While the market has had a great start to the year, there are still signs that the U.S. could slip into a recession later in 2023. If that’s the case, jeans won’t be anyone’s top priority.
That’s the takeaway from Jefferies’ latest look at the apparel sector, which includes multiple stock downgrades, most notably
American Eagle Outfitters
As Barron’s has noted, there’s no shortage of indicators that expecting the economy to execute a soft landing is a tall order, and although consumers have been resilient, Jefferies analyst Randal Konik notes that they are actually behaving as one would expect ahead of a downturn.
Looking at eight past recessions, he found that softer spending on autos and durable goods—on full display in the fourth quarter—have historically come ahead of past downturns. Consumers are still spending on things like transport that are still recovering toward normal levels postpandemic, but ultimately the data “point to a slowdown in consumer spending with apparel likely one of the weakest categories ahead,” he writes.
His downgrade of American Eagle stock to Hold from Buy, with a $16 price target, is part of his larger response to his belief that “consumer spending appears poised for a downturn,” given that clothing “is typically a low-performing category from the start to the exit of the recession.”
American Eagle, a Barron’s stock pick that’s rallied nearly 25% since our recommendation through Tuesday’s close, ended 2022 with strong earnings and has already provided an upbeat update about its holiday quarter, due out on March 1.
However Konik argues these encouraging signs won’t be enough for the company to overcome mounting headwinds for shoppers, and that the rally has left its valuation quite full.
That said, he still thinks there are some apparel sellers that can buck the trend, calling
Abercrombie & Fitch
(RVLV) his top picks. The former is benefiting from a successful turnaround giving its brands momentum, while the latter’s focus on higher-income consumers should at least partially insulate it from lower demand.
Many retailers will report holiday results in coming weeks as fourth-quarter earnings season ends. Some, such as American Eagle, have already hinted at robust results, but overall consumer-spending patterns may hint at a recession. Considering that, with the retail sector’s surge in 2023, the current rally could soon be hanging by a thread.
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