The outlook for retailers this Christmas

This week in Talking Finance:

• Julia Lee, Equities Analyst at Bell Direct tells me what the markets have been up to;
• Stephen Koukoulas, Managing Director of Market Economics checks the pulse of the economy;
• Malcolm Farr, National Political Editor for news.com.au updates me on the performance of Prime Minister Scott Morrison; and
• David White, Retail, Wholesale & Distribution Group Leader at Deloitte tells me what’s in store for retailers this Christmas.

Hello and welcome to Talking Finance, I’m Alan Kohler.  There’s a lot going on in the markets at the moment, the US market is up and down like a bit of a yo-yo, mostly down, so we’ll talk to Julie Lee, Equities Analyst at Bell Direct to find out what’s going on; Stephen Koukoulas, who will give us the pulse of the economy; and Malcolm Farr will bring us up to date on Politics and how Prime Minister Scott Morrison is going.  Also, Christmas is approaching so let’s talk to David White who is at Deloitte’s, in charge of their annual survey of retailers about how they see Christmas, which I think is worth talking about.

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And now for her take on the markets, here’s Julia Lee, Equities Analyst at Bell Direct.  Julia, things have got a bit bumpy on the markets at the moment, what’s behind that?  

JL:  We have seen increased volatility and I guess it stems mainly from the US.  Markets are a little bit nervous about valuation, given that there are signs that earnings growth could be rolling over.  When we’ve see an earnings growth so strong in the US for S&P 500 companies, six out of the last seven quarters have seen double digit growth.  In fact, the recent quarterly earnings season, we’ve seen growth of around about 25%.  The view is that this can’t continue forever, especially as those tax cuts roll off and the market’s getting increasingly worried about valuations in a softer growth environment. 

We have seen in particular technology stocks here and the worries are that we have seen a peak in the cycle for growth for technology earnings as well as for margins in that space.  In particular, Apple has been in the spotlight this week.  It’s interesting watching the US indices perform.  This week we saw all three of the major US indices, the S&P 500, the Nasdaq and the Dow Jones Industrial Average all dipping into the red for the year, and of course the Australian market following suit.  After what’s been a pretty terrible October for the Aussie share market with a fall of 6.1%, we’re following that up in November we’ve increased volatility once again and we’re tracking for a 3% fall for the month of November.  

It is interesting to talk about those indices because the world’s biggest company, Apple, which you mentioned just now, is in all three of them of course and is having an impact on all three of those indices.  In fact, Apple – I was looking at it last night – it’s down nearly 24% over the past couple of months.  I suppose in the technical sense it’s a bear market for Apple.  

JL:  It is a bear market for Apple and the fears are that iPhone sales are slowing down.  I guess just overall from an investing point of view it does become more difficult to make money in a stock when you still see growth coming through for a company, but you see slower rates of growth.  The fear is that the growth rates for Apple from here have peaked and it’s going to be much harder to grow their earnings further from here.  I guess we’re going to see a slowing down in terms of growth and that’s the fear of the market and that’s what’s started to be priced in.  It’s been a pretty dramatic reaction by Apple shares.  As you mentioned, Alan, the last couple of months we’ve seen a 24% decline.  But just in November to date we’ve seen a 19% decline in Apple shares and with that being a major component especially in the Nasdaq Index that’s had a big impact, not only on sentiment in the US, but globally as well.  

I suppose you’d call Apple a global market leader and if it’s down 20% in not very long then that’s going to impact everyone, isn’t it?

JL:  Absolutely, and I guess from a more macro point of view, the US Federal Reserve is now considerably down that path of tightening, already now beginning to impact on the economy, and the fear is that that impact will continue on especially with those trade tensions between the US and China.  Next week’s going to be a huge week because there are going to be talks between President Trump and President Xi.  At this stage I guess the market’s thinking that the best case scenario may be just to delay moving those tariffs on Chinese goods into the US from 10% to 25% at a later date than 1^st of January. 

