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As we approach the always-crucial holiday sales season, retailers in the U.S. and Europe may not feel so festive, given the prospects for consumer caution.

What We're Watching

Even amid seismic shifts in consumer behavior that have widened the year-end shopping window—with online shopping now accounting for about one-fifth of retail sales worldwide—the holiday season remains highly relevant to retailers' results. This is especially true for those that rely on discretionary spending (e.g., apparel and luxury goods, housewares, and leisure products and electronics).

As the 2024 holiday shopping season gets underway, persistent inflation continues to eat into consumer purchasing power. This is likely to result in slowing sales growth during retailers' most important quarter. Moreover, next week's Thanksgiving holiday in the U.S. is at the latest possible date, Nov. 28, which makes for five fewer post-feast shopping days than last year.

And while "Black Friday"—the day many U.S. retailers reach profitability (that is, move into the black) for the year—used to be largely an American phenomenon it has rapidly grown in popularity in Europe.

Last-quarter sales—including Black Friday and the Christmas season more broadly—are essential to European retailers. What is sometimes referred to as the "golden quarter" can account for as much as one-third of sales and up to half of annual profits for retailers of discretionary products, such as electronics, apparel, jewelry, and toys and other gifts.

What We Think And Why

We forecast U.S. holiday sales growth will slow to about 3% this year—well below last year's 4.7% and the 10-year average of 5.3%. Similarly, S&P Global Ratings expects retailers in Europe will grow year-on-year fourth-quarter sales by 2%-3% on average, compared to the same period last year.

Elsewhere, retail spending growth is slowing in China, as well, in the lead-up to Lunar New Year on Jan. 29. We expect soft macro conditions to persist in the world's second-biggest economy, as the country's weak property market and lukewarm economic outlook weigh on consumer confidence.

On the bright side, the resilient U.S. labor market and expectations for further interest-rate cuts are bolstering consumer confidence. Many retailers have also accelerated inventory orders to get ahead of any supply-chain disruptions and will likely lean on deals (and spend more on advertising) to draw buyers.

As customers hunt for value, we expect retailers that cater to the more resilient middle- and higher-income consumers, including TJX Cos. (which operates TJ Maxx in the U.S. and TK Maxx in Europe), to fare better. Similarly, "big box" stores such as Walmart will also likely perform well as consumers seek to stretch their dollars.

We expect other sectors, such as department stores and apparel retailers, will rely on bigger discounts to increase traffic and offload inventory. Furthermore, soft demand in specialty categories like consumer electronics and home furnishings will also make promotional activity necessary to spark demand.

And while robust labor markets and higher household disposable incomes will underpin sales in Europe, we expect retailers will similarly increase promotions to boost volumes with unit prices remaining elevated.

Sticky inflation is affecting consumer products companies, as well. In Europe, consumer goods brands are shifting their focus from price- to volume-driven organic growth, not least because many consumer-goods companies' capacity to keep raising prices is limited. We expect promotions will pick up as competition remains intense. In short, consumers have been slow to embrace the decline in inflation because of the cumulative effect of previous price jumps.

All of this has affected ratings. In the U.S., slowing consumer spending has softened companies' topline growth, and this, coupled with the difficulty of absorbing fixed costs, has increased negative ratings actions. Additionally, high debt burdens and onerous debt-servicing costs for retailers that were part of private-equity buyouts during the pandemic have made for constrained operational and financial flexibility.

The bulk of negative rating actions in the past 12 months has been in the apparel, accessories, and specialty subsectors, where exposure to discretionary spending is high. More broadly, the negative outlook bias in the U.S. is 21% in our retail and restaurants portfolio, with 28% of ratings having a negative outlook or on CreditWatch with negative implications and 7% with positive outlooks or on CreditWatch positive.

When we remove restaurants and divide retailers between discretionary and nondiscretionary, the pressure on credit quality in discretionary subsectors such as apparel, specialty, and department stores, is even higher. The negative bias for retailers with exposure to discretionary spending is nearly 1.5 times that of those exposed to nondiscretionary spending.

Among European retailers we rate, one-quarter have 'weak' or 'vulnerable' business risk profiles, and more than one-third have highly leveraged financial risk profiles. As competitive trends continue to intensify, these retailers in particular will be tested on their ability to protect earnings and free-cash generation.

What Could Change

Consumers—especially in the U.S.—have proved resilient through the year, and recent data on the consumer savings rate suggests this trend could continue. Annual revisions in September of gross domestic income dating back to 2019 showed that American households were in a surprisingly strong position, in the aggregate.

In fact, households had $500 billion more income in 2023 than previously thought, as well as a savings rate (as a percentage of income) of 5.2% in the second quarter of this year, according to the Bureau of Economic Analysis. That's sharply higher than the pre-revision 3.3%. And while there's some differentiation by income cohort, the revision was across-the-board.

For September, the savings rate was 4.6%, and retail sales data for that month (an early indicator of holiday shopping trends) suggests that this may be a successful season if sellers focus on improving their value propositions. While total retail and food-services sales were up 1.7% (annualized), some retailers with exposure to discretionary categories continued to struggle, with sales declining year-over-year.

As a result, we expect U.S. retailers with heavy exposure to discretionary products will rely on promotions to generate demand—or risk a disappointing holiday season. At the same time, significant discounting to combat volume pressure earlier on in the season can eat into already thin retail margins.

Writers: Joe Maguire and Molly Mintz