Stocks were mixed yesterday. The Dow Industrials fell when component member Home Depot# reported decent results that were below Street expectations. That’s a no-no in the investment world. Other than that, it was a relatively quiet session. One should note, however, that the 10-year Treasury yield has fallen almost 20 basis points over the past couple of weeks and the yield curve is flattening once again.
The lower interest rates translate into higher P/Es for stocks, partly explaining the recent move up. But to the extent that lower rates suggest a sluggish economy, that will be a headwind in the long run. The Atlanta Federal Reserve Bank maintains an online site called GDP Now where it distills all recently reported economic data into a real-time forecast of GDP. At the moment, that suggests Q4 growth of 0.4%. One should take that into context. We are only halfway through the quarter and only have a decent amount of data for one month, October. December, because of Christmas, is by far the most important month. Thus, the 0.4% estimate can and will change. But, clearly, the optimism that seemed evident over the past few weeks as the 10-year yield was pressing toward 2.0% has faded a bit.
For most companies, October is when they report third quarter results. But retailers mostly have fiscal years that end in January and, as a result, they report results one month later. Therefore, this is primetime earnings season for retailers. According to the Census Bureau, through the first 10 months of this year, retail sales are up 3.4%. If I exclude gasoline, that is an even more impressive 3.8%. The consumer is healthy.
But the spending isn’t uniform across categories. Sales at electronics and appliance stores are down 4%. Department stores have shown a decline of almost 5%. Clothing and apparel are slightly negative. Meanwhile, online sales are up 12.7%. Among individual companies, the picture is just as varied and confusing. Wal-Mart# and Target both had solid results and improved margins. The general merchandise category is more than holding its own. Do-it-yourself retailers like Lowes# and Home Depot# have reported same store sales growth of 3% or better. But Kohl’s and Gap Stores were big disappointments as was Urban Outfitters overnight. We still have to hear from Macy’s and Nordstrom. Macy’s has been one of the year’s biggest losers and expectations are low.
What can we make of all this? Before answering the question, since we are Philadelphians, picture yourself standing at the corner of 8th and Market a couple of decades ago. Down the street, stood Wanamaker’s. And within a few feet stood Strawbridge & Clothier, Lit Brothers and Gimbel’s. W.T. Grant and Woolworths weren’t far away.
Today they are all gone. Their customers didn’t die; they went elsewhere. They died because another set of retailers did a better job of satisfying their customers. When customers began to leave, these stores, instead of innovating and changing, responded by cutting costs. That means cutting service. Cutting value. More customers left until all eventually died.
There isn’t any magic formula to retail. The concept is simple. Give the customer what he wants at a fair price. Make him feel good. Service him again and again. Compare Amazon to Macy’s. It is easy to say that the new generation likes online shopping and that explains everything. But look closer. Which store generally offers the best price? Which store gets the product to you faster if you order on line? Which site is easier to use? Which company makes returns easier? Which company is more effective following up with suggested items based on your purchase history? Which store offers free shipping and movies to boot?
Macy’s may be moving in the right direction, but it is moving so slowly that it is falling further behind every day. Unless it changes its pace of innovation quickly, it will die. And the Macy’s housed in the former Wanamaker’s flagship store, will become something else in the not-too-far distant future.
Macy’s doesn’t face an impossible task. Look at Best Buy. It was the last big electronics chain standing but was getting beaten by Amazon every day. Customers would come to Best Buy, find what they liked, scan the bar code, and then order through Amazon while they were standing in the Best Buy store! So what did Best Buy do? It matched or beat Amazon on price. It created the Geek Squad to service and install your big TVs and computer networks. It delivered quicker. It upgraded its web site. Simply put, it met the competition. It invested!
Wal-Mart# decided two years ago to upgrade everything from its supply chain, to its store appearance, to its website. You see the results today as the company’s stock is at record highs. Target got started a bit later but is doing just as well. In short, retail changed and the stores that invested to adapt have been winners. Those dragging their feet are the losers. The list of retail or restaurant chains that have failed will fill many graveyards. They die slow deaths. Like cancer, if caught early, chances of survival are reasonably good. But beyond a certain point, death is inevitable. Sears, Penney and K-Mart are all going to die. Toys “R” Us is already dead.
Today, Internet retailers are establishing a physical presence. You can buy a Casper mattress or a Peloton bike in the mall. Conventional retailers operate some of the biggest online sites. Witness Wal-Mart. The magic isn’t whether you operate a physical or online store; it’s how you serve your customer. If you offer the best products, the best value, and the best service, you win. Sounds easy. But it is incredibly hard to execute. If you are a baby boomer as I am, think back to your childhood. Are there any stores or restaurants that you frequented as a child that still exist? Capitalism, entrepreneurship and technology ensure that there will be a better way to do everything down the road. Some businesses, like making cars, have huge capital costs that create barriers to entry. But when I was a kid, there were no Toyotas and no Teslas.
Look at the largest companies in the S&P 500 today. Apple# has been around since the late 1970s, but it wasn’t until this century when it created the iPod followed by the iPhone (essentially an iPod with a phone chip) that it took off. Amazon was a creation of the mid-1990s to sell books online. Microsoft# goes back to early PC days, but its recent success came about when it moved away from Windows and captured the value of the Internet. Google# and Facebook# are both 21st century creations. Both were Internet babies.
Will 10-20 years from now be so different? Perhaps. But remember that Amazon, Facebook, Google, and, to a large extent, Microsoft wouldn’t have happened if there hadn’t been an Internet. And, of course, there are many online retailers, social networks and search engines that never got established. But for the next generation of megacompanies, there is going to have to be another technological seismic change matching the Internet that creates the platform to build upon. Right now I don’t see it, probably because it isn’t there yet. But I have little doubt that it will be there over time.
None of this necessitates the demise of retail stores, restaurants, cars, etc. I like to say to people that when I was young, my alarm went off at 6:30. I got dressed, ate breakfast, went to school, played sports after classes, came home, ate dinner, did homework, watched TV and went to bed. Life has changed a lot over those years in many ways. And in many ways, it hasn’t changed at all. Adults work to support families. We like to be entertained. We live in houses or apartments. We drive cars or use other means of transportation. We take vacations, enjoy sports and movies.
But the businesses we frequent and how we execute our daily lives, in all its details, has changed drastically. And that is the key to investing; finding the businesses that make my life better and easier. It can be as exotic as a semiconductor chip or a McDonald’s kiosk that operates using that chip. It can be an online retailer or it could be a Lululemon store. It could be a Peloton bike or a new spinning studio. Change requires investment. Those that invest properly will be rewarded. The rest, ultimately, will die.
Today, Bo Derek is 63. Joe Walsh of the Eagles is 72. Former VP Joe Biden is 77.
James M. Meyer, CFA 610-260-2220