Episode Details

As economic pressures continue to drive consumption in the U.S., how will the health of the economy influence the soft lines industry? Head of Retail and Consumer Credit for Fixed Income Research Jenna Giannelli and U.S. Soft Lines Retail Equity Analyst Alex Straton discuss

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Jenna Giannelli: Welcome to Thoughts on the Market. I'm Jenna Giannelli, Head of Retail and Consumer Credit within Morgan Stanley's Fixed Income Research. 

Alex Straton: And I'm Alex Straton, Morgan Stanley's U.S. Soft Lines Retail Equity Analyst. 

Jenna Giannelli: And on this special episode of Thoughts on the Market we'll discuss soft lines from two different but complementary perspectives, equity and corporate credit. It's Tuesday, January 24th at 10 a.m. in New York. 

Jenna Giannelli: Our economists here at Morgan Stanley believe that tighter monetary policy and a slowing labor market will be the key drivers of consumption in the U.S. this year. Against this still uncertain backdrop where we're cautious on the health of the U.S. consumer, we're at an interesting moment to think about the soft lines industry. So let's start with the equity side. Alex, you recently said that you see 2023 as a 'tale of two halves' when it comes to soft lines. What do you mean by that and when do you see the inflection point? 

Alex Straton: So, Jenna, that's right, we are describing 2023 as a 'tale of two halves'. That's certainly one of the taglines we're using, the other being 'things are going to go down before they go up'. So let's start with a 'tale of two halves'. I say that because in the first half what retailers are facing are harder compares from a PNL perspective, an ongoing excess inventory overhang and likely recessionary conditions from a macro perspective. On top of that, what we've got is 2023 street EPS estimates sitting about 15% too high across our coverage. As we know, earnings revisions are the number one driver of stock prices in our space. So if we have negative revisions ahead, it's likely that we're also going to have our stocks move downwards, hence the bottom I'm calling for some time here in the first quarter, while that may seem like a pretty negative view to start the year, the story is actually very different when we move to the back half of the year. Hence, the 'tale of two halves' narrative and the 'down before up'. So what do I mean by that? In the back half, really, what we're facing is retailers with easier top line compares and returns that should enjoy year over year margin relief. That's on freight, cotton, promotions, there's a number of others there. On top of that, what we've got is inventory that should be mostly normalized. And then finally a recovering macro, I think with this improving backdrop and the fact that our stocks are the quintessential early cycle outperformers, they could quickly pivot off these bottoms and see some nice gains. 

Jenna Giannelli: Okay, Alex, that all makes a lot of sense. So what are the key factors that you're watching for to know when we've hit that bottom? 

Alex Straton: So on our end, it's really a few things. I think first it's where 2023 guidance comes in across our space. And, I think secondly, its inventory levels. Cleaner levels are essential for us to have a view on how long this margin risk we've seen in the back half of 2022 could potentially linger into this year. And then really finally, it's a few macro data points that will confirm that, you know, a recession is here, an early cycle is on the horizon. 

Jenna Giannelli: I mean, look, you touched on a bit just on inventory, but last year there was a lot of discussion around the inventory problem, right, which was seen as a key ri