Holiday Sales Won't Be So Jolly

Includes: SPY, XRT
by: Taesik Yoon, CFA

The National Retail Federation (NRF) recently released its forecast for sales for the upcoming holiday shopping season. The trade group projects sales covering the 55 days in November and December to decline one percent from the prior year to $437.6 billion.

Despite the expected decline, this would be a marked improvement over the 3.4% drop experienced in 2008—the first decline in holiday sales since the NRF began tracking industry sales in 1992. There are probably some that believe sales will be even better. They point to the recovering economy, the rise in equity values, and the reduction in overall consumer credit balances as reasons why Americans may be more optimistic about their financial security heading into the holiday season. This could induce greater spending than in 2008 where all of these metrics were trending in the opposite direction. Additionally, there is an extra shopping day between Thanksgiving and Christmas, which should also provide a boost.

But I don’t see it. In fact, I think it is quite possible that holiday sales will be worse. There are several reasons for my pessimism. The most significant of these is the pervasion of the value/bargain hunting mentality that has swept across the country. A recent article by the Associated Press titled Great Time for U.S. Consumers: America on Sale highlights this shift in mindset. Examples mentioned include everything from rare discounts on Tiffany engagement rings to lower spending on premium dog food.

Some may call this a trend. But I view it as more of a lifestyle change, which is typically longer lasting. This change has been fueled throughout the year by an absurd level of promotional activity. Value is everywhere. Airfare is cheaper, rents have come down… Heck even the Yankees just cut the price of certain seats at Yankee Stadium by about half. As such, I believe it will be difficult to get consumers to pay full price for anything during this holiday season.

Furthermore, it is possible that promotional activity may not be as heavy as consumers are expecting. A portion of the deals that consumers have come across over the past year have been due to aggressive inventory management. Retailers have been clearing out excess or past-season merchandise at sharp discounts as a way of improving cash balances and the overall health of their balance sheets. But many of these retailers are now very lean on inventory. This reduces the likelihood of excess supply as well as the associated markdown activity.

For example, it may be valid to question whether a consumer that paid $20 for a pair of jeans regularly priced at $69.50 during a denim sale (a promotion the Gap ran the first week of July) would be willing to pony up more during the holiday season. But perhaps an equally valid question may be whether the Gap will even run such a generous promotion during the holiday season now that inventories have come much more inline with the expected level of sales.

The change in tender mix is also very telling. Credit card usage (as a percentage of payment methods during the holiday season) rose in 2006 and 2007 while cash fell in both those years. The opposite occurred last year with cash usage rising and credit card usage declining. I believe the same trend will occur this year due to the aversion to credit many consumers have adopted over the course of the year. Credit card companies have also been extremely aggressive at reducing credit limits and become more stringent in approving new credit cards applications. These actions reduce the total pool of resources available to consumers to pay for purchases.

Then there are also the additional job losses since the 2008 holiday season. Indeed, according to the Bureau of Labor Statistics, the U.S. has lost 5.55 million jobs in the 12 month period ending in September. The number of workers that are underemployed also continue to climb, hitting 17% last month. No doubt this will also negatively impacting holiday spending.

The combination of all of these factors—value mindset, potential for less promotional activity, a shrinking pool of consumer credit/credit aversion, and the continual rise in unemployment—could prove costly for holiday retail sales. But more importantly, it could also prove costly for owners of retail stocks, many of which have fared extremely well so far this year. Indeed, the S&P Retail Index is up 36% year-to-date and a whopping 66% since its March 9th low. Some profit taking may be prudent. And while I would normally advocate booking profits in January in order to defer taxes on capital gains, in this case, that will probably be too late.