Especially given the tensions that we saw between China and the rest of the Asia-Pacific countries at that APAC conference on the weekend.  The fear of the market, I think, is twofold.  One, that we are seeing growth rolling over in S&P 500 earnings.  Also, we are seeing as a consequence, global growth looking to roll over as well.

Thanks very much, Julia.

JL:  Thanks, Alan.

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Now, to talk about the economy, here’s Stephen Koukoulas, he’s got his own blog called Market Economics and he’s also Chief Economist for Dun & Bradstreet.  Stephen, I was struck by a tweet that I saw the other day by you saying that wealth destruction in Australia over the past year is something to behold.  I think you’re saying that it’s getting close to half a trillion dollars.  How do you arrive at that sort of number?  That’s quite large.  

SK:  Yes.  Two things are unfolding.  The bulk of our wealth, that’s us Australian households and consumers, is tied up in housing and in the stock market either directly through our share ownership or through our superannuation fund.  Since the start of this year, we know that house prices nation-wide, which of course is how we should look at it, are down around about 5.5% or thereabouts and given that the housing valuation was about $7 trillion dollars at the start of the year, 5.5% of $7 trillion is about $350-375 billion dollars.  Now, not all houses are held by the household sector, some of them are held by foreigners, so that’s why it’s an approximate number. 

We know that the ASX – oh my goodness, it’s had a troubling last couple of months and a pretty soggy year, to be blunt.  It’s probably dropped in value from the start of the year, not the peak in August but from the start of the year, by about $100b.  Some of that of course is held by foreigners as well.  It’s not all the household sector, but the point of the tweet and some of the analysis I’m doing on the topic is that we householders have lost an awful lot of wealth in the last year or so and I think that’s going to have an impact on our sentiment and our spending. 

What is the connection?  Can you kind of describe to us the connection and how close it is between what’s called the wealth effect and things like employment and GDP and so on?

SK:  Yes.  There’s a strong correlation.  There’s been lots of academic research globally that does look at the link between changes in household wealth and changes in the momentum of household spending.  And while there’s a little bit of a discussion about the order of magnitude of the change in wealth and its impact on spending, there’s nonetheless an undeniable correlation.  When we’re having higher wealth through either a stock market rally or house prices rising solidly, we tend to feel more comfortable, we tend to be reducing our savings because we don’t need to save as much. 

All of a sudden, our other assets are worth more, so our discretionary saving declines and spending goes up.  We also tend to be able and willing to borrow more money, so our borrowings go up.  And of course, the opposite is true in a period where we’ve got this decline in wealth.  A nice little example is if you look at say, the Sydney and Melbourne housing markets, versus Western Australia and Perth for example, when Sydney and Melbourne were booming up until the latter part of last year, consumer spending in Sydney and Melbourne was the strongest in the country.  When Perth house prices were falling, WA consumer spending was the weakest in the country, so that was a mini example of that.

As we get towards the end of 2018 and this wealth decline, housing decline, stock market weakness prevails, there seems to be a pull back in what we consumers will be spending in the Christmas period and probably into the New Year as well.  That reduces some of the demand for workers and then you get just a slowing in the rate of economic growth.

I saw David Scutt of Business Insider tweet a graph the other day showing that employment tends to follow wealth after about six months, so it’s quite a strong correlation.

SK:  Yes, it is, and Alex Joiner who’s the economist at IFM, the people looking after a lot of infrastructure investments for the superannuation funds and others, he’s actually done a really nice chart as well which does show the change in house prices plotted against real per capita growth in retail sales.  It sounds a bit of a mouthful but the correlation is very, very strong.

Where does that leave you and your views about interest rates?  Do you feel more strongly that the next move in interest rates will be down?

