“If you believe today's paradigm will not change, ask the caveman if his paradigms changed. If you think for yourself, you lose. If you think for coming generations you win.”
-Sameh Elsayed
Let's go ‘mega macro’ today. Keith takes his clients there every day, but in the world of Retail, I’m lucky if someone asks me about business trends as far back as three minutes. I can count on one hand the number of times someone asked me a question over the past year about what drove retail in the 23 years since I started my Wall Street career. And today, it might really matter for the first time in (my) forever.
Why, you might ask?
PMs and Traders whipped retail stocks around over the past week with the frequency of a cheap ham radio. I’d bet that most of them don’t even know why.
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.
Back to the Retail Macro Grind…
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).
- 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…
- 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.
- 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…
- From the 1990s, we saw the cost of apparel come down by 5-10% per year – every year for two decades.
- 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).
- 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.
- 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.
- The punchline is that this trend boosted per capita unit consumption to 84 units!
- 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.
- 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.
So, all people needed to hear last week was ‘anti-China’ and ‘Border tax’, and even without a comprehensive understanding of the depth and breadth of the impact this would have, they (rightfully) started rolling the dice on the stocks. Some stocks took it harder than others, but every single retail stock would and should go down in this instance – even AMZN.
In fact, I could argue that the perverse discounting we’d see out there would take away AMZN’s competitive edge – at least until we saw a wave of bankruptcies and consolidation that would allow AMZN to regain its positioning. $2,000 stock, huh?
I’d normally point out the winners and losers of a mega trend like this…but the reality is that everyone loses -- the consumer, the brands, the retailers, the consumer/retail equity market, and ultimately, President-Elect Trump.
And that is why my personal view is that this will never come to fruition.
Fortunately, we don’t have to rely on my personal view. Hedgeye has what many consider to be the best Policy research team on the Street. JT Taylor and his team are shoulder-deep in any and all things tax-policy related. Expect to hear from them – a lot – early in the New Year. Ping your Hedgeye salesperson for their work. It matters today more than it ever has.
This issue has been elevated to the top of our queue. Whether it’s going to happen or not is critical. We have to decide, first, if people are shooting retail stocks today with a Red Ryder BB Gun when they should be using a Bazooka.
Make it a great day, and an even better 2017.
Brian McGough
Retail Sector Head
