Mirror, mirror on the wall, what will 2020 bring for us all?
For one, there’ll be a bit of economic stability for at least the first half of the new year, and then perhaps some stock market volatility as the second-half focus shifts to the U.S. presidential election, as well as the U.K. following its expected exit in January from the European Union.
More mergers and acquisitions deals also are likely in the first half, and the initial public offerings of Madewell and Old Navy are slated for 2020.
What’s more, the retail sector shrink will continue in 2020 as the industry is still overstored. The ratio of stores needed to meet consumer demand likely won’t match up for another five years as the downsizing continues.
And after three years of bankruptcies where many retailers ended up in the retail graveyard, expect more to file in 2020, although perhaps not at the same rate as in years past.
Here are some highlights of what to expect in 2020.
The U.S. economy
A still relatively strong U.S. labor market suggests consumer confidence should remain high at the start of 2020.
The Federal Reserve in its December meeting unanimously agreed to keep rates on hold. More importantly, its view of the economy at the time was that little changed since the October meeting when it decided to cut interest rates by one quarter of a percent. The Fed continues to see the labor market as “solid” and consumer spending as “strong.”
One concern was business fixed investment and exports, which the Fed considers “weak.” Some of that weakness in 2019 has been due to businesses not knowing how to plan for the future as the trade dispute between the U.S. and China raged on. While an overhang of uncertainty continues to exist because the dispute itself remains unresolved, any concerns probably won’t kick back into high gear until late 2020 when businesses start planning for 2021. The “Phase One” agreement that President Trump is expected to sign on Jan. 15, provided Beijing signs as well, should help dissipate some of that weakness throughout most of 2020.
With the U.K. expected to formally leave the EU, the big question will be what kind of long-term agreements British lawmakers will opt to pursue with their former EU partners.
But since the deadline for those agreements isn’t until the end of 2020, the “status quo in terms of trade and regulatory alignment appears most certain for 2020,” according to a December research report from Jefferies International. The U.K. sectors most expected to benefit in 2020 are utilities, banks, buildings and retail, according to the report from a team of economists and equity analysts led by European economist David Owen. The economists also expect fiscal stimulus to accelerate GDP growth above 1.5 percent in 2020 and to 1.7 percent in 2021.
In other parts of the world, slowing growth and uncertainties have been a global phenomenon, according to Nick Bennenbroek, head of currency strategy at Wells Fargo. Weakness has been concentrated in manufacturing, which has been a consistent theme in the major economies where “the output in all [the majors] are in negative territory,” said the currency strategist, who concluded that he’s not yet ready to call a contraction in the manufacturing sector, but, he said, “we are close.”
“The costs for business is starting to rise a little bit faster than prices,” Bennenbroek said, noting that margin pressure will result in a slowdown in profitability. “If this were to continue, [you’ll start to see] weaker business expansion and [pressure on the] employment [front],” the strategist explained.
As for currencies, “We won’t see much more in terms of a Fed [rate] cut, maybe one. The European Central Bank also could see one more rate cut,” he said.
Central banks raise rates to cool down an economy that’s heating up. They also rely on rate cuts to spur economic activity when growth slows to avoid a recession.
Mergers, acquisitions and IPO activity
Baird’s investment banker Matt Tingler sees the economy as “still good,” with the availability of leverage plentiful due to continued access to financing. More importantly, there’s been “interest in pitch activity in recent months,” he said. That means that as bankers try to put possible deals together, potential buyers–strategic and financial–are at least receptive to what they’re pitching.
“Private equity firms have more equity than they’ve ever had, and the dry powder continues to go up. The strategics are looking for avenues to grow,” Tingler explained. “Some like Lululemon are looking for internal paths for growth. Others are looking to acquire to grow as a better option than share buybacks. Acquisitions are a good way to use capital, get new consumers and move into new markets.”
The banker expects some disruption in M/A activity as the year moves closer to the presidential election.
“Uncertainty can slow down markets and deal activity. If [investors] are uncertain over whether a Democratic candidate or [incumbent] Republican will get elected, that could [slow down] some deal activity. Right now the investment community believes that Trump will get re-elected,” Tingler said.
More and more aggressive trade tariffs on the global front, a rise in interest rates, and declines in consumer confidence are risks that could impact M/A activity, Tingler said.
As for the IPO market, the public markets have started to push back on companies looking to go public, Tingler noted. That’s mostly due to the number of recent firms that have struggled post-IPO and still don’t have any earnings to report. That kind of thinking might mean investors now deem the IPO market as reserved for firms considered best-in-class, the banker said.
Currently, the Madewell spinoff from J.Crew and Old Navy spinoff from Gap Inc., are slated for a 2020 IPO. Footwear startup Allbirds is one rumored to be eyeing an IPO. And Rent the Runway was another possibility mentioned in 2019.
Store closures and bankruptcies
Retailers will continue to close stores, and could very likely do so for at least another five years.
