As we head into autumn, investor attention turns to the holiday shopping season. It’s an economically important time: in less than three months, over 1 million people will be hired. That’s a massive boost to wages. For many companies, their profitability depends on strong consumer spending.
What happens over the next few months sets the tone for the 1H 2016 and determines business confidence, which in turn determines hiring and continued investment in equipment and so forth.
Plus, everything depends on consumer spending, which in turn is both determined and limited by wage growth. Consumers have not leveraged up in this cycle, using home equity loans and credit card debt to boost spending. For example, Revolving Consumer Credit (credit cards) is low in both dollar terms and growth terms, and that’s six years after the recession ended.
Instead of going into debt, households are living within their means: what they spend (personal consumption) is entirely dependent on the wages they earn. Wage growth and therefore spending growth have reverted back to the cyclical trend of 3-4% year over year.
Focus on Corporate Profits
If holiday season spending will be determined by wages, the next link in the chain is corporate profits. Why? Because companies hire and give bonuses and raises only when (1) they are profitable and (2) the labor market is tight enough. Corporate profits tend to lead hiring and wage growth because companies:
- Need to boost staff to meet rising demand
- Must pay more to attract and retain talent
- Can afford to hire and pay more
Put simply, if we want to predict holiday season strength or weakness – and invest accordingly – we should look at the current corporate profit picture.
Recent domestic non-financial profits have been robust, but wage growth hasn’t followed and hiring has sharply slowed (payrolls for August and September are half the levels of the previous months). That’s because companies are achieving strong profit growth in a flat-revenue environment only by keeping costs down, aka keeping a lid on hiring and wage growth.
John Chambers, the former CEO of Cisco, was famous for telling his sales team that he expected 10% sales growth and if they delivered below that, then he had too many sales people. The point here is that companies start with an expectation of sales per employee and then look for efficiencies. When revenues aren’t growing, not only is hiring going to be stopped, but some amount of firing is next.
Looking forward over the next year, domestic profits remain strong (especially ex-energy), but growth is both mild and slowing. Per Factset, 3Q revenue growth guidance for the S&P 500 is:
Low single-digit revenue growth will not drive much hiring or create wage pressure. For 2H 2015, companies are expecting low revenue growth, which is forcing them into a more defensive wait-and-see posture. Naturally it all looks different for next year (doesn’t it always?). S&P 500 companies forecast almost 9% revenue growth.
Turning back to the next few months and this holiday season, however, corporate frugality is translating into milder employee expectations regarding bonuses and raises.
The Vice Spending See-Saw
In another sign that households may be getting a little more frugal, vice spending popped over the summer but it’s already retreating. There’s a certain consumer retrenching in the face of no signs of big raises or big bonuses and lingering stock market doldrums.
Supply Chain Indicates Mild Growth
By the time retail sales go ballistic in December, the import activity is already winding down. In order to get stock onto the shelves, toys and clothes have to hit the docks in September. To get a sense of retailer expectation based on the amount of stuff they have ordered, study the activity at the ports of LA and Long Beach. These are the major ports for Chinese imports, which form the backbone of the holiday shopping season. Note the recent upturn in cargo imports through August.
Building on the insight from import traffic, Hackett Associates tracks all US ports and forecasts total US cargo import volumes to grow 3.9% this year, about half the pace of last year.
Conclusion: Holiday Season Will Disappoint
Retailers are positioning for sales to be higher than last year, but only slightly (based on their import volumes). In the same vein, consumers are set to spend more than last year, but only a bit.
Avoid stocks and ETFs in the following areas:
- Consumer discretionary
- Consumer services stocks
- Gambling
- Travel
For example, cruise ship companies and casinos depend on mad money. They are luxury companies with global exposure and unfortunately face a convergence of global and US consumer spending slowdown.
There aren’t great inverse ETFs for these areas, but investors with a strong risk appetite could consider long-dated puts on long ETFs. For example, the March XLY $69 Puts are $2. The ETF is trading ~$76, so a 10% drop is needed, and the ETF recently dropped 5%. But we don’t need a full 10% drop to be profitable. A 5% drop in the ETF in the next three months would probably boost the value of the puts by 30%.
