In a recent news article published by SeekingAlpha, the headline reads Retail stocks jump as investors adjust again to Trump. I'd like to present another possibility.
On Tuesday morning, January 17th, William C. Dudley, President and Chief Executive Officer of the Federal Reserve also made his remarks at the National Retail Federation Annual Convention at the Jacob K. Javits Convention Center in New York City. The title of the speech was Evolving Consumer Behavior. It was sent out to members of the public at 8:47 am via email. The speech was a 'market event' for analysts and traders, which is the reason the market rallied, but don't expect the jump to hold.
What Did Dudley's Speech Say
In a nutshell, the speech said the challenge in the retail sector is not the economy or lack of money, but changing consumer demand.
Dudley begins the speech by discussing the importance of the retail sector to the general economy. He says,
Retail activity plays a key role in the U.S. economy, with consumption comprising about two-thirds of total gross domestic product. As such, understanding what is happening in your sector is critical in assessing the economic outlook-and, with that, the outlook for employment, inflation and interest rates.
Dudley then goes on to explain why he believes consumers aren't spending as much as they have been in the past under similar market conditions. In other words, there's a general acknowledgement that the sector is facing some headwinds. Dudley believes one of those headwinds may be an unwillingness by the consumer to take on more debt. He believes the unwillingness is due to "some dramatic changes that have taken place in the way that households finance their consumption." Dramatic changes eh?
"I believe-and hope to convince you," Dudley states, "that changes in the housing and mortgage markets have affected the willingness and ability of households to borrow, and that this, in turn, has had important consequences for the dynamics of consumption over the last decade."
It appears as though Dudley is telling the retail sector, 'if the fish ain't biting, it's not your bank's fault'. Indeed, Dudley tells the sector that the more likely reason for a downturn in demand is driven by the consumer's change in appetite for debt. He explains to the audience:
In order to be able to assess the evolution of household finances more precisely, we worked with Equifax-a major credit bureau-to create a new database that tracks the credit files of a random sample of households over time. From this consumer credit panel data, we conclude that between 2004 and 2006, households were increasing their cash flow by over $200 billion a year by borrowing against their housing equity collateral. They supplemented that with another $185 billion through non-mortgage borrowing. So, at the height of the boom, annual consumption was being supplemented by around $400 billion in cash flow from debt, much of it collateralized by housing.
There are many ways to interpret this data, but it appears to be saying that the only way for retail to return to the glory days had between 2004 and 2006 is for the average consumer to be laden in debt. It isn't that the banks aren't lending, it's that the consumer isn't interested in the lending game.
The Impact of Less Debt on The Retail Industry
I think it is fair to say that the basic assumption here is that it is normal for households to use debt to finance retail purchases. Indeed, the boom the economy experienced running up to the Great Recession appears to be financed. In a way, Dudley is saying that the banking industry will no longer be able to subsidize the retail industry if the consumer isn't willing to take on more debt. At the very least, the consumer appears to have developed a more discerning regard for debt.
In a nutshell, Dudley believes that households are "scarred" from the Great Recession and therefore more reluctant to finance a boat with home equity. The challenges in the retail space over the near term, therefore," said Dudley,
are not likely to be a shortfall of aggregate demand from households. Instead, it seems to me the challenges lie more in how to satisfy households' changing demands for goods and services, and the medium through which these demands are satisfied-whether it be brick and mortar or online. Also, there is the important issue of how to retain brand loyalty in a world where information is ubiquitous and always near at hand, and it is easy to shift purchases among participants in the retail marketplace.
The jump in retail prices on the morning of January 17, 2017, had nothing to do with Trump. If you thought they did, you may have bought into the rally, which would have cost you.
In actuality, the rally was driven by a short-term boost in market volatility created by a speech that was far from optimistic about the retail sector. The best thing retail investors can take away from the speech is that consumers have room to take on more debt. The bad news is that they don't want to. This only confirms the coming race to the bottom in the retail space.
Congratulations to all traders that had sell stops at $45.00 on the SPDR S&P Retail ETF (NYSEARCA:XRT).
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.