Retailers are navigating some difficult crosscurrents this holiday season. Shoppers are worn down by inflation, but investors are wary of retailers that could get whacked by falling prices. The trends seem in opposition to one another but might be key to picking which retailers will fare the best when all the holiday gifts are unwrapped. “I definitely do think that there is certainly inflation fatigue that has happened out there,” Chad Lusk, managing director at Alvarez & Marsal’s consumer and retail group, told CNBC. The professional services firm periodically polls consumers and saw a change in sentiment from the spring to the fall that could that could weigh on spending in the coming weeks. Lusk explained that consumers were holding up as prices rose, and showed a lot of optimism and willingness to spend in the springtime. Those feelings have soured somewhat and consumers are dialing back spending, he said. However, he added, they remain more upbeat compared with last holiday season and should spend more on gifts this year. Consumers will still want to spend on loved ones this holiday season, but they are very focused on value and basic needs over experiences and indulgences, he said. That means mass merchants like Walmart and Target are in the sweet spot, he said. According to Lusk, most consumers feel like we are already in a recession and they still expect prices to continue to rise. Discounts start early That means bargains are going to influence the purchases consumers make, and it’s easy to see evidence of that. Black Friday deals have started early this year . “Retailers know that shoppers have become price-sensitive and are looking for steep promotions and discounts. Therefore, retailers have ramped up the amount of merchandise on sale, hoping that more shoppers will open their wallets ahead of Black Friday,” Jharonne Martis, director of consumer research at LSEG wrote in an email Tuesday. LSEG, which was formerly known as Refinitiv, worked with Centric Market Intelligence to analyze discounting patterns. They found that the percentage of items on sale rose to 42% in November. During the same period last year, the discount penetration was about 33%. While more items are on sale, the average markdowns are slightly lower than the price cuts made last year, at an average of 37.5%. According to Martis, this suggests that retailers are using the buzz of price cuts to lure shoppers into the store but they are being mindful of profit margins. Of course, those numbers are averages. Digging in deeper, investors might see more signs of stress among specific retail chains. Inna Kuznetsova, CEO of ToolsGroup, a supply chain planning and optimization firm, said a hallmark of retailer stress is when discounting tops 60% to 70% off the original price and inventory on the store floor isn’t turning around rapidly. Another warning sign is when markdowns are widespread across the store, she said. The Centric Market Intelligence data is tracking broad and deep discounts at mid-tier department stores such as Macy’s and Kohl’s . About 69% of the merchandise is on sale, down from 77% this time last year. Also, the average discount is about 29.5% this year, compared with 28% in 2019, the firm said. DDS 3M mountain Dillard’s shares over the past 3 months. Most analysts have hold ratings on department store stocks. Some, like Macy’s, have logged double-digit declines this year. But even for Dillard’s, which has risen about 6% since the start of the year, the outlook isn’t rosy. Average analyst price targets suggest a roughly 28% decline could be ahead for the stock. LSEG said specialty retailers are the second-most promotional sector. On average, shoppers will find slightly more than half of the merchandise will be marked down, with an average discount of about 22%, according to Centric Market data. AMZN 3M mountain Amazon shares over the past three months. Of the 205 retailers tracked by LSEG, the broadline sector, which includes discount chains like Walmart and Target , is headed for the highest earnings growth rate driven by Amazon’s strength, Martis said. Amazon shares have logged an impressive 71% gain in 2023. According to FactSet, analysts anticipate there could be upside of more than 20% ahead, based on average price targets. The e-commerce giant is JPMorgan analyst Doug Anmuth’s top pick for the holiday season. “We project US e-comm penetration at 23.4% of adj retail sales this holiday season, +90bps above the 22.5% in 2022,” he said. “Amazon maintains a leading 44.6% share of US e-comm & enters the holiday season with strong momentum from early holiday promotions, increased same-day/1-day delivery (SD1D), regionalized US fulfillment infrastructure, record holiday hiring (AMZN an outlier), wide selection, & competitive prices.” D is also for deflation The irony of consumer’s weariness around inflation is that there are some signs that the Federal Reserve’s attempts to cool prices is finally making headway . Walmart spooked investors last week when CEO Doug McMillon spoke about the possibility that food prices could fall in the coming months. The stock dove sharply, and for good reason, according to Deutsche Bank analyst Krisztina Katai. She said deflation is bad for retailers, but the conditions usually don’t last long. Katai looked at the stock valuations of food retailers, discounters and dollar stores during deflationary periods in the past. “We find that traditional food retailer saw their P/E multiple compress by an average of 2.5x. WMT’s multiple [expanded], which we attribute to the retailer becoming more competitive with its offering and prices, while COST’s and DG’s multiples were largely unchanged,” Katai wrote in a recent research note. This puts Walmart at the top of her list. She also thinks Costco is in a “beneficial” position. Outside of food retailers, Katai likes cosmetics retailer Ulta Beauty and discounter Five Below . “In fact, lower prices at the grocery store could provide a tailwind to these retailers as discretionary budgets could free up,” she said, noting that these retailers have continued to see strong foot traffic into their stores. ULTA 3M mountain Ulta shares over the past three months. Ulta is a stock that is well regarded in the retail sector. Eighteen analysts rate it a buy or strong buy, according to FactSet. Based on its average price target, shares could rise about 27% from here. Still, the stock is down nearly 14% year to date. Top picks for the holiday season On Monday, UBS analyst Michael Lasser reiterated Ulta as one of his top picks, saying it has been maintaining its share gains even when the category’s growth slowed. But Lasser expects growth to pick up heading into next year and cited Target’s recent strong sales of beauty products as evidence trends could improve. “We think beauty has the potential to be a relevant gifting solution for cash-strapped consumers during the upcoming Holiday season,” he said. “Lastly, we think newness and innovation can help stabilize category demand into next year.” With Ulta shares trading at a multiple that is below its historical average, Lasser added, “downside risk is largely priced in.” FIVE 3M mountain Five Below shares over the past three months. ToolsGroup’s Kuznetsova said other traditional holiday categories could have a more challenging time because of the purchases people made during the Covid pandemic. She cited televisions as an example, saying she doesn’t anticipate that many people will be ready to upgrade at this point. “You only have so many rooms in your house,” she said. KeyBanc analysts agree with this sentiment. Among the holiday underperformers it cited are Best Buy as well as furniture retailers such as RH , Wayfair and Williams-Sonoma . “While these companies could benefit from cyclical recovery when the Fed eventually cuts rates, we still see near-term challenges from the many headwinds on the consumer,” the firm wrote Monday. KeyBanc expects shoppers to turn out for Black Friday weekend and the pre-Christmas shopping period, but the focus will be on deals and bargains, which is why it favors names like Five Below, Ollie’s Bargain Outlet and Walmart. “Black Friday is still the pivotal point,” Alvarez & Marsal’s Lusk said. “It will be the telltale in terms of how things are manifesting.” —CNBC’s Michael Bloom contributed to this report.