“It’ll take five years to level out due to retailers’ leases,” said Michael Brown, a partner in the consumer and retail practice at A.T. Kearney. “There are different terms within the leases, renewal terms [that are separate] and retailers will use the time to learn what role stores will play in the future. Right now, more retailers are reactively closing stores when there’s no more profit at those doors. They need to be more proactive in looking at the network of stores and resetting the base.”
While he expects newer, direct-to-consumer brands to begin opening stores as they scale their business, he doesn’t expect them to open doors in the same numbers as their non-DTC counterparts.
“These digitally native brands will open stores as they seek to scale their business. Online is great to incubate, but the brands won’t achieve scale unless they have some kind of physical presence. Ninety percent of consumers still go to the store, touch the product and do research,” Brown said, noting that Allbirds and men’s apparel brand Untuckit are among those opening stores at a rapid pace.
As for bankruptcies, BDO’s David Berliner, partner in the firm’s restructuring and turnaround group, expects to see some filings in 2020 given that malls continue to have a hard time generating traffic.
“At some point, the filings are going to slow down,” said Berliner, who noted–but didn’t disclose–that he’s got a few names on his watchlist. Of those names, a few might enter Chapter 11 and emerge, but then will likely re-enter bankruptcy proceedings and end up in liquidation mode.
Berliner also expects to see some mall closures, especially the weaker ones, which once had department stores as its key anchor tenants.
“It’s become difficult to keep those malls open,” he said. “Malls need to do better at bringing in entertainment and food options.”
And while retailers like Dick’s Sporting Goods took over some Sports Authority locations when the latter liquidated, similar to Michaels more recently acquiring some locations when its crafts competitor A.C. Moore shut down, Berliner doesn’t expect to see that trend continue in 2020.
“I don’t see the advantage of that now because retailers today are trying to optimize the right store footprint,” he said. “A lot of retailers prefer fewer stores, but it can be expensive to get out from a lease. So they wait for the right opportunity to get out and move to a smaller store when they can. Years ago, it was all about growth and retailers were opening stores. It was what Wall Street wanted. Now it’s the opposite–Wall Street wants fewer stores, but more profits with the right [ones].”
Retail and apparel
A pronounced global economic slowdown could raise recession risk for U.S. retailers in 2020, while domestic policy shifts and geopolitical uncertainty could threaten to undermine credit conditions in many regions, according to credit analysts at Moody’s Investors Service.
For now, analysts are expecting 2020 to be relatively stable for U.S. retail, with operating income growth above 4 percent that’s led by the dollar store sector and the off-price channel. The struggling department store sector will continue to be a drag on overall retail, although retail sales growth for 2020 is expected in the range of 3.5 percent to 4.5 percent.
Moody’s credit analysts who track retail don’t expect a recession in 2020, but the risks could grow if the political backdrop has an impact on trade policy uncertainty.
“Also, fiscal and monetary policy in advanced economies remains limited to prevent a future downturn,” according to a Moody’s report, which also noted that if there is a recession, that would result in a consumer pullback that would not bode well for the U.S. retail sector.
Walter Loeb, former retail analyst and now consultant, expects retail sales growth in 2020 at between 3 percent and 3.5 percent, helped by the rollback in tariffs and the Phase One trade agreement. One reason why it’s not higher is the concern over global tariffs. That’s a reflection of the global trend toward protectionism, which will likely result in more taxes on imported goods.
Already, French lawmakers are instituting a 3 percent digital tax, and Italy’s parliament has one planned, too, also 3 percent, for the digital revenue of some technology companies. The Trump administration is currently looking at a proposal for additional tariffs of up to 100 percent on French goods as a result of the tax. And with the Italian government’s decision on Dec. 26 to impose its own version of the digital tax, the Trump Administration could eye additional tariffs on Italian goods as well.
As for apparel sales, Gabriella Santaniello, founder of research firm A-Line Partners, expects “fourth-quarter earnings for many retailers will come in shy of expectations,” given the anemic 3.4 percent retail sales growth over holiday 2019 and what the heavy discounting might mean for margin compression.
From the shopping pattern she observed over the holiday season, Santaniello said there seems to be a shift in how consumers are buying apparel.
“In the fall there was talk about a certain coat, and then about a changing silhouette that would force [consumers to buy] different tops, but then that [talk] dissipated. Earlier in , we saw the wide leg [pant] that people wanted, but they didn’t buy in the same volume like they used to,” she said. “What we’re seeing is selling that is very item-driven. People are not buying the whole outfit. They’re buying a piece, and then waiting to see how it works with what they have. Maybe later they’ll go back and buy another piece.”
Goldman Sachs is forecasting lackluster growth for the apparel and accessories space, according to analyst Alexandra Walvis, who noted soft demand trends and an ongoing headwind from the shift in consumer spending away from the mall toward the off-mall and online channels. While Walvis is positive on the off-price sector and on active brands like Nike and VF Corp., she’s cautious on mall-based department stores and the core apparel brands that are exposed to the channel.
Overall, “we expect a stable but slowing U.S. consumer backdrop in 2020,” Walvis said, adding that apparel as a category is expected to underperform.