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After strong gains post the US presidential election, global equity markets grew at a more moderate pace by the end of February: for the month, US equity indices advanced with low single digit rates, whilst Europe and Asia were roughly flat. The more subdued mood amongst equity investors can partially be explained by the lack of detail regarding US fiscal policies and the Finance minister’s indication that these plans will be introduced by August (and not during the first 100 days of the new US administration). Also, a number of FED officials suggested that a March rate hike would be possible, which is shifting investors’ attention away from Trumponomics and towards monetary policy.  

Meanwhile, global economic data continue to point towards accelerating growth. In Europe, a major leading indicator - the so-called composite PMI - jumped to 56 in February from 54 in January (readings above 50 indicate future expansion). The most impressive recent statistic was the major jump in US retail sales. Investors should, however, take into account the structural under-currents of consumer spending:  there is an increasing gap between winners and losers amongst consumer companies, as Ecommerce is rapidly becoming the dominant distribution method.

Retailing: Ecommerce accelerates

The first surprise regarding incoming economic data this year was the release of US retail sales for January. Analysts were not expecting the acceleration in retail sales growth to more than 5% in spite of a drop in car sales. Given the importance of consumption to the economy, analysts are probably re-examining their economic growth forecasts for potential upgrades.

The composition of the US “shopping basket” is nearly as fascinating as the overall consumer expenditure. The increase in consumer spending is clearly not benefitting all retail categories: the underlying spending shift is showing signs of accelerating as illustrated in the table: the decline of sales at department stores is increasing whilst the growth in non-store retailers is showing the opposite effect.

us retail sales jan17

US Retail Sales Highlights– January 2017

An overview of the financial performance of retailers provides impressive evidence of the “seismic shift” in retail distribution. Ecommerce has caused what only can be described as a bloodbath amongst traditional retailers, with many falling short of critical solvency levels. Managers and investors have learned, often the hard way, that leasing contracts for shops (often for long periods and at expensive locations) are very real liabilities and mostly do not appear in companies’ balance sheets, though Dominion has long included such off-balance sheet liabilities in its proprietary company analysis. Insolvency often comes as a surprise for many and, in line with the unrelenting advance of digital channels, is becoming increasingly commonplace. In January, for instance, the US women’s’ apparel chain The Limited filed for Chapter 11 bankruptcy protection following a dismal list of bankruptcies of well-known brands over the last 12 months which includes Aeropostale Inc., Pacific Sunwear, Sports Authority, Vestis, and American Apparel. In addition, it is no secret that trading conditions for traditional department store chains such as Sears, JCPenny and Macy’s are worsening and forcing them to close an increasing number of stores. In contrast, Amazon’s US sales increased by 25% last year.

Whereas US retailing led the move towards ecommerce, the rest of the world is quickly catching up, and also, increasingly, showing signs of corporate stress at established brick & mortar chains. According to the UK Centre for Retail Research, three regional groups went out of business in February and The Post Office announced that it will close an additional 37 offices this year (after 62 branch closures last year). In the Netherlands there were already 3 retail bankruptcies in the first two months of the year.

 1703 outlook

SOURCE: Eurostat

So, what are the detailed product trends and is official data failing to capture the structural change in spending habits? One can observe that the US data, for instance, mainly seem to be based on a sample of traditional retailers (those that receive the monthly call from the Census Bureau) except for the bottom entry of “non-store” retailers, suggesting a sample bias toward long-established chains even as their influence declines, and against fast growing online retailers (many of whom are yet to be recognized by the US Census Bureau).

While the  UK’s Office for National Statistics provides more in depth insight with statistics of the penetration of ecommerce for each retail sector (see table below), we continue to observe the under-representation and under-estimation of ecommerce sales growth within retail. For instance the table has ‘All retailing’ internet growth of ‘only’ 10.1%, but this stands in contrast to other independent bodies estimates, such as +12% according to Capgemini and IMRG, and results from online-only (non-store) retail companies such as clothes retailer ASOS who saw sales increase +32% year on year in 4Q16, despite the official Non-store retailing statistics – which, as per the US, one would expect to be the fastest growing segment - showing the slowest growth at +6.7%.

There appears to be a consistent disconnect between survey data collected by government agencies and empirical evidence on the ground, therefore it seems logical to conclude that official statistics possibly under-estimate the significance of ecommerce and thus the growth rate of consumption in many economies. This means that economies, and consumption therein, may be stronger than incoming statistic data indicate because the seismic economic benefits of the Ecommerce consumption megatrend are not being accurately measured by survey methods that are lagging retail shifts.

Great Britain Internet Retail Statistics: January 2017

 britain internet sales jan17

Monetary Conditions remain supportive

Monetary authorities in the USA and Europe published minutes of their most recent meetings, which suggest that any threat to the economic growth momentum form excessive tightening is relatively small. Central bankers on both sides of the Atlantic opt to err on the side of caution and will only temper monetary growth with a lag to strengthening fundamental economic trends. To illustrate this policy, the minutes of the Governing Council of the ECB of its January meeting contain statements which are particularly relevant: “The balance of risks to the economic outlook was seen as remaining on the downside, with risks related mainly to the global environment, political uncertainties and continued balance sheet weaknesses in some sectors. It was nevertheless also noted that downside risks had receded somewhat, and the case was made that overall the risks surrounding the scenario of a gradually firming recovery were starting to become more balanced.”

The US recovery has, of course, gathered momentum over the last 12 months and the FED has therefore embarked on the process of normalizing monetary conditions in December 2015, followed by another interest hike in December last year. A recent complication has been the potential additional boost to the economy proposed by the new government. The Minutes of the Federal Open Market Committee (FOMC) state the following: “…the Committee might need to change its communications regarding the anticipated path for the policy rate if economic conditions evolved differently than the Committee expected or if the economic outlook changed. Moreover, most participants continued to see heightened uncertainty regarding the size, composition, and timing of possible changes to fiscal and other government policies, and about their net effects on the economy and inflation over the medium term, and they thought some time would likely be required for the outlook to become clearer.” In those Minutes the FOMC states that it saw the market’s expectations of a March rate rise as a 25% probability (and a June rate rise as a 70% probability). Comments from FOMC members Williams and Dudley at the end of the month, suggesting that a March rate rise would be possible, raised these odds to above 80% according to Bloomberg. Based on the FOMC’s policy stance however, any imminent further tightening will crucially depend on surprises regarding the economic growth momentum, tightening labour markets and rising inflation.

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The views expressed in this article are those of the author at the date of publication and not necessarily those of Dominion Fund Management Limited. The content of this article is not intended as investment advice and will not be updated after publication. Images, video, quotations from literature and any such material which may be subject to copyright is reproduced in whole or in part in this article on the basis of Fair use as applied to news reporting and journalistic comment on events.