Analysts are upbeat about a handful of consumer discretionary stocks despite economists forecasting retail sales to fall from May highs as higher interest rates and the threat of an economic downturn hamper consumer sentiment and spending.Although cost of living pressures, lower house prices and elevated wage increases are driving earnings downgrades, analysts say these concerns are priced in, noting the sharp sell-off in retail stocks since February.Department stores recorded the largest rise increase in sales in May, up 5.1 per cent and 18 per cent higher on pre-pandemic levels. Joe ArmaoRisks are also partially mitigated by elevated household savings, sitting at around $250 billion, said JPMorgan analysts Bryan Raymond and Chris McKegg.“The optics around year-on-year declines will clearly be large given the very high base, but we expect the trough sales and margin levels in the financial year 2024 to be better than share prices are factoring in,” they said, adding that Australian retailers have underperformed their global peers in share price terms.They cited a preference for “deeply discounted discretionary retailers” such as Super Retail Group and Harvey Norman “with buffers built for further downgrades”.AdvertisementSandwiched between inflation and higher interest rates, consumer discretionary stocks have been in a tailspin this year. Harvey Norman is down 25 per cent, Super Retail Group 32 per cent and City Chic 66 per cent.Wilsons analyst John Hynd is cautiously optimistic, arguing the market reaction over the past four to six months versus what he infers from the data “seems pretty extreme”.“The [retail spending] data continues to surprise on the upside, given we saw variable interest rates increase in May and the consumer has that expectation that rates are going to continue to increase – yet they’re still willing to spend,” he said.“However, I think it’s too early to call whether consumers will be resilient through the rate cycle.”Mr Hynds’ top pick is plus-size clothing brand City Chic. He says the high-quality global retailer should withstand headwinds thanks to its niche product offering and sticky customer base. “Their customers need to shop irrespective of a difficult or positive economic climate and the end market is significant,” he said.Citi retail analyst Adrian Lemme said discretionary retailers will need to be cautious in managing their inventories, though he also notes many are already priced at steep discounts.The broker has a “buy” rating on housing exposed retailers including Harvey Norman, Beacon Lighting and Nick Scali, and fashion names like Premier, City Chic, Lovisa and Michael Hill.Wallets outAustralian retailers enjoyed a fifth straight month of retail sales gains in May, demonstrating continued resilience in the face of rising interest rates.Retail sales advanced 0.9 per cent from April in seasonally adjusted terms, more than double consensus expectations. Retail sales are now 23 per cent higher than before the pandemic.Combined with the imminent 5.2 per cent rise in the minimum wage, economists say this sets the scene for aggressive interest rate rises, supporting an expected 50 basis point increase at next week’s Reserve Bank meeting.May sales growth was broad-based across five of six retail industries, the ABS said. Department stores saw the largest rise, up 5.1 per cent, followed by cafés, restaurants and takeaway food.UBS chief economist George Tharenou said this suggests it wasn’t just food inflation driving nominal retail sales to record high levels but also underlying real consumer demand.Fashion bucked the trend, recording a fall of 1.4 per cent following three consecutive monthly rises.The question now is whether the retail boom can withstand the pressures, particularly once borrowers digest the second RBA rate increase (to 0.85 per cent) in June.Comparison website RateCity estimated the average borrower with a $500,000 loan over 25 years will incur a rise in repayments of almost $200 a month following the May and June rate increases.AMP Capital Markets senior economist Diana Mousina said it may take a few months to see the impact of retail data as consumers adjust their spending.RELATEDRBA has a warning for Australians’ shift in ‘inflation psychology’But she believes consumer spending is likely to slow over the remainder of 2022 as “consumers battle with increasing interest rates and high inflation”, noting that weekly credit card spending data from the major banks stalled in June after months of high growth.Barrenjoey chief economist Jo Masters expects the strong labour market, accelerating wages growth, household savings and the fact that a large portion of borrowers are sitting on fixed rates to support consumption growth over the remainder of this year.However, she forecasts growth materially slowing next year when several of these offsets roll-off.
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