Q4 Earnings Season Is a Crucial Indicator of Retail Health Amidst Rising Credit Card Use

Fourth quarter earnings season is set to unfold, and it could be one of the more important ones to watch. It will provide a report card for the year’s final – and typically busiest shopping — quarter, which includes the holiday season. Major retailers have been vocal about shifts in consumer behavior, sounding alarms over a potential downturn.

And retail stocks have confirmed this for nearly a year with their sideways movement. In recent months, consumer confidence indices have painted a mixed picture. On one hand, unemployment rates have remained low, and wage growth has been steady, suggesting a resilient economy. On the other, inflationary pressures and economic uncertainties have led to cautious spending behaviors among consumers.

As such, many retailers have been issuing warnings that the rosy sales figures of the past may not be a reliable forecast for the future. It’s undeniable that retail sales have been growing, yet this growth is increasingly reliant on credit. Credit card usage has surged , with consumers stretching their purchasing power to keep up with the demand of the holiday season and beyond.

This trend raises concerns about the sustainability of such spending patterns. If consumers are overleveraging themselves, the retail sector could face a significant challenge when the bills come due, potentially leading to a decline in future spending. The reliance on credit is a double edged sword for retailers.

On one hand, it can boost short term sales, making balance sheets look healthy and attractive to investors. On the other hand, it signals that consumers may be reaching the limits of their financial capacity. The key metrics to watch will be the levels of consumer debt and the default rates on credit cards.

A spike in defaults could be indicative of a looming credit crisis, which would inevitably impact retail sales negatively. While credit can stimulate economic activity, it’s fundamentally unsustainable as a long term strategy for growth. As interest rates rise, the cost of borrowing increases, and consumers might rein in their spending to manage debt.

This shift could lead to a significant cooldown in retail spending, particularly for non essential goods. The Bottom Line I wonder if this is why markets are acting so volatile to the start the year, and if it explains outperformance in consumer staples stocks relative to consumer discretionary stocks .

For investors, the Q4 earnings reports will be a crucial indicator of the retail sector’s health. Beyond the sales figures, it will be important to analyze the underlying metrics such as inventory levels, consumer debt, and profit margins. These will provide a clearer picture of whether the sales growth is sustainable or if it’s a precursor to a downturn.

Either way, I think markets are sniffing real risk here, and earnings would solidify it. On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines ..