Cowen issued a report offering a dismal view of holiday spending as it sees trends across discretionary spending weakening and inventories reaching peak levels to drive markdown pressures. The investment firm said it’s “cautious” on third-quarter and fourth-quarter guidance for Under Armour, Burlington Stores, Adidas, Allbirds, Hanesbrands, Puma, PVH, Skechers, and Figs.

Also compounded by rising currency-exchange risk, Cowen believes gross margin estimates are “too high” as consensus estimates assume margin expansion for 95 percent of Cowen’s coverage in the space in FY23.

The investment firm reduced its price targets across its coverage.

“There are record high levels of inventory across the sector with demand slowing,” Cowen noted in its report. “Consensus gross margin expectations into 2023 are too high as markdown allowances rise, storage costs rise and higher cost inventory flows onto income statements and FX transactional pressure is rising (COGS in dollars and sales in weaker currencies). Nike’s 150bps increase in markdown pressure one quarter into the company’s calendar FY is indicative of a fragile environment.”

Cowen said its collaborative proprietary monthly survey showed 77 percent of respondents in August 2022 indicated prices for day-to-day purchases were up versus a year ago, unchanged versus July 2022 and ahead of 60 percent in February 2022. The survey also showed that social events, travel and apparel were the top three areas consumers anticipate spending a smaller share of their wallets.

“In the face of greater macro uncertainty and an elevated promotional environment, retailers could be challenged by both cut-backs in consumer spending and trade-downs to more affordable product lines and brands,” Cowen wrote.

The survey showed that when consumers were asked if they planned to reduce their spending in response to the inflationary environment, 64 percent said they planned to cut back in August, in line with the figures from its July 2022 survey but up from the 50 percent of consumers in February 2022 that said they would cut back on spending in response to higher costs.

On inflationary pressures, labor remains a headwind as there are two job openings per unemployed person based on data from the U.S. Bureau of Labor Statistics, up 53 percent from pre-COVID levels.

Cowen estimates that labor costs for stores and distribution centers account for about 8 percent to 10 percent of sales for retailers.

SG&A pressure for stores and distribution centers (labor is 8 percent to 10 percent of sales for retailers) remains a headwind. Federal fund rates project the Terminal Rate to reach ~4.6 percent in FY23, which, in theory, should raise the unemployment rate—a move to 5 percent unemployment would create 2 million job losses.

With housing, affordability is at a 20-year low, and Cowan anticipates shelter costs, 32 percent of CPI, could exert pressure on Core inflation readings.

The other headwind on core inflation is housing/rent, with housing affordability at 20-year lows and shelter costs accounting for 32 percent of the Consumer Price Index (CPI), the largest component of any category. Cowen wrote, “While the category has not seen the rapid acceleration that has been present in other categories such as energy, shelter inflation has steadily risen from 2 percent y/y at the start of 2021 to current levels of 6 percent. Commodity items, ex-food and energy and food are the next largest components of CPI at 19 percent and 14 percent, respectively.”

Cowen sees downside risk to the industry’s holiday sales projections and plans.

“Holiday 2022 is shaping up to be a very different dynamic than 2021 given a multitude of macro pressures that are likely to negatively impact the level of holiday consumer spending versus prior years along with heightened inventory levels across the sector which have begun to trigger a ramp in promotional markdowns,” noted Cowen.

Cowen forecasted that assuming core CPI inflation of roughly 6 percent, and an underlying “real” retail sales growth rate, excluding food and gas, of 0.5 percent year-over-year, nominal holiday 2022.

Cowen wrote, “With the promotional activity ramping through the 2H of 2022, Holiday 2022 is likely to reflect a return to the highly promotional cadence of years past among both retailers and brands, be they brick & mortar, omni-channel or digitally native.”

Heightening the promotional atmosphere, Amazon added a second Prime Day for 2022, called Prime Early Access, to run from October 11-12. Target is also holding a holiday event from October 6-8.

Other observations in the study include:

  • E-commerce traffic is broadly moderating across the consumer ecosystem and within softlines retail.
  • Customer acquisition and retention costs are rising on search and social commerce.
  • Promotions increasing over search engines and social platforms.
  • Promotions are seen increasing over search engines and social platforms.
  • Through the first half of 2022 the savings rate has fallen to 5 percent, or below pre-pandemic levels.

“We are still in the early stages of shifts back to services and that discretionary goods could suffer as the economy slows amid rising interest rates and challenging consumer spending compares,” Cowen reported.

On the positive side, Cowen noted that freight, fuel and certain raw materials, such as cotton, experienced “a deflationary trend as U.S. consumer demand is slowing, providing prospects for the development of future margin relief for retail and consumer brands at some point beginning in fiscal-year 2023 but likely not before the second half of fiscal year 2023.”

Shipping rates on containers moving from Shanghai to Los Angeles dropped below $4,000 to $3,779 in the most recent week for the first time since September 17, 2020, and rates are down about 70 percent from the September 16, 2021 peak, the firm noted; however, the war in Ukraine, China’s “zero tolerance” COVID-19 policy and tensions with Taiwan “are indicative of a macro and geopolitical environment that is causing some of the highest cross-asset volatility in history across interest rates, FX, fixed income and equity valuations/discount rates,” said Cowan.

Cowan continued, “Radical changes to fiscal and monetary policy in North America and Europe will likely keep volatility high across financial markets, which will feed back consumer sentiment and behavior. It is challenging to see resolutions to many of these issues in the near future.”

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