consumer spending makes them vital for investors who are eager to hear the companies’ outlook for inflation and profit margins, especially since price pressures aren’t moderating the way the Federal Reserve would like to see.
Wall Street expects the retail segment to post five straight quarters of earnings-per-share declines year-over-year, before returning to growth in the second quarter of 2023, according to estimates compiled by Bloomberg Intelligence.
“There’s still near-term weakness, but consensus estimates among Wall Street analysts signal that they are hopeful the outlook will be more stable than it has been in past few quarters,” said Michael Casper, an equity strategist at BI.
Around 71% of discretionary companies have reported for the quarter, measuring by market cap. Firms that beat estimates have outperformed their peers by 2.6% on average as of Wednesday — more than any other sector, according to Christopher Harvey, head of equity strategy at Wells Fargo. Misses, meanwhile, have been penalized mildly, given consumers’ resilience.
After many retailers grappled with bloated inventories in 2022, progress on unloading excess merchandise will also be a focus of the earnings updates. Retail sales rose in January by the most in nearly two years, underscoring robust consumer demand for goods that threatens to keep inflation elevated and is spurring bets that the Fed will keep hiking rates deeper into 2023.
Cheap Valuations
There’s a risk those headwinds bedevil large discretionary companies and derail a broader market rebound as elevated prices paint a murky picture for margin outlooks.
“I don’t think it’s necessarily a bet on the consumer,” Karen Short, an analyst at Credit Suisse, said of the rebound in discretionary shares. “Investor sentiment this year has swung to lower-quality, lower-valuation-multiple names that were fairly beaten down last year.”
Of note, more than half of the discretionary industries are cheap compared with history, which is part of the reason investors have been snapping up the stocks, according to Casper. Leisure products, internet and direct marketing and autos carry the steepest discounts, while household durables are the most expensive.
“An earnings recession is expected to extend only into the first quarter for retailers,” according to Casper. “There is growing optimism for their outlooks starting in the second quarter on improving comps, which should drive earnings growth on possible signs of margin stabilization or even expansion to come.”
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