Holiday Shopping Season Recap: Overall holiday shopping reports appear to be very strong. According to a report by Mastercard, total sales for the period November 1st to December 24th grew by 3.4% from the same period in 2018. Online sales jumped 18.8% over the same comparison period. All of the major categories (apparel, jewelry, electronics/appliances, and home furniture/furnishings) saw increases over sales from last year. The only weak areas of the report came from expected places - department store in-store sales which saw a decline of 1.8%. This is more or less in line with U.S. Department of Commerce (DoC) figures for at least the start of the season. In mid-December, the DoC released its November report which showed retail trade sales up 3.1% over last year and non-store (online) up 11.5% in the same comparison period. This is also consistent with reports from Adobe which does an annual look at online sales for the Black Friday through Cyber Monday period. That report showed record numbers for both of those shopping events. In general, most reports seem to attribute the steady growth in spending on a strong job market with near record low unemployment and a soaring stock market which closed out 2019 at near all-time highs after a substantial recovery from the pullback we experienced in the fourth quarter of last year.
Our Takeaways: This was a very positive development for the U.S. economy. As we have highlighted in previous letters, the economy in the United States has been primarily driven by consumer spending so to receive validation of their continued willingness to spend is a good indicator. Underneath the headline numbers, we are continuing to see the development of trends that have been going on for the last few years as it relates to retail. First, in-store sales are declining along with foot traffic. This has been pretty well documented and reported on with annual measures of in-store sales and traffic falling by low single digit percentages year-over-year. Second, online sales continue to grow at double digit percentages year-over-year. This seems to be consistent across the industry and among product categories with the exception of traditional department stores which are only seeing their online sales grow in the high single digits year-over-year. Third, mobile has continued its dominance as the fastest growing segment for both online traffic and sales at nearly 50% year-over-year for the second year in a row. One thing of particular note when it comes to mobile is that there is a noticeable difference emerging in market share of traffic and sales when the data for online is broken down between mobile and desktop. While the trend appears to be that consumers are more willing to search for products on their phones, it is becoming clear that there is a decided preference for actually making purchases from a desktop. Finally, omni-channel still appears to have strong adoption. In-store pick-up of online purchases grew significantly again this year. The adoption of this model has been very helpful for retailers combating Amazon’s dominance since companies like Walmart and Target have a built-in advantage over the online giant due to their vast network of physical stores. One area of concern coming out of the holiday season were the reports of yet another increase in purchases that were financed with increased credit card debt. Although this trend has been going on for the last several years now without a noticeable or outsized effect on future consumption, it stands to reason that there will eventually have to be a trade off in consumption to pay off the accumulated debt at some point.
The Service Economy Remains Afloat, Manufacturing Struggles: An early December report on non-manufacturing (otherwise known as service) based business activity came in below expectations, but still indicated expansion in this sector of the economy. One area that stood out in particular was yet another monthly decline in the amount of imports which has further plunged the service sector into contraction mode for this metric, but measures of new orders were once again positive indicating that firms are directing their purchasing power to domestic firms instead of turning to imports. Assuming all goes smoothly with the signing of the “Phase 1” trade deal between the U.S. and China, it could be expected that we see a rounding out in this decline of import purchasing, but we likely will not see a recovery in importing if and until the tariffs still in place on a significant number of Chinese goods are removed entirely. A particularly positive portion of the report showed a strong hiring trend for the sector despite a significant downtick from the previous month. This is in contrast with the manufacturing sector of the economy which has lost, on net, about 23,000 jobs in the last 12 months. Even though this is not a huge number, it is in stark contrast to the other side of the U.S. economy which is experiencing strong, albeit variable, growth in employment.
