What is Really Wrong with U.S. Retail Stocks
Retailers are quick to blame outside factors like Walmart, Amazon, and now tariffs. The reality though is that they just overextended themselves and are now faced with fixing this.
Retailers are up in arms about President Trump’s planned tariff escalation set to happen this September 1. It’s not that we don’t have tariffs now, and the current ones are set at a rate of 25% instead of the “small” tariff of 10%, as Trump puts it, that is set to be rolled out, but this particular escalation targets a lot of consumer goods and this has U.S. retailers clearly in its crosshairs.
We might think that all that will happen here is that people will just pay the tax and other than that things will just go on as usual, but Americans only have a certain appetite and budget for retail spending and having to pay more for things will mean less to spend on other things, and therefore less spending in the sector overall.
An option might be for retailers to just have these tariffs come off of their margins, but this is a sector that has had to cut their margins too thin already, and this is already serving to be their undoing. This is therefore really not an option and the additional costs will instead be passed on to their customers, although that’s not a good option for retailers either as this will mean that their revenues will be cut by this 10%.
It is even laughable to portray this tariff as taxing the Chinese, as Trump is trying to do, no doubt because the truth wouldn’t serve his political purposes at all. He is considerably less likely to get away with maintaining this illusion this time around though as when people see the price of all these things go up by 10% in September, it will be all too obvious to most people who exactly is being taxed by this.
In any case, these new tariffs will be putting the hurt on an industry that is already hurting, and in some cases, barely keeping things together. The major reason why they are hurting so much is that the industry has expanded well beyond their current needs and are often reluctant to do the right thing and bring the amount of space they have down to more sustainable levels.
The retail sector is actually growing pretty nicely overall, growing by 4.3% in 2018 and set to grow by another 3.5% in 2019. We are seeing a distribution toward online sales, which is the part that is growing, while traditional retailing is shrinking, but not really by all that much.
It is not really hard to imagine how we could still have a vibrant retail sector, when we look at the fact that we spend $6 trillion a year and the vast majority of this is actually not spent online but in good old-fashioned retail outlets. Traditional retailers account for over $5 billion of this $6 billion, and that’s a pretty nice size indeed, if costs were managed properly that is.
There’s Just Way Too Much Retail Space Out There
The real problem with retail in the United States these days is how much space they have versus how much space they actually need. This is a far bigger problem than Walmart and Amazon put together, which only comprise 16% of the market, leaving 84% of this $6 trillion market to the rest, which adds up to a huge number, 8.4 times the size of Walmart and 14 times bigger than Amazon. Collectively, the rest of the industry dwarfs both of them.
While the rest of the industry is simply enormous, it is saturated at a level well beyond what we see anywhere else in the world. The United States has 23 square feet of retail space per person, compared with 5 in the U.K. and only 2 in Germany. The American approach to retail has been called Darwinian, which is a good way to put it as in this retail jungle, as only the strongest will indeed survive in the midst of all this massive overpopulation.
An even better way to compare this difference might be to compare a first-world economy, which keeps its population fairly well in check to keep GDP by person up, to third-world countries who are simply overrun with people and this relative overpopulation overwhelms its resources and produces a very low GDP per person.
We then end up with a lot of people but only so much food to go around, and there isn’t enough to feed everyone so the worst-off die. A lot of the rest are left hungry and barely getting by though and the average person is not well off at all.
Overextending retail space means that the overall profits in the industry will be diminished not just by having too many competitors out there but especially by way of all of these additional costs of having all this space.
It’s not that this space isn’t shrinking, but it needs to shrink at a faster rate than just the normal Darwinian survival of the fittest effect playing out over time. We did see a net decline in stores of 4,512 last year, significantly more than the 2,606 lost in 2017, but this is still all happening too slowly.
This is by no means a new phenomenon. 22 years ago, a report from Women’s Wear Daily observed that “the suburbs are overstored and undershopped, and experts say that only the top 20% of malls are thriving.” This has only gotten worse since then.
We Need to Cut Space at a Much Faster Rate
JPMorgan analyst Matt Boss predicts that, at the current rate of store closings, it will take another 10 years to reach the point where we don’t have too many of them. That’s a lot of time and a huge amount of wasted resources and money while we watch this situation resolve slowly and painfully.
By skimming 10% of the cream off the top, these tariffs might even be just what we need to move this all along. This is still no way to do it, to harm retailers so more of them will be forced to close more stores and even go out of business, and this is clearly harmful to the economy as a whole but might be helpful to the retail sector at least by turning up the Darwinian heat and having less survive.
As popular as online shopping has been, brick and mortar retailers do allow us to view and try out the real thing rather than just have to go by pictures. The trend toward online shopping will continue to grow by leaps and bounds for a good while and it’s not hard to imagine this all getting a lot bigger but this is unlikely to completely replace actual stores.
The industry has to really cull itself to get to the point where they are not overspread, and this culling will need to continue for quite some time as we transition more and more toward online shopping. The current way that things are managed just isn’t cutting it, and for the survivors to ever prosper, we cannot remain overrun with retail space.
If Trump’s new tariffs help trim things a little faster, while the industry may complain loudly, they may even be left better off by this in time. This certainly isn’t a good enough reason to justify these tariffs though, not that anyone would even want to try to justify them this way.
Editor, MarketReview.com
Robert really stands out in the way that he is able to clarify things through the application of simple economic principles which he also makes easy to understand.
Contact Robert: robert@marketreview.com
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