Overall consumer debt is growing and should act as a wakeup call for consumers and banks.
Overall consumer debt is growing and should act as a wakeup call for consumers and banks.
Amazon and Sears share prices versus the broad market, rebased to 100.
Amazon and Sears share prices versus the broad market, rebased to 100.
Local retail sales growth.
Local retail sales growth.

Retail sales, a key indicator of the health of consumer spending, grew more than expected in the US and South Africa according to official data released last week. In both countries, consumption spending is the largest sector of the economy. However, the conditions in the retail sectors of these two economies are very different.
Confident consumers

In the US, consumers are doing quite well, but traditional retailers aren’t. US retail sales numbers (excluding car and fuel sales) grew by 3.2% year-on-year in July. Low inflation (below the Fed’s 2% target) is a benefit for consumers, since inflation erodes the purchasing power of each dollar (or rand) earned and spent. US jobs growth is around 1.5% per year, and this has seen unemployment halve since the depths of the recession. Average wage growth is still remarkably low at 2.5% given the low unemployment rate, since one would normally expect workers to have more wage bargaining power when jobs are plentiful. Still, it means that the overall wage bill growth (jobs growth plus wage growth) is around 4% per year. Not bad in a low inflation economy.
Unsurprisingly, consumer confidence as measured by the Conference Board’s long-running survey, is close to levels last seen in 2000. While the dollar amount of consumer debt has surpassed the 2008 peak (causing much consternation), as a percentage of household income, it has declined considerably from a peak of 132% in 2007 to 103%. More importantly, the cost of servicing that debt (i.e. interest payments) only amounts to 10%, close to historical lows thanks to rock bottom interest rates. Obviously further increases in rates could increase pressure on households, but a decade of relentless consumer deleveraging, together with low inflation, are making it highly unlikely that the Federal Reserve will hike rates aggressively. The consumer should therefore continue to drive US growth.
Retail apocalypse

It therefore makes sense that retail sales are growing strongly. However, 24 US retail chains have gone bankrupt in 2017, up from 18 in total during 2016. Surviving retail groups, especially big department stores like Sears, are closing unprofitable outlets. The combination of the growth of online shopping, oversupply of floor space and changing consumer behaviour (especially of younger people) has led to what is termed the “retail apocalypse”. Non-store (including online) sales as a share of total retail sales in the US has grown by a third over the past three years to almost 14%. Shopping malls are closing in droves, but then the US has the highest shopping mall floor space per capita of any country, several times the European average. One prominent bank predicts a quarter of US malls will close in the next five years. Over the past year, multiline retail shares have underperformed the S&P 500 by 35%, while clothing retailers lag by 30%. Meanwhile, the biggest of the online retailers, Amazon.com, has outperformed the S&P 500 by 13% over the same period.
US President Trump directly attacked Amazon on Twitter last week, saying it “is doing great damage to tax-paying retailers”. His other recent highly controversial statements have hurt his credibility with business leaders who are publicly distancing themselves from him. This further diminishes the chances of him passing growth-enhancing reforms.
Unlike in South Africa, US listed property companies tend to focus on a particular sector, and those companies (REITS) that own retail properties like malls have struggled with the EPRA/NAREIT US Retail REIT Index falling 24% over the past year. Sentiment has soured so much that three exchange traded funds have recently been listed, allowing investors to bet against listed bricks and mortar retailers. 
A good second quarter in South Africa

South African retail sales grew more than expected in June, rising by 2.9% from a year ago in real terms. For the second quarter as a whole, real retail sales grew by 2.1% from the first quarter. Since wholesale, mining and manufacturing data have also been positive, overall second quarter economic growth will be fairly robust, ending the technical recession. Nominal retail sales growth (including inflation) was 7.4% from a year ago, up substantially from January’s 4.5% growth rate.
The rebound in retail sales was fairly broad-based across the main categories. General dealers (which includes the likes of Pick n Pay and Shoprite) account for around 40% of the total and grew by 2.5% year-on-year. The best performance came from specialist food and beverage outlets (like bakeries and liquor stores), with 12.4% real growth. Clothing stores posted 4% growth, a substantial improvement from the first quarter when sales declined in real and nominal terms. Since much spending on clothing is discretionary, it would be one of the first areas where consumers cut back. StatsSA does not report separately on non-store sales, but combines it in the “other” category that includes jewellers, bookstores and second-hand stores. This category has increased from 8% to 12% of the total over the past decade, but it is not clear what portion of this is driven by online sales.
Outlook and investment implications

Since there is little to no formal jobs growth locally, income growth in the economy is only driven by wage and salary (plus bonus and commission) increases. Employee compensation (wage bill) growth slowed to 6% in the first quarter, having grown around 8% per year previously.  Fortunately, inflation is expected to ease further during the course of the year, helped by the appreciation of the rand over the past 18 months. This should increase real income growth. Like their US counterparts, South Africans also spend on average around 9% of disposable income on servicing debt (debt levels are lower, but interest rates much higher). Further interest rate cuts in response to a more benign inflation outlook will obviously also help consumers. But consumer confidence remains very low, therefore new borrowing should remain limited, meaning that a strong rebound in spending is unlikely.
Apart from a tough environment, local listed clothing retailers face increased competition from foreign brands. At the same time, several of them have also expanded abroad, and are no longer solely exposed to the local consumer (but they do face exchange rate hassles). Year-to-date, the sector is flat and lags the JSE All Share Index by 11%. The Food & Drug Retailers Index has outperformed the All Share this year.
Retail accounts for more than half the portfolios of the JSE SA Listed Property Index constituents (according to Catalyst Fund Managers). South Africa’s shopping mall floor space per capita is also very high and way out of line with other emerging markets, but unlike the US, South Africa is still adding mall space. Greater penetration of online shopping, which would probably require much cheaper and faster internet access, would therefore be a risk to certain property counters over time (others would benefit from increased demand for warehouse space). But the larger influence at this stage is the overall health of the consumer, which is stabilising at best.

Submitted by Dave Mohr (Chief Investment Strategist) & Izak Odendaal (Investment Strategist), Old Mutual Multi-Managers.