NEW YORK— The economic momentum that built through the first half of 2018 is likely to carry consumers along through the second half and a holiday season that should generate significant gains at retail. But macroeconomic and political developments could weigh more on the fourth quarter than is normally the case outside a period of recession, and they will almost certainly impact 2019.
With inflation creeping up and consumer confidence showing the occasional crack in its otherwise solid foundation, fourth quarter prospects, while strong by most reckonings, still may be buffeted by trade wars and rising interest rates among other factors. However, a general consensus of financial analysts, economists and industry consultants tapped by HOMEWORLD BUSINESS® is for a strong holiday season.
Comparisons will be challenging and proportional gains may not match last year’s numbers, but gains on that high-rolling holiday will represent significant advances for the retail sector.
Major retailers generally reported second quarter financial gains that have matched or beat Wall Street expectations, prompting many to raise their guidance for the remainder of the year. Although that’s a good signal as for second half sales prospects, retailers have established a higher bar for themselves they’ll have to work harder to negotiate.
Walmart was among those retailers who provided higher financial guidance numbers as it reported second quarter results, including sales, those for adjusted operating income and adjusted earnings per share. At the same time, Target picked up its full-year earnings per share guidance.
The need to make the new numbers in the second half looks to be a factor that could turn retailers aggressive in their approach to the market as the year winds into the holiday season. The inherent ability to meet those numbers and the degree of aggressiveness required to do so is bound to vary by retailer.
In a pair of research notes, Morningstar analyst Zain Akbari proved more positive of Walmart’s potential to continue in its upward momentum, particularly given the omnichannel advances it is making, than of Target’s ready ability. Akbari did note that Target is making strides in store modernization and fulfillment options, but noted that the company remains more vulnerable to competition than its Bentonville-based rival.
Akbari wrote that Walmart’s “considerable competitive advantages, borne of its brand and cost standing, should continue to translate well into digital retail as Walmart uses its buying power to enable its characteristically low prices.”
As such, Target may have to turn up the promotional juice to defend its market position and draw more consumer dollars in the second half, but in a way that doesn’t impinge on profits.
At the beginning of August, Morgan Stanley analyst Kimberly Greenberger, in a specialty retail, department stores and off price industry review, noted that, as the second half began, the consumer ability to spend remains “robust” with unemployment at its lowest ebb since 2000. She cautioned, however, that consumers are more interested in spending on experiences than was once the case and that they face pressures on their discretionary income, including rising fuel prices.
Upmarket consumers in the luxury segment continue to purchase based largely on Wall Street, so they’ve gradually been spending more since the 2015 stock market correction, while, on the flip side, 18 states have raised their minimum wages in 2018, affecting 4.5 million workers, which represents purchasing potential in the second half.
Morgan Stanley analyst Simeon Gutman, in a research note weighing cyclical and internal drivers in recent sector gains, observed that, in the second quarter, retailers delivered some of their best comparable store sales figures in recent memory, He highlighted three favorable factors going forward: the strong macro environment including consumer spending, better retail execution including better omnichannel performance and big players taking share.
Retailers enjoy significant momentum going into the second half but face some speed bumps, Gutman noted, including a less favorable consumer spending backdrop with real wage growth slowing and tax reform benefits being less influential versus last year.
Among retail observers, the consensus is that conditions favor a happy second half at retail with a few concerns that might disturb the remainder of 2018 only slightly but 2019 more significantly.
The Conference Board reported solid gains in consumer confidence for August. However, consumers had mixed feelings about the labor market. The percentage saying they expect more jobs to open in the months ahead decreased from 22.6% in July to 21.7% in August, yet those anticipating fewer jobs also decreased from 15.2% to 14.1%. Overall, consumers felt better about the economy at present, including their short-term income prospects, but were less enthusiastic about future conditions.
In introducing the Conference Board August numbers Lynn Franco, the organization’s director of economic indicators, said, “Overall, these historically high confidence levels should continue to support healthy consumer spending in the near-term.”
As Housing Goes…
Second half prospects for home furnishings and housewares look good in the larger economy, however, the developments in the housing sector complicate the outlook. A surging real estate market suggests that home-related product categories should get a boost as consumers get and give gifts meant to cozy up new and remodeled living spaces.
Yet, in the new home market, where the U.S. Census Bureau recently reported housing starts are down, softwood tariffs already are driving up costs. With home builders already facing challenges finding labor and affordable land to develop, any price rise in new homes could drive consumers into the market for existing homes, eventually making housing less affordable to many consumers.
According to the National Association of Home Builders, the Trump administration’s 20% tariffs on imported Canadian softwood lumber are increasing home construction costs particularly because U.S. domestic production of the commodity is insufficient to meet demand. Recent record high lumber prices have increased the price of an average single-family home by $7,500. The additional cost has priced more than 1.1 million U.S. households nationwide out of the housing market.