SK:  I think I am, yes.  I think that the RBA is still optimistic and I hope they’re right, in a sense.  I hope that we do get GDP growth locked above 3%, we get the unemployment rate well below 5% in the new year because that will lead to a wage and inflation pickup, so I hope they’re right.  But I’m really concerned that this wealth effect is something that they’re glossing over.  They welcome the fall in house prices and to give them their due, they did want housing to cool off and so in a sense they’re not yet terribly worried. 

But I think it might be a bit of a case of careful what you wish for, because there seems to be a further tightening in credit which perhaps they didn’t factor into their forecasts, that’s come from the banking Royal Commission, the change in credit provision from the banks and other financial institutions, that they are tightening in credit.  The last thing they want to do now is be having a dodgy loan exposed some time next year.  There’s undeniably a tightening in credit which I think will have an impact, so the RBA to me, they’re certainly on hold but I still think it’s a better than even bet that the next move is down and not up and that this time next year we’ll be looking at a cash rate perhaps at 1%. 

You’re certainly at odds with the Governor of the Reserve Bank.  His speech the other night reinforced the idea that the next move will be up. 

SK:  He did, yes, and he’s upbeat.  He’s got a view that the momentum in things like infrastructure spending is very much entrenched.  He’s got a view that we consumers will continue to spend despite this wealth effect.  I think that’s the point of disagreement between my work and the RBA’s and the RBA Governor, that it’s the household sector.  Because I think business investment is looking okay, I think infrastructure’s still looking strong, our export performance is looking great.  But it’s this household sector and housing more generally – and remembering that household consumption is over half of GDP, it’s about 55%-odd of GDP, so when it starts to slow down you need the other sectors to be doing a lot of heavy lifting to get that GDP number sustained above 3% in terms of annual growth. 

It’ll be household sector, house prices, consumer sentiment readings, retail sales readings…  They’re the things I’m looking at to see whether there’s any crack to the downside on the economy, or whether the RBA is in fact right and we consumers are resilient into the new year.

Good on you, Stephen, thanks a lot.

SK:  Thanks, Alan.

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[Parliament audio clip]

Now, here’s Malcolm Farr, the National Political Editor for News.com.au.  Malcolm, interesting stuff going on with Tony Abbott and Malcolm Turnbull.  What is it, Roseville wants to sack Malcolm Turnbull from the party and they’re actually ganging up on Tony Abbott and his electorate.  What do you make of all that?

MF:  Well, it’s as if some senior Liberals have signed a suicide pact on the eve of the Federal Election, which is anywhere from about six months away.  Can you imagine what punters are going to think?  They’re so busy pursuing each other, you can’t imagine that voters have got much time left for them.  This business about wanting to eject Malcolm Turnbull from the Liberal Party because he liked something on Instagram is just absurd.  It doesn’t bear scrutiny.  It’s the sort of thing you see in satirical novels, and not particularly good satirical novels at that.  The pursuit of Tony Abbott at least has a grassroots element to it. 

There are people in Warringah who are keen to see him leave the parliament at the next election.  The most significant point is, there’s no one there to replace him.  He’s got Liberal preselection so another Liberal can’t do it and there’s no decent substantial independent yet to put their hand to run against him.  That’s all fantasy land stuff as well.  The Liberal Party seems condemned to be talking about itself and not about the things that voters want, despite Scott Morrison’s quite robust and hyperactive attempt to switch that conversation. 

Well, speaking about that, what he tried to switch it to this week is population and he appears now to be against it.  Firstly, is it a big shift for them and will it actually make any difference?  

