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November 2007
The Most Wonderful Time Of The Year?
The Most
Wonderful Time Of The Year?…Yes,
that’s right, the holidays are upon us.
The most wonderful time of the year?
Usually that’s the case, especially in terms of family
time. But this year it very well may not be the most wonderful time
of the year if you happen to be in the retail business. We’ll just have to see what happens. A number of week’s back, the good folks at the National
Retail Federation put out their forecast for upcoming holiday
season retail sales gains. Cutting
right to the bottom line, the sales gain estimate for this year
from this industry group heavyweight is 4%.
Not wildly bad in nominal terms, but if the NRF is even
close to being correct, this number would translate into being the
lowest holiday retail sales growth gain in five years.
And if you believe, as we do, that headline inflation stats are
not reflective of true domestic cost of living increases, then
this growth rate is not positive in real terms. Not too happy a thought.
As per the NRF commentary, “with the weak housing market and the
current credit crunch, consumers will be forced to be more prudent
with their holiday spending”.
Imagine that. No,
not that housing will affect consumer spending, as we’ve
personally maintained for many a moon. The
NRF actually had the guts to use the words "consumer" and
"prudent" in
the same sentence. That’s somber sentence structure and characterization if
we’ve ever seen it. These
folks must really be bearish, no?
Anywhere
You Go, I'll Follow You Down?...A
quick few comments on the most recent retail sales numbers for
September. Why? As we've been arguing, if history is
to be any guide at all, US consumption trends follow peaks (and
troughs for that matter) in housing market cycles. So too do
retail sales trends. Below is simply a little reminder.
As always, the National Association of Home Builders Index in blue
representing conditions in the residential real estate sector, which recently hit a record low. Along side is the
year over year change in the twelve-month moving average of total
retail sales; a statistical method of smoothing out what can be
volatile monthly retail numbers. The lead-lag relationships
between housing and consumption (directional change in retail
sales) are crystal clear.
Headline retail sales grew 0.6% in September, but stripping out the volatile auto and gasoline influence leaves us with 0.2% growth. Nothing to write home about. Importantly, the standout characteristic of the this report was that discretionary retail spending was weak. Down month over month numbers in furniture, clothing, and general merchandise retailers. Restaurants flat for the second month in a row, quite unusual for late summer. Lastly, building materials was a complete non-event, barely registering a positive number. Alternatively, non-discretionary retailing held up, as you'd imagine it would. Importantly, we need to keep a very close eye on the discretionary components of retail sales as we move ahead. That's where weakness will clearly show up first if indeed macro consumer spending is now in the process of slowing from here. And after all, holiday retailing is all about discretionary spending. Remember, forget the retail sales headlines. It's the details underneath the glowing red neon headline that will be most important looking forward. The bottom line being that as we move ahead, all eyes should be glued to the discretionary components of the retail sales report. As a bit of a corollary to these comments, it's absolutely our impression that as the headline equity indices have moved higher over the recent past, the rise is being built on the back of ever narrower participation. As a very generic comment, in the domestic equity markets it's the big caps that have led the way (those companies capable of generating meaningful foreign revenue and earnings growth), along with a number of momentum favorites that have experienced near vertical price runs since summer. As you know, the big caps are academically weak dollar beneficiaries. Very quickly, here's a rather lengthy chart showing you exactly what we're talking about. Yes, new highs for the large cap dominated SPX recently, but the Transports, Banks, Retailers, Techs (as measured by the SOX), and smaller caps have not followed. Of course this list of sectors is far from being comprehensive, but neither has been the character of the equity rally to date. A rally also lacking in volume conviction, except on downside days, which is more than clear.
As of now, it
just so happens that the retail sector is yet another large equity
sector not following the major averages to new highs recently, at
least not yet. Are new highs in the retail sector stocks as
a group in the cards somewhere down the road? Usually the
fourth quarter is a period of seasonal strength for retailing
stocks, for very obvious reasons. History is pretty clear on
this consistency, in good macro market environments and bad.
For now, no 4Q retail rally in sight. A break with
historical rhythm.
For a number of retailers, the entire year is really made
in 4Q in terms of fiscal earnings.
Our answer to the question as to whether the
retailers will catch up to the major averages would be "it
depends". It depends on whether retail sales turn back
up on a trend basis from the clear decline you saw in the first
chart. And that's going to have to happen fast. Will the holiday season ahead do the trick? Not
according to the NRF. Although
we hate to sound like we're stretching for a rationale or
coincident relationships, as we look at the transports and the
bank index (BKX) in the chart of equity sector relative price
movements above, to us they symbolize two
concepts central to the reality of the US economy – the credit
cycle (banks) and consumption (transportation of consumer goods).
Both are much nearer to their August lows than not.
What are they saying in a collective sense?
And is the NRF telling us exactly the same thing vis-à-vis
the US consumer?
Below, we're
again looking at the smoothed retail sales trends used above in
the top portion of the graph. This time it’s being
compared to the longer-term directional movement with the S&P
retail index itself. It just so happens that in early 2000,
the peak in the actual retail data we prefer to use coincided almost
directly with the peak in the S&P retail sector. In like
manner, the bottom in 2003 for real retail trends coincided with
the bottom for the stocks that represent the sector. The
point being that stock prices followed industry fundamentals. As
you'll see, interestingly the latest retail sales trend peak in 2006 was
not a peak for the retail stocks, that along with the major equity
market
averages blasted off in the summer of last year. So we now
have a prior twelve month divergence between the direction of
stock prices that represent the sector and actual fundamental
results.
It virtually goes without saying at this point
that if indeed the macro equity markets are to move higher in a
very healthy manner ahead, multiple lagging equity sectors of the moment
have one heck of a lot of catching up to do. Retail
included, especially important for an economy driven by credit and dominated
by consumption. As of the end of October, the S&P retail index is
barely off of the summertime August closing lows.
In the following chart you can see exactly where we stand at the
moment. Moreover, as we've noted, the retail sector
participated meaningfully in the broader equity market celebration
rally post the first Fed rate cut in September. Price
response of the retailers post the second rate cut in late
October? The S&P retail index couldn't even muster a
mildly positive day. The retailers are telling a story to
those who choose to listen.
One last comment before we head off into this most wonderful time of the year. We've suggested many a time in the past that some of the market's most meaningful messages are found in divergences. As we've shown you above, our current environment is littered with such divergences. Divergence between the headline equity averages and the transports, the banks, many a non-bank financial sector, the techs as represented by the semis, and the retailers. Additionally and quite importantly, at least as has been true historically, in monetary easing cycles past, top equity sector performance has been seen in the financials and the consumer discretionary stocks (the retailers). So far in our current rate cutting cycle, the financials and the consumer discretionary stocks are in an all out race for dead last in terms of relative S&P sector performance. This is clearly a major divergence with past macro equity market response in prior monetary easing cycles. And so we're to believe this is a normal Fed rate cutting cycle where the domestic economy is stimulated, borrowing and spending increases in response to lower rates, and everyone lives happily ever after? At least for now, the collective message found in these glaring divergences of the moment is that the equity market itself begs to differ.
YEAR
2006 MONTHLY ARCHIVES
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Copyright ContraryInvestor.com © 2007