By Teresa Rivas
When the market gained late last year, retail stocks surged. That leaves them exposed now that a key positive factor appears less likely to pan out.
Retail stocks tend to get a boost when interest rates are lower: Consumers can more easily borrow money, which can increase spending. They have to set aside less cash to cover the cost of their debt.
Therefore, it isn't surprising that from mid-November to the start of February, when the yield on 10-year Treasuries fell from 4.62% to 3.85%, retail stocks outperformed the S&P 500 in anticipation of that cycle playing out.
As Citi analyst Paul Lejuez notes, stocks that saw the biggest gains during this time were Macy's, PVH, Abercrombie & Fitch, and Burlington Stores, all of which jumped more than 55%. Only a half dozen of the more than 50 stocks he covers -- Gildan Activewear, Nike, BJ's Wholesale Club, Ollie's Bargain Outlet Holdings, Chewy, and Petco Health & Wellness -- declined during that time.
The problem now is that yields have crept back up because the market expects interest rates to remain higher for longer. Federal Reserve Chairman Jerome Powell acknowledged earlier this week that the fight against inflation has stalled, following March's disappointingly hot reading for the consumer price index.
With yields near where they were before retail and the broader market took off last fall, the chances that retailers will benefit from lower rates appear to have faded. Yet the stocks' valuations haven't caught up.
As Lejuez highlights, among the companies he covers, the median ratio of stock prices to earnings expected for fiscal 2024 is up nearly 20% since mid-November. Seven -- Advance Auto Parts, Williams-Sonoma, Macy's, RH, Dick's Sporting Goods, Bath & Body Works, and Floor and Décor -- have seen their ratios increase by more than 50%. Lululemon Athletica, Ollie's Bargain Outlet, Under Armour, Five Below, Capri Holdings, and Abercrombie & Fitch are the only six whose valuations have fallen.
That disconnect becomes more concerning when you add in earnings.
Since mid-November, consensus earnings estimates for 34 companies Lejuez covers have fallen, with a median decline of 1.3%. (That figure excludes Soho House & Co.and Petco because they are expected to report losses for fiscal 2024.)
The upshot is that "although the 10-yr yield is back to where it was mid-November, retail stock multiples are significantly higher than they were at that time," Lejuez writes. "As the market continues to digest a 'higher for longer' interest rate backdrop (again), we believe those stocks that have elevated multiples compared to the mid-November period are at risk for multiple contraction, especially if business fundamentals show any signs of deterioration."
That could lead to ongoing pain for the retail sector. The SPDR S&P Retail ETF is up more than 19% in the past six months, but that is mostly because of the rally in late 2023. The fund has fallen 1.7% since the start of the year and is off 6.5% in the past month alone.
Still, Lejuez doesn't think investors have to avoid all retail. He has Buy ratings on more than a dozen names. Walmart, Signet Jewelers, Birkenstock Holdings, Tapestry, and TJX Cos.are among his favorites.
Nonetheless, higher interest rates, lower expected earnings, and elevated valuations look like a triple threat to many retail names.
Write to Teresa Rivas at teresa.rivas@barrons.com
This content was created by Barron's, which is operated by Dow Jones & Co. Barron's is published independently from Dow Jones Newswires and The Wall Street Journal.
(END) Dow Jones Newswires
April 19, 2024 12:12 ET (16:12 GMT)
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