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Retailers Might be Too Bullish on Holiday, and Consumers Aren’t So Optimistic Near Term

Anyone want to place bets on this year’s holiday selling season?

Apparel vendors and retailers are traditionally perennially optimistic about the next season ahead, regardless of how the last one fared. And holiday is one time where the expectation is typically that consumers will shop because they have to buy gifts. But this year has a huge wrinkle in any projections as a result of the trade war between the U.S. and China, and there are indications in place suggesting caution might be the watch word for Holiday 2019.

Wells Fargo retail analyst Ike Boruchow is negative on the upcoming holiday season.

According to the analyst: “[W]hen we take a high-level look at the group, we see risk ahead–a group with downward momentum on fundamentals calling for accelerating trends three months from now, with building inventory in the channel, an unfavorable holiday calendar ahead and likely headwinds coming from tourism and weather.”

With most of retail’s second-quarter earnings reports completed, Boruchow said he found the majority of companies seem optimistic about their ability to drive growth in the fourth quarter. The “holiday setup this year is actually quite bearish and thus we continue to view our space through a more cautious lens,” he said.’

“First and foremost,” he added, “fundamental trends have deteriorated thus far in 2019–this fact is neither lost on investors nor is it overly insightful.”

As for why such a bearish stance, Boruchow said one big reason was guidance given by the companies. Despite what he described as a choppy second quarter, companies seemed to reiterate their second half outlooks, but relied on a “significant acceleration” of fourth quarter sales to hit their guidance targets. He noted Fossil Group Inc., Capri Holdings Ltd., L Brands Inc., Urban Outfitters Inc. and Under Armour Inc. as examples.

What’s hurting those projections is his second factor for bearishness, is the six fewer days in the holiday shopping season between the Thanksgiving and Christmas holidays this year. The last time the holiday selling season was condensed was in 2013, a year where many retailers ended up experiencing “significant traffic [and] promotional issues and miss plan,” Boruchow said. While wholesalers ended up okay in 2013, retailers saw their fourth quarter comp sales slow and gross margin pressure accelerate.

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Inventory this year has built up, too, due partly to tariff dynamics and a slowing top-line. That’s a reversal of inventory levels from 2017 to 2018 that saw sales growth exceed the rise in inventory levels.

Adding another reason to be cautious for holiday, Boruchow said, “To put this in perspective, the inventory-to-sales spread 12 months ago was a healthy up 1.7 percent, while as of today it stands at down 4.2 percent.” Tourist spending as a headwind due to the stronger U.S. dollar versus most other foreign currencies, and weather concerns, were also contributing factors. For the latter, he said warmer weather conditions after two straight cold winters could be a risk for weather-sensitive categories.

Not all retailers are at risk, however.

Discounters that have been doing well in the first half of 2019, like Walmart Inc. and Target Corp., have raised guidance for their full-year outlook. And companies like Ross Stores Inc. and Deckers Brands have taken a more cautionary stance, planning for slower results in the fourth quarter.

As the trade situation plays out, there’s also concern that if a resolution isn’t found soon, continued escalation of tariffs could put the global economy at risk for a recession.

Last week, China retaliated with tariffs of its own on U.S. imports and U.S. President Trump upped the escalation by hiking tariffs further. In addition to what those actions might do to the supply chain, Morgan Stanley economists last week also noted that if the tariffs on both sides go through as planned, there’s a chance that the global economy could see a recession as soon as in nine months.

For now, U.S. consumers are still opening their pocketbooks, but cracks might be on the horizon.

The first indication came on Aug. 16 when a preliminary reading of the University of Michigan’s Sentiment Survey had the index dropping to 92.1 from 98.4 in July, with the expectations component of the index leading the decline by 8.2 points.

Moody’s Analytics economist Scott Hoyt said at the time that the decline in the expectations component was the biggest drop since December 2012, and that the “flare-up in the trade war and the drop in the stock market undermined consumer confidence in early August.” Hoyt also said keeping a close eye on the consumer bears watching as a “sustained drop in confidence could set off alarms.” The final tally for August is expected later this week.

On Tuesday, The Conference Board said its Consumer Confidence Index slipped marginally in August to 135.1, down from 135.8 in July. On the surface, the reading indicates consumer confidence is relatively unchanged.

However, a deeper dive shows that the August reading was led by an increase of 6.3 points in the present situation component of the reading. That was enough to offset the 5.4 point decline in the expectations portion of the overall index. The expectations portion is often the more important indicator, as it highlights what consumers are thinking about in the near term (six months out).

Right now, consumers are less confident about the future, with those expecting business conditions to worse rising to 10 percent from 8.4 percent. Lynn Franco, senior director of economic indicators at The Conference Board, said “if the recent escalation in trade and tariff tensions persists, it could potentially dampen consumers’ optimism regarding the short-term economic outlook.”

Tim Quinlan, senior economist at Wells Fargo Securities, said because of the Aug. 16 cut-off date for the Consumer Confidence Index report, it didn’t take into account the stock market jitters and trade war escalation, both of which occurred in the second half of August. “There is scope for downward revisions once the dust has finally settled,” he noted.

Quinlan also said one clear takeaway from Tuesday’s report is that consumers “see the writing on the wall in terms of how long the good times can last,” citing to the 70-point gap between the present and expectations components of the Index. According to Quinlan, there was only one other time during the 18-year span from 2001 to 2019 where there was a similar gap between “where we are and where consumers think we are headed,” and that such a peak tends to be associated with turning points in the cycle.

“More important than the level is the direction,” he said.