What happened to retail stocks last week?
We don’t often comment on idiosyncrasies of individual sectors from week-to-week as the short-term returns aren’t often that meaningful or are self-correcting, but news here represents a microcosm of broader paradigm shifts in consumer behavior, and one that some economic metrics are having a hard time relaying.
The Friday retail sales report was considered decent, with strength coming from ‘non-store retail’ (which is a misc. catch-all category that includes online retailers); however, most traditional stores sell online as well, convoluting the measurement. Consumer behavior overall doesn’t look to be drying up, although some of the report’s strength was due to ‘gasoline station sales’, which is generally a byproduct of higher gas prices more than anything else (other than summer vacation season where gas volumes increase). Whether consumers paying more for gasoline indicates ‘strength’ is debatable, but does shift the composition of discretionary spending, especially at lower rungs of the income ladder.
Several individual company reports in the retail group (a subset of ‘consumer discretionary’ stocks mainly) pointed to the ongoing shift in industry dynamics. Several articles written with the theme of ‘is brick-and-mortar retail dead?’ naturally followed. The conclusion is complicated, but continues to be that, with the internet as a disruptive lower-cost and market share-grabbing force, the competitive environment is becoming increasingly difficult for traditional firms, who are saddled with the overhead of higher employee counts and other high fixed costs, such as real estate leases. The shock came from a variety of companies reporting such results at the same time, including Macy’s, JC Penney, Gap, Kohl’s and Nordstrom (while the Amazons of the world continue to surprise many on the upside). Such trends are many years in the making, so traditional firms have worked to adapt and will need to continue doing so to keep their business models relevant. This will affect some firms more than others. Higher-end retailers such as Coach, Tiffany, Prada, et. al., have seen growing volumes from foreign buyers—particularly increasingly-wealthy emerging market nations—which tend to be more status-conscious than they are price-sensitive. The mid-range firms, like department stores, which sell less differentiated goods with either lower margins or high seasonal ‘fashion’ risk may be in a more challenged environment.
This may mean a continuation of what we’ve already started to see in recent years, which, in the worst case, is store consolidations and consequent reductions in employee headcounts. Retail REITs can also be affected as this translates to larger vacancies at high-profile properties; private real estate trusts are even more vulnerable due to lower quality of tenants in properties such as run-of-the mill strip malls. This is a healthy move from a business standpoint, though, as cutting costs from less productive operations is a good thing, and we likely had too many stores anyway—some companies have a tendency to over-expand their reach during good times. This is also good for consumers, as it lends itself to continued ‘price shopping’, which tends to have a dampening effect on prices paid. On the downside, during the economic recovery, it’s been argued that a larger-than-average percentage of jobs added have been on service/retail side, so job losses here could be painful if not easily absorbed by other areas.
Read our Weekly Review for May 16, 2016.
Read the previous Question of the Week for April 25, 2016.