Retailers and consumers have been navigating a volatile landscape recently, with slowing economic growth, sticky inflation, and ongoing trade tensions all testing their resilience. John Kernan, Managing Director at TD Cowen, discusses how the current environment has created winners and laggards in the retail space.
Transcript
Greg Bonnell – Retailers and consumers are navigating a volatile landscape with slowing economic growth, sticky inflation, and ongoing trade tensions testing their resilience. My next guest says this current environment has helped create a few winners and a few laggards. Joining us now is John Kernan, Managing Director and Senior Analyst at TD Cowen, who covers the retail and consumer sectors. John, welcome to the program.
John Kernan – Thanks for having me.
Greg Bonnell – All right. We’ve got a lot to dig in here. I want to start with those tariffs, still a main concern and source of uncertainty. How has the US retail sector fared in this environment?
John Kernan – Yeah. Tariffs created uncertainty for consumers, investors, CEOs and CFOs as we exited April. But we’ve not seen much inflation yet in discretionary retail, which is encouraging. The retail sector as a whole is now preparing for back to school and holiday. Those are the two most important earnings drivers of the year.
Inventory levels are higher than they need to be in a few areas, but that’s because some companies pulled forward inventory ahead of tariffs. I would characterize the demand environment across discretionary as solid but not great. But, really, the biggest piece of uncertainty is the tariff impact on cost of goods sold for all companies and the ability to pass that through with price.
And that will be a big determinant of the winners and the laggards into holiday. And I think if you look at sector valuations now, they’re back to 2025 highs, and they’re above historical averages. So we are expressing some optimism here in the market.
Greg Bonnell – And when you mentioned back to school, I think back to school sales, and I don’t think about companies passing on tariff costs to the consumer. I know as an analyst, we have to take a look at a company. They have to reconsider in the analyst community out there, about where they get their products from. Can they pass that price along to the consumer?
John Kernan – Yeah. I think a lot of the inventory that’s in the marketplace now is sourced earlier in the year when slightly lower tariffs were in place, excluding China. So the biggest pieces of inflation you’re going to see are going to be October through December and then into the first half of 2026.
And we really haven’t seen much of a tick up in CPI as it relates to a lot of the key discretionary categories yet. But we’re watching those rates carefully and do expect those rates to move higher as we get into October and beyond.
Greg Bonnell – When we think about those companies that are getting their products from other countries — you said, obviously, a lot of buying was pulled forward, will be later this year. You start mentioning the summer, I start thinking about the holidays. At this point, is there clarity when we’re looking at the retail sector as to which companies are the most exposed and others that, perhaps, are not as exposed?
John Kernan – For sure. When you think of recent trade policy, it’s a good thing for companies as we head into August 1. That said, when most of the companies issued guidance when they reported the first quarter three months ago, they were assuming lower tariff rates for their Southeast Asian sourcing bases than what we saw with the recent trade deals that were reached, most notably with Vietnam and Indonesia. We’re also still awaiting clarity on Cambodia and Bangladesh, which are huge sources of supply.
So there’s some clarity on the trade policy front, but not enough for companies to make definitive decisions. But we do expect companies to have to adjust their guidance for a higher tariff hit, particularly from Vietnam and Indonesia, and it could be a much higher hit for Cambodia and Bangladesh as we go into the back half of the year.
Greg Bonnell – Now, that’s the companies. Obviously, the consumer has to show up to buy. That’s the whole business. What is the mood of the US consumer right now given all this economic uncertainty, the tariffs?
John Kernan – Well, we’re finding our companies with premium innovation and differentiation in the marketplace are expressing confidence in their outlooks for the fiscal year, regardless of the tariffs. But it’s a bifurcated environment. There’s others that are struggling.
When you look at the broader consumer, it’s been a bifurcated choppy year so far. 2024 was a very strong year for the US consumer, and we’re in a much more moderate environment from a traffic and spending perspective broadly in 2025. With financial markets at all-time highs, the high-income consumer is on better footing than the lower-income consumer. The top 10% of income earners in the US account for 50% of total PCE spend. So they are huge drivers of consumption.
Those lower income consumers, they’ve been much more strategic in their discretionary spending. We’ve seen much choppier results and inbound data on companies servicing lower income consumers.
Greg Bonnell – In a recent conversation I had on one of our other MoneyTalk shows, I had a guest basically saying that more budget-conscious, lower-income consumer threw in the towel a while ago. And now, the well-heeled ones are maybe showing a bit of caution. Is that what we need to watch right now – what people who have a pretty solid bank account start to do in this environment?
John Kernan – Yeah, they’re always a very important piece of the overall pie. If you look under the hood, you’re seeing pockets of definitely weaker results among consumer-facing companies that have exposure to younger- and lower-income consumers. When you look at the higher-income consumer, we have not seen that consumer crack yet.
And they’re certainly allocating discretionary dollars more carefully than they were in 2024. And that’s created some volatility among our companies. But I still think the consumer, broadly, is in decent shape. We’re, obviously, closely watching the unemployment numbers, the inflation numbers. So there’s a lot of policy and macro data that’s still coming down the pike.
Greg Bonnell – Heading into the fall, how do you see borrowing costs, interest rates, and Fed activity?
John Kernan – Yeah, we think the median outlook among the Fed committee for two rate cuts seems fair. We’re in the camp that the Fed can and will cut rates into the fall, into 2026, by roughly a total of 125 basis points. Over time, that should be a slight tailwind to the consumer.
And if they can cut further as tariff inflation ebbs, you could see more than 125 basis points of cuts. Consumers benefit from lower rates and also lower inflation. Inflation has done quite a bit of damage psychologically to the consumer, as it directly drives their own cost of capital for borrowing and their perception of value when they’re using their discretionary dollars.