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Consumer Spending is Strong but Can it Show in Retail Results?

August 5, 2016
Consumer spending analysis and retail stock trading data.

All hail the consumer who accounts for 2/3 of the nation’s gross domestic product (GDP) by spending on apparel, food and beverage, home improvement, and an enormous assortment of other goods and services. And judging by the most recent GDP numbers, if not for the consumer, the anemic 1.2% growth in Q2 might have looked worse.

Consumer spending rose by a robust 4.2% in the quarter, according to the Commerce Department. In June alone, retail sales climbed 0.6% to set an all-time high of $457 billion, some 20.8% higher than the last cyclical peak of $378.4 billion in November, 2007, according to S&P Global. Can that momentum hold up through the third quarter?

“Retail sales continue to be the gift that keeps on giving,” says S&P Global. Indeed, the consumer is doing more than her fair share of keeping the cylinders of the economy firing, even if she has to dip into savings, as she did in June according to the Commerce Department. In the last three months, household spending has grown at its fastest clip since 2014.

Good News for the Economy, Right?

That should bode well for some of the nation’s largest retailers when they report Q2 earnings en masse later this month. Right? That might be true if the retail industry was an impartial creature. But it’s not, instead made up of a cluster of merchants who sell things that have absolutely nothing to do with each other, like sports equipment, gardening tools, sweaters, and couches.

And consumers are changing behaviors in big ways: increasingly blending shopping with online and in-store purchases, spending more money on “experiences” than “things,” and shelling out big bucks for big-ticket items like autos and trucks.

These behavioral changes will be on display when retail earnings pour out by sectors and individual merchants. Durable goods, for example, have long been the main driver of retail sales and may well be again in Q2. Those are the big-ticket items we buy that last a long time, like cars, computers, lawn mowers, and refrigerators—items that some retailers report have been selling well.

Nondurable goods, items like milk, socks, shoes, and medicines have experienced rough patches tied to consumer spending, and results may underscore that too. Earnings among the S&P 500 (SPX) overall have come in a bit better than the expected 5.2% decline so far, though are still expected to fall for the quarter. Of the 10 sectors, only four are projected to post increases and consumer discretionary is the leader, with a positive 9.4% forecast.

Where Consumers Consume

Retailers like Home Depot (HD) and Lowe’s (LOW), purveyors of home-improvement goods that consumers have snatched up in recent months, are projected to have much stronger sales results than the likes of department-store behemoths like Macy’s (M). Why? Because consumers are increasingly spending more money on homes and gardens than they are on bedding and kitchen wares, according to retail sales report. Plus, they’re finding cheaper alternatives to the traditional routes of department stores. And M, parent to Bloomingdale’s, is in the crossroads of those spending trends. That said, the Commerce Department report showed that purchases are broadening beyond just big-ticket items as the labor market shores up, and inflation and borrowing costs stay in low single digits.  

“The consumer is on a solid track,” Thomas Simons, a Jeffries senior money-market economist who correctly nailed the spending gain, recently told Bloomberg. “The momentum is going to continue into Q3 and is fueled by strength in the labor market.”

Meanwhile, the shift to e-commerce may boost results for the likes of China’s mobile e-commerce giant Alibaba (BABA) if Amazon’s (AMZN) recent results are any indication. AMZN handily beat earnings and revenue forecasts and upped its Q3 outlook, with thanks mostly to strong outcomes from its Prime and web services divisions. Analysts see AMZN, and by association BABA, as a “serial disruptor” that has worked its way into a number of categories—books, music, movies, apparel, cosmetics and electronics, to name a few—by selling products on thin margins. These thin margins can be viable when there aren’t hundreds of stores to maintain and sales clerks to pay like most brick-and-mortar retailers do.

AMZN is far larger than BABA both in market share and market capitalization (AMZN’s $364 billion market cap compares to BABA’s $207.9 billion), but the BABA’s sales’ trajectories tend to follow AMZN’s, sometimes to a great degree owing to BABA’s lower revenue base. But BABA earns some 60% of its revenue through marketing services, which analyst say are more resilient to merchandise volume growth. That’s important considering the tenuous economic position of China. Still, BABA’s Chinese e-commerce sales are nearly double its U.S. sales, which analysts attribute to a dearth of high-end brick-and-mortar stores on the mainland.

Willing Spenders

HD is in another sweet spot for the consumer, as Chief Executive Craig Menear boasted recently on CNBC. “We’re in a space where consumers are willing to spend,” he said, noting that sales are augmented by home-value appreciation, housing turnover and new-home formation. “Overall the environment in housing has been gold,” he said.

Like Q1, Menear said he’s seeing sales strengthen across the store, from windows, lighting, and building materials, to gardening and tools. Like he noted on last quarter’s conference call, Menear says big-ticket items, in the $900-plus range, are also powering better sales.

Plus, he said the trend for older adults to stay put in their homes is helping HD as well. “It’s a positive factor if people aren’t moving,” he said. “We’re definitely seeing a benefit from that.”

No Help to Some Retailers

Part of the spending conundrum between Baby Boomers vs. Millennials is what they’re spending money on. Though Millennials are now the largest demographic in the U.S., they’re not the biggest spenders. Baby Boomers still are. And while Boomers may be sprucing up their homes, eating out at fancy restaurants, and taking extravagant trips, they’re not spending on hip new outfits, trendy shoes, or potpourri. That’s not to say Baby Boomers don’t care about their appearance—cosmetic surgery sales are soaring—but they’re more content wearing stylish, more age-appropriate wear that will, well, wear well.

Meanwhile, Millennials are finding hot, chic trendsetter clothing at discounters ranging from Target (TGT) to H&M (HM-B). It’s mostly throwaway clothing, the quintessential nondurable, which they can replace a few months after purchase for relatively cheap. That has also helped sales at Five Below (FIVE), Big Lots (BIG) and Dollar General (DG), as well as other discounters like T.J. Maxx (TJX).

M was among those that missed Wall Street’s expectations in the prior quarter and offered downbeat forecasts moving forward. Weak demand for apparel forced M to cut its full-year forecast. How will Q2 shake out? Trends were improving in May and June, according to Cleveland Research, but took a sharp turn lower in July.

Here’s where the dipping into savings to buy stuff begins to matter, according to analysts. It means that current robust sales levels are not sustainable. Consumers can only tap savings so much. And department stores like M as well as those ranging from Kohl’s (KSS) to Nordstrom (JWN) are vulnerable.

“Items like clothing are among the first things that are going to get cut out of that spending,” Bridget Weishaar, a Morningstar analyst, told Bloomberg. “The fact that department stores are down more than other brick-and-mortar retailers doesn’t surprise me,” she added. “The most exposed to e-commerce are the department stores. They’re carrying the same merchandise, and the in-store experience isn’t spectacular. So they’re losing foot traffic, and they’re discounting heavily.”

Given the spending mood of the consumer in recent months, investors will be listening for some insight from all retailers into the next quarter. Is this rampant consumer spending a blip caused by pent-up demand? Remember holiday sales weren’t exactly robust last year. Or are consumers getting out of their savings mode and back to buying on impulse, maybe even splurging?

Or, if the forecasts for an “auto recession” are correct after sales hit record heights, are consumers getting tapped out again? Time will tell.

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