David Logan, NAHB director, tax and trade policy analysis, noted that home prices already are growing faster than wages, which is another factor that can complicate prospects in housing, and that many Millennials suffered not only unemployment but underemployment in the post-Great Recession environment, making them less able to purchase homes and further suppressing demand in housing.
Housewares and furniture providers who are closely aligned with the new home sector, such as major appliances, are likely to feel the effect of housing troubles most while those that are less a new-home purchase priority should be less impacted.
Still, Logan said, “The saying is: As goes housing, so goes the economy.”
Will Trade War Impact Momentum?
In looking at factors that might impact consumer spending in the second half, Neil Stern, senior partner at consultancy McMillan Doolittle, noted, “Macro economic factors will be the big issue. There is a ton of momentum coming into the holiday with
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overwhelmingly positive indicators. The one wrench is the potential impact of tariffs and an all out trade war. Retailers have needed to forward buy in anticipation of certain tariff measures, but this could derail the economy in a hurry. My point of view is that it doesn’t reach that level but it’s the biggest concern.”
A National Retail Federation and Hackett Associates Global Port Tracker August report indicated that container movement gained 7.8% in May, the latest month for data collected, with NRF vp/supply chain and customs policy Jonathan Gold saying, “Tariffs on most consumer products have yet to take effect but retailers appear to be getting prepared before that can happen.”
Stern said that tariff-conscious retailers who are building proportionately more inventory for fourth quarter purposes who also, in many cases, recently upgraded their guidance based on the consumer momentum that buoyed them in the second quarter, could find themselves pressured to promote more heavily than they might want. Major retailers who have the most resources at hand may put promotional pressure on the market early.
“It can turn into a frenzy pretty fast if early returns aren’t good,” Stern said. “Walmart’s strength coming into the holidays will pressure everyone else. And look out for 2019 when tax cuts have cycled.”
Still, what may initially look like a negative may turn into a positive for retailers who can be creative in their approach to the consumer and disciplined in their approach to business.
Jaysen Gillespie, vp/head of analytics and insights at Criteo, which operates an open Internet advertising platform, pointed out, “Inventory and pricing strategy is the name of game in the fourth quarter this year. The stakes are higher if you are front-running a tariff. You are gambling on getting profit on stuff that moves.”
Ryan Fisher, partner in the retail practice of global strategy and management consulting firm A.T. Kearney, said conditions warrant cautious optimism on retailers meeting their revisited financial guidance, with even concerns about inventory at least partly exaggerated, as not all participants are purchasing to get ahead of tariffs.
“From a consumer spending perspective, nothing is going to shake that,” he said regarding the second half. However, he made the point that retailers have made significant commitments to online and delivery operations, so their e-commerce capabilities and logistics could be challenged. So, any failures along the lines of Amazon’s partial web collapse on Prime Day could cost consumer confidence as wells as sales.
Andrew Duguay, senior economist at Prevedere, an industry insights and predictive analytics firm, said that retail is poised to have a solid or better second half.
“The thing that I’ve been telling our customers is we’re in a unique time where all the numbers are looking pretty good,” he said.
However, as he looks at the far horizon, Duguay said he’s more cautious. “One thing is, we’ve never seen a delta this large between consumer confidence and what people are taking in take-home pay,” he said.
Although it may not be substantial enough to generate attention of consumers, consumer discretionary income is eroding. At the same time, some business categories including construction, manufacturing and transportation, are facing skills gaps that hurt both production and productivity. In that environment, income stratification is occurring and, with tariff effects, economic gains are geographically uneven, which means that some parts of the country are going to generate less purchasing as soon as the holidays.
Even if their immediate impact isn’t powerful, tariffs will impact the U.S. economy and consumer spending next year and perhaps beyond. How that will play out is difficult to predict, said Philip Nichols, Wharton School professor of legal studies and business ethics who focuses on trade issues. World trade conditions, he said, given factors including U.S. and retaliatory tariffs, and Brexit, could realign the global economy in ways that could hurt American consumers even if other developments are more likely.
“The more orthodox thinking is to focus on three possible scenarios: tariff struggles that do not lead to an all-out trade war, which would just cause some price and supply chain disruption, a trade war in which everyone suffers a lot, and everyone else blinks, which would perhaps lead to reduced trade barriers in major trading countries, including the U.S., from which most people would benefit. Given the possible fragility of the economy right now— because in these times of growth the U.S. has been pursuing policies usually undertaken during recessive periods, which leaves the U.S. economy quite vulnerable to shocks— one has to be especially concerned about possible trade wars,” Nichols said.