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Ahead of Wall Street

Thursday, August 15, 2013

"The retail environment remains challenging in the U.S. and our international markets, as customers are cautious in their spending. Net sales in the first six months were below our expectations, so we are updating our forecast for net sales to grow between 2 and 3 percent for the full year versus our previous range of 5 to 6 percent,"

This is a direct quote from Wal-Mart’s (WMT - Analyst Report) weaker than expected earnings release this morning. Given Wal-Mart’s size and reach, the retail giant’s weak second half outlook provides an unsettling view of the low-end consumer. But before we assume that the issue is restricted to the low-end consumer only, we shouldn’t lose sight of the underwhelming guidance from Macy’s (M - Analyst Report) on Wednesday. Macy’s may not be a proxy for high-end retailing as a Nordstrom (JWN - Analyst Report) would be, which reports after the close today, but it is no Kohl’s (KSS - Analyst Report) either, which incidentally also guided lower this morning. Beyond the retail sector, we got something similar from networking giant Cisco (CSCO - Analyst Report) in its earnings release last evening.

The takeaway from these retail sector earnings reports is not that the outlook for consumer spending is deteriorating. But rather that the long hoped-for second half recovery may have to be put off some more. Corporate profit growth has been anemic in the year, but consensus expectations have been looking for a growth ramp up in the second half of the year. Earnings estimates for Q3 for a number of sectors have been coming down sharply since the Q2 season got underway, but we haven’t seen much negative revisions for the broader consumer centric sectors. A big contributor to those hopeful expectations is the steadily improving labor market. This morning’s sharp drop in initial Jobless Claims further feeds those expectations.

But what these earnings reports from Wal-Mart, Macy’s, and others show that those second-half earnings growth expectations will need to come down. The question at this stage is whether the market will take the downshift in earnings expectations in the stride, as it has been doing over the last few quarters, or finally start paying attention. I have been of the view that investors will find it hard to disregard negative estimate revisions going forward, particularly if the Fed will be removing its protective embrace from the market.

Sheraz Mian

Director of Research

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