MF:  Well, something seems to have happened on the way from being Treasurer to being Prime Minister to affect Scott Morrison’s view of immigration.  He previously was a big fan of a largish intake, as he put it, it was good for the economy, because people coming in got jobs, paid taxes, started businesses.  Also, you’ve got to remember that they’re a lot younger than the rest of the population.  It kept the average population of Australia down.  They served all sorts of good purposes, but suddenly, as I say, on that road between the Treasurer’s office and the Prime Minister’s office, something changed.  And I would suggest – and I’m sure you wouldn’t say this because you’re not as cynical as me, but I would suggest it was an indication that voters wanted population and immigration to be a topic because they blame migrants essentially for traffic congestion and crammed cities.  Even though you’ve got to say that the blame has to go with serial state governments and federal governments who neglected the infrastructure needed for that sort of thing.  Scott Morrison has even gone to the extent of saying Australia will vote against a United Nations compact on migration, a compact which doesn’t oblige the people agree to it to do anything, doesn’t commit them to doing anything, doesn’t intrude on sovereign rights of limiting who comes here and who doesn’t, but I guess it’s just the spectacle of agreeing to those nasty people at United Nations who just want to flood the world with migrants and refugees, that would be too much for this government to carry in the lead up to the election.

More broadly, Malcolm, how do you think he’s going, Morrison?  I mean, I haven’t spoken to you in a few weeks, what do you think?

MF:  I think he’s doing a lot better than a lot of pundits would indicate.  Certainly, he’s tireless and even if you want to poke fun at that Queensland bus that actually was a plane ride that he took, even if you want to poke fun at him trying to be Harry on the Hill at a football match with a pie in one hand and a can in the other, taking all that into account, I think he’s getting over to punters in a way that might eventually worry Labor.  Don’t downplay this guy in terms of energy and determination.  He’s much like Bill Shorten.  Shorten should not be underestimated in terms of his application to the job and his ability to keep running right until the end.  I think we’ve got two high energy leaders clashing at the next election, both of whom will be claiming to be the voice of the ordinary folk and it’s going to be an interesting policy clash, if anything.  But most certainly, a clash of personalities which will be fascinating to watch.  

Good on you, Malcolm, thank you.

MF:  A pleasure, Sir.  Bye.

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And now here’s David White, the National Leader of Retail, Wholesale and Distribution at Deloitte, to talk about their annual Christmas survey of retailers.  David, we’re talking about your annual Christmas retailers survey.  Tell us about the survey to begin with, how many people do you talk to and what do you ask them?

DW:  We talk to around about 50 senior executives across Australia from retail companies that are either listed, private, multinational, so quite a selection of them.  The questions we ask them are focused, I guess, two-fold.  One is around what are they doing around Christmas in terms of sales, strategies, margins, discounting, key strategic priorities.  Then we turn our attention to what they’re looking to do in 2019.  So again, where are they going to grow, what are the focus areas, what are the key challenges and whether they see the opportunities for next year.  They’re kind of the two areas that we look at.

Before we get into the detail, what was your overall impression of what you heard from them?

DW:  Overall, Australian retailers are going into this Christmas really quite optimistic, which on one hand is a little bit surprising given some of the challenges we’ve seen in the market.  We’ve had some retailers unfortunately go into bankruptcy, continue to see lots of increase in competition.  To see such a positive response from retailers is a little bit surprising and compare that to last year where retailers were quite sort of neutral or pessimistic, it’s quite a shift.  But when you stand back and look at the market itself, the market in Australia is continuing to grow and we are seeing consumers putting their hands in their pockets and spending money.  And so the size of the pie is growing, it’s just becoming that much harder and that much more competitive to gain that market share.  

The optimism that you talk about shows up in what sort of increase you’re expecting this year in sales, right?  And 5% increase or more is 41% and usually it’s around about the 20% - 18% and 24% in previous years.  41% is quite a surprising increase I must say and I was surprised by that. 

DW:  It is.  In total, 8 out of 10 retailers expecting to grow compared to last year and you’re right, 41% expecting a 5% growth.  Then the other story around that is also just around margins.  We’ve seen huge pressure on margins with cost increases, fuel prices, competition meaning it’s really hard to pass on those price increases to consumers.  But we also saw some bullishness around margins, just over half expecting to have some form of margin increase over Christmas.  That’s really quite telling.  The trade-off always over Christmas is discounting and just how much and when retailers are going to need to discount to be able to bring the consumer into their store or shopping online. 

