Retail goes on sale

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Oh joy, mid-November… it’s that time of year again where we have to dig out our winter clothes, my sports teams are out of play-off contention, and strong third-quarter US earnings are largely reported and in the books. But so far, this November has been different. Unseasonably warmer weather has swept across most of the US, leaving many hats, coats and scarves still safely tucked away. My sports teams are leading their divisions. And as of 13 November, 461 companies have reported their third-quarter earnings, only this time they have come in negative.

According to Bloomberg’s earnings analysis, third-quarter earnings declined by 4.5%, driven largely by the energy and materials sectors as well as by the stronger US dollar translation impact on foreign-derived earnings. These headwinds were identified before the start of the earnings season, but what we have since learned is how companies are guiding analysts going forward. It is here that we are getting a better picture of what to expect in the coming quarters, and unfortunately, it is not an encouraging picture. As shown in Exhibit 1 (below), analyst expectations for quarterly earnings per share will be sequentially lower in the next two consecutive quarters before showing signs of positive growth in the second quarter of 2016. Some of this weakness can again be attributed to the energy and materials sectors, but we are also getting signs of weakness from retailers.

Exhibit 1: Quarterly bottom-up earnings per share (EPS) actuals & estimates

FFTW1

Sources: FactSet Earnings Insight, 13 November 2015; Bloomberg

In the week of 16 November, the market was delivered a heavy dose of retail data, from corporate earnings and the monthly aggregate retail sales data from the US Census Bureau. Macy’s, one of the largest US retailers representing nearly 10% of softline (excluding autos, building materials, gasoline) aggregate retail sales, reported notably weaker-than-expected revenue. Part of the reason given for the weaker results was the unseasonably warmer weather as customers held back on purchasing winter items. The explanation sounds reasonable as other ‘bulge bracket’ retailers have given similar comments. But what struck me as most interesting was that the CEO of Macy’s, Terry Lundgren, was in attendance for the earnings call ― the last time he attended was for the fourth-quarter 2009 announcement. During the call, he made the following comment:

“We believe that the retail industry is going through a tough period. We seem to experience something like this every five years to seven years or so, and this one feels familiar in that regard.”

Some might call those ‘periods’ recessions, but I would not characterise the current economic data as recessionary. Instead, I would borrow a term from today’s youth and suggest the economic data and select corporate earnings are more ‘meh’. Which is to suggest that on aggregate, the data is okay; it is not great, and certainly is not bad.

Home Depot, the largest discretionary retailer, will report in the week of the 16 November, and this is likely to give the market more clarity on the US consumer.

Retail sales data released by the US Census Bureau on 13 November continued to show positive year-on-year growth, but growth was below historical trend levels. Exhibit 2 shows core retail sales, or what is frequently referred to as the retail sales control group. For much of the year, the series has been hovering around 2% ― which is rather unimpressive. But there were some positive signs as consumers spent on large-ticket items from autos and furniture to building materials, suggesting a higher degree of consumer confidence. One trend which continued was the consistent growth in online shopping, while brick-and-mortar (department) stores again showed a decline. Online retail sales now represent nearly 9% of total retail sales.

Exhibit 2: Retail sales year-on-year, excluding food, auto dealers, building materials, gas stations

FFTW2

Sources: FactSet Earnings Insight, 13 November 2015; Bloomberg

Looking at the longer-term weather forecast, it does call for colder weather, which means if I cannot find my safely-tucked-away winter clothes, I might head over to Macy’s ― or perhaps I will order them online while I sit in the comfort of my house watching my sports teams.

Dan Singleman

Senior Portfolio Manager, Sector Rotation

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