Our Takeaways: While there does not appear to be any relief on the horizon for the manufacturing segment of the economy, the continued strength of the service segment has been very helpful in ensuring overall economic growth. Probably one of the biggest things to note is the extent to which much of this growth in the service segment is coming from healthcare. From the most recent report, nearly half of the job gains came from the healthcare sector. We largely expect this trend to continue since the underlying drivers for this trend are coming from demographic changes relating to the overall aging of the population in the United States. Another segment that has done well, at least recently, is leisure and hospitality. Growth in the demand for jobs in this sector is generally viewed as a positive indicator for the economy since these jobs are servicing consumption that, unlike in an industry like healthcare, is generally discretionary in nature. Another aspect of December’s report that is generally positive is the extent to which the service segment of the economy seems to be dealing with the impact of the tariffs on Chinese imports. Given that segments such as manufacturing and farming have been highly affected by the trade war, judging by the dislocation between imports and new orders (the former being once again lower with the later maintaining strength), it would appear that service-oriented companies have a higher degree of flexibility in sourcing inputs. While it is probably the case that service oriented firms are less dependent on raw materials in general (e.g. a law firm whose cost of service is the professional staff it employs), the higher flexibility must indicate a greater ability to source inputs domestically rather than internationally.
A Few Things to Keep an Eye On: As we start the new year, there are a few trends we are keeping an eye on. The first stems from a recent report from the Financial Stability Oversight Council (FSOC) which identified non-bank mortgage lenders as being a potential risk to the economy. Of particularly interesting note, the report highlighted the systemic risk that comes from these non-bank lenders lacking deep capital reserves and their over reliance on short-term lending which is known to contract dramatically in times of financial stress. The report also identified non-financial company borrowing (read regular corporate debt) as a potential issue. This comes as no surprise since companies have been taking advantage of low borrowing costs for a number of years now and piling debt onto their balance sheets in favor of share buybacks or just outright holding cash. In a different vein, Ned Davis Research recently put out an updated series of charts which showed that the amount of capital deployed in money market funds relative to that in the stock market is near all-time lows. This is a slightly more nuanced look than other reports which have just noted that nominal values of dollars in money market funds is near an all-time high. The difference highlights the liquidity preference (or lack thereof) in the current market which some analysts view as an intermediate bearish signal.
Our Takeaways: The FSOC’s report on non-bank lenders presenting a potential risk to the economy is definitely worth taking note. In the aftermath of the Great Financial Crisis a handful of things have converged to create this risk. First was increased bank regulation. Traditional lenders, both domestically and abroad, were subjected to a much more restrictive set of policies relating to capital requirements and risk management metrics. This in turn led many banks to shift away from or drop entirely some of the riskier business lines or lending market segments. This then created an opportunity for private, specialized companies to come in and take market share for lending products in areas such as first-time homebuyers or lower income borrowers. The other convergent trend was lower yields. Globally yields have essentially fallen through the floor causing large pools of capital (such as those found in pension funds and endowments) to become even more creative in finding ways to deploy this money. Despite this giving these private lenders an abundant source of capital from which they are able to make loans, it would appear that with such a tremendous need for capital deployment there is concern that these private lenders have gone too far. Another metric we keep an eye on when following this trend is credit quality. This is, in simple terms, a way of measuring the lender's ability to protect itself in the event of a borrower default. Particularly in the last few years, credit quality has deteriorated considerably without offsetting increases in the cost of borrowing (expressed in higher yields at issuance) all while originations are pushing ever higher. The big concern is that when economic conditions start to deteriorate and defaults begin to rise, these non-bank lenders will be ill prepared and their financial backers will bear a larger than expected share of the losses. Turning to the Ned Davis charts, this nuanced breakdown of deployment in capital markets paints a clear picture of where we stand currently. The obvious takeaway is that while there is a considerable amount of cash invested in money market funds compared to years past, on a relative basis, investors are highly invested in equities. This is typically congruent with late cycle investment behavior since investors are viewed as wanting to be as involved as possible with the bull market run and have a fear of missing out on further gains since they may have been late to the party, missing out on the beginning of the rally. For this reason, and as noted above, it is viewed as being intermediately bearish for markets since the lack of marginal cash to purchase more structurally limits future buying activity (i.e. reduces the number of would be buyers in the market) and creates the opportunity for more would be sellers.
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