Stock markets are forward looking which means investors think mainly about a company’s prospects when they decide
how much they are prepared to pay for its shares, or at what price they want to sell.

Potential bad news tends to be priced into a company’s valuation before the event happens. Expectations are lowered and when the company eventually updates on matters, you often see the market shrug off gloomy news because it was already anticipated.

The ‘pricing in’ part of this trend is in play with retailers and housebuilders, where share prices have fallen by approximately 25% year-to-date based on the performance of the FTSE 350 sector indices.

Both sectors have major headwinds linked to inflation and consumer spending and so earnings prospects are clouded.

It’s becoming more expensive to run a retail business because wages are rising, energy bills are going up and raw materials are more expensive. At the same time, consumers are under significant financial pressure which suggests many might put off buying new outfits or gadgets for a while.

Housebuilders face the prospect of rising interest rates which makes mortgages more expensive. The higher cost of living also makes it harder for aspiring homeowners to save up for a property deposit. The cost associated with remediation work on fire safety for certain buildings has been another uncertainty for the sector, although we now have more clarity on this front.

It’s easy to conclude all the bad news has been priced in when you see double-digit share price declines over a short period. Unfortunately, there continue to be significant risks for the retail and housebuilding sectors.

Bank of America says a basket of key raw materials for clothing retailers has gone up by 24% year on year. Notably there has been an 85% rise in the price of cotton and a 15% hike in the cost of polyester.

It believes premium-priced retailers are better placed to put up prices or stomach extra costs given they have higher gross margins. The ones to worry about are low-priced clothing retailers as many of their customers will be lower income individuals who will suffer more from the rising cost of living, as bills take up a greater chunk of their monthly income.

Bank of America flags ASOS (ASC) and Primark-owner Associated British Foods (ABF) as being most at risk of a hit to earnings in this situation.

As for housebuilders, Barratt Developments’ (BDEV) history on the stock market would suggest anyone invested in this sector should brace themselves for more difficult times. High interest rates and high inflation in the 1970s saw shares in Barratt struggle for quite some time.

This time round the sector in general is in a decent position financially with companies sitting on large amounts of cash which should act as a buffer and ensure generous dividends are still paid.

It feels as if retailers might experience a short sharp shock while housebuilders’ problems could be more of a slow burner. In either instance, it pays to be aware of the risks ahead before swooping for supposed bargains.

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