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"Risk happens slowly at first, then all at once."

Those are the words our firm's Founder and CEO Keith McCullough is fond of reminding our subscribers. It's in that spirit of risk management that we highlight a complimentary, extended excerpt of our Early Look market newsletter. While written most mornings by McCullough, today's is by veteran retail analyst Brian McGough. He shines a light on an important issue global investors should be keeping a close eye on.


...People are talking about Trump’s anti-China move in naming Dr. Peter Navarro as Assistant to the President, and a new role of Director of Trade and Industrial Policy. Seriously, the dude wrote a book called Death by China, describing the risk that China's form of capitalism and militarism poses to the future of the US. 

Yeh…I get it, protectionism is bad for Retail margins without a corresponding offset in the form of higher wages and stimulated consumer spending. In other words, a pair of Air Jordans may cost $50 more, but the consumer can afford it so it does not matter (well, not really, but that’s the Trump argument).

But what I think people are missing is that this would – quite rapidly – undo the biggest consumption trend most of us have seen – in any industry – in our careers. Consider the following.

1) Before 1994 there was a protectionist measure in place (simply referred to as Import Quotas) that limited quantities of apparel that we could import from non-WTO countries. Yes, that meant that we could only import fixed quantities of goods from these countries (let’s simply call all of those countries ‘China’ for arguments sake).

  1. That meant that we could only import about 1mm pairs of denim, a few million pair of socks, and maybe 200k ugly holiday sweaters, etc…
  2. This measure was lobbied by Warren Buffett and others who had acquired a nice little portfolio of North Carolina-based apparel manufacturing plants, and were threatened by Chinese labor.
  3. At that point in time, the consumption norm in the US was about 30 units per capita. Plainly put, each of the 270mm Americans alive at that time purchased an average of 30 garments per year. Yes..some bought 100, and some bought 3, but you get the drift.

2) HERE’s the key..Starting in the late 1990s, we started to see apparel import quotas phased out. It took the better part of 7 years – though the factories starting jockeying in price wars to secure a customer base in a post-quota environment. That, my Macro-Loving friends, was the beginning of tsunami of apparel deflation that lasts through today.  Consider the numbers…

  1. From the 1990s, we saw the cost of apparel come down by 5-10% per year – every year for two decades.
  2. Yet the CPI for apparel only came down by only 2-4% annually. So that means that the brands, retailers and virtually everyone in the supply chain had a multi-billion dollar kitty to boost margins every year (by about 700-1,000bps in total).
  3. That allowed the industry at large to both boost margins AND pass lower costs through to consumers in order to boost per capita unit consumption.
  4. That is anomalous in every way. Most of the time, when this happens we see either consumption OR margins take off. Not both. But in this instance, we saw both.
  5. The punchline is that this trend boosted per capita unit consumption to 84 units!
  6. I’ll say that again, the average number of units purchases by US consumers on a per capita basis more than doubled over 25 years.
  7. This is a paradigm change. People bought lower quality stuff at far lower prices, and simply cycled those every 3-4 years instead of every seven years (remember the 7-year fashion cycle? That was effect, not cause).


3) This ultimately took the barriers to entry down to the point where lousy brands (by our standards) could fill the shelves at the Kohl’s and JC Pennys of the world, and actually allow the bottom of the barrel retailers to earn money, while also allowing short-sighted investors to say ‘but they’re so cheap on cash flow’.

Here’s the killer chart folks.

Our Retail Analyst's 'Killer Chart' of the Day - mcgough chart