Two-thirds of retailers are planning to discount again this year.  That’s still quite a high number but the retailers are telling us they’re going to try and put that off until Boxing Day or beyond, so try and hold out in the early couple of weeks in Christmas.  Historically, that’s always been the case.  Retailers really don’t like going early on discounting, but the flipside is customers are repeatedly, over the last few years, looking to delay their Christmas purchases.  I think over the next two weeks it’ll be really interesting to see whether retailers are able to sort of hold their nerve and keep away from the discounting trick and whether they’ll need to go and really trigger that to get customers in. 

Let’s talk about online, most of them expect a 10-30% increase in online sales because it’s Christmas, and that has been increasing every year, 59% expecting 10-30%, which is up.  But they also are expecting increased competition from foreign online competitors which basically means Amazon, I guess.  Or at least around about 28% expect more competition from international online competitors, so how do you kind of marry those two things?  

DW:  With Amazon coming into Australia what we’ve seen is retailers really double down on their investment on the digital strategies.  Previously, it was the nice to have.  Now it’s become a really important part of how retailers go to market.  Retailers have invested there and they’re expecting to reap the rewards of that over Christmas and through to 2019 is what they’re telling us.  Also coming through the survey, 90% of retailers say that Amazon hasn’t even had an impact on their business so far and 83% of them think that Amazon won’t affect them over Christmas. 

It’s really quite staggering numbers in terms of the number of retailers that haven’t been impacted by Amazon.  But I think the times are changing and it’s been a slow start for Amazon but we do expect that to ramp up.  This Christmas won’t be the decider in terms of whether or not they’ve been successful, but I think we’re going to get a really good indicator of just how far they’ve come over the last 12 months.  Amazon themselves are really helping to drive Australian consumers to spend more online.

That impact of Amazon that you’ve picked up is remarkable at this point, 90% saying no impact, 3% saying positive impact, so obviously a few of them reckon they’re getting caught up in Amazon’s wind.  Negative impact 7%, so really not much at all at this point.

DW:  Some retailers are benefitting because they’re actually selling through Amazon, so it’s another channel to market which is good.  I think the smaller retailers have benefitted particularly from that area and those that sell through wholesale, it’s given them another option.  I think it’s symptomatic of what we’ve seen so far with the Amazon market entry, it’s been a little bit slow and steady.  But actually, that’s not too much of a surprise.  We’re talking about potentially a $10 billion business in Australia, that’s not going to setup overnight. 

Obviously, they launched Amazon Prime this year.  That’s the key for Amazon to build their business.  That’s how they’ve been successful in the US, the UK and we’re starting to see a lot of traction in India.  That’s really the key to watch out for, is people subscribing to Amazon Prime and those services being delivered, ramping up and improving and being comparable to the UK and the US.  

Do you think those survey results indicate a degree of complacency among Australian retailers?

DW:  I think there is a little bit of complacency there to be honest.  I think whilst Amazon haven’t had a huge impact here, I think they really will have a big impact in Australia.  There’s a little bit of complacency coming through.  I’m pretty confident over the next 12 or 18 months we’re going to see a significant ramp up in consumers shifting to Amazon as they get their infrastructure in place, they get the pricing right, they get the product selection.  I think Australian consumers will respond well to it and we’re starting to see Australia and Australian consumers shift their spending a lot more to online.  I do fear that there’s a little bit of complacency there creeping into the retail market.

Great to talk to you, David, thanks a lot.

DW:  No worries, you’re welcome.

Michael Hutchence of INXS died on this day, 21 years ago, aged just 37, and what a pity that was.  But it gives us an opportunity to Never Tear Us Apart, his masterpiece in my opinion.  He wrote the lyrics, Andrew Farris wrote the music and of course, Kirk Pengilly’s fantastic saxophone solo caps it off, but what a great song this is. 

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That’s it from me, have a great week.