Holiday Boom for Some, Blues for Others: Lasting Investing Implications for 2017
We continue to see solid gains in the economy and markets overall, although the devil’s always in the details. The consumer is still leading the way, but new macro policies coming out of the incoming Trump Administration should reinforce many of the trends we see in place. Finding safe places to invest in 2017 has grown more challenging following the sharp run-up following the Trump win and we see significant market expectations for tax reform and growth-promoting policies already built into valuations. Our chief concerns center on stocks that are vulnerable to coming interest rate increases (utilities, consumer staples) and on those that have grown more expensive relative to history and the market. Nevertheless, we are still finding good value and long-term prospects in some corners of the market. We highlight a few trends from the 2016 holidays that point to a few areas of opportunity and caution.
Holiday spending made for a strong finish to 2016 and helped buttress the sharp rise in stock prices since the election. Nevertheless, the S&P 500 is now trading at 17.1 times earnings in the coming 12 months and that’s slightly above both 5-year and 10-year averages. Earnings for S&P 500 companies are expected to grow 11.5% on revenue growth of 5.9%, but this is driven primarily by the energy sector, where earnings are expected to surge over 300%. Elsewhere, earnings growth is expected to range from 3.7% for telecomm to 16% for materials. In contrast, utility profits are expected to be roughly flat, while real estate is expected to contract by just over 20%.
Beyond energy and financials, 2017 is likely to be defined by whether consumer spending continues to strengthen and data regarding economic trends are pointing in the right direction. Year-end consumer spending and confidence reports confirm further strengthening in demand. After strong showings during November and into December, retailers are expecting the strength to have continued through post-Christmas sales. This bodes well not just for the holidays, but for 2017 as gas prices likely remain low and wages accelerate. Household balance sheets remain strong, house values continue to rise-and should continue to do so even in a rising rate environment, and inflation (for now) remains tame. We continue to see opportunities to invest in companies likely to benefit from higher consumer spending, the growth of the housing market, and the ongoing replacement of aging autos.
Some Investing Takeaways from the 2016 Holidays:
- Spending more. The National Retail Federation (NRF) was forecasting a 3.6% increase in holiday spending this year, but even as the Thanksgiving weekend sent the season off to a tepid start, total seasonal spending beat most estimates. Through the first half of the holiday shopping season (November), sales increased 5% year over year. Online spending continues to grow as a share of the total, as consumers increased outlays by 15% over 2015 to $12.8B for the Thanksgiving weekend alone. Online Black Friday sales topped estimates with 21.6% growth over last year. Some had concerns that Cyber Monday sales would be diluted by earlier deals and 24-7 shopping throughout the weekend, but Cyber Monday broke records, reaching $3.45B in online sales, up 12% over 2015. This beat expectations and exceeded all prior online single-day spending records. While online sales outpaced expectations, not all retailers shared in that strength. Amazon was the clear winner, while brick-and-mortar department stores lagged.
- Going upscale. Toys for young and old saw strong demand through the holidays. Consumers were spending on toys which points to Toys R Us, Walmart, and Amazon all having done well, but Amazon is the winner by a large margin, even though it failed to capitalize fully on strong demand for its Echo home companion. Analysts point to discounts as the key reason for sell outs. Amazon should take a lesson from Nike, which debuted $720 high-tech sneakers this year for those of you who’ve grown tired of lacing up your own shoes. They sold well and remained available throughout the holidays. Bottom line? Consumers showed a willingness to pay up for higher-priced discretionary goods and we expect that to continue this year.
- Moving to mobility. Mobile device-based sales played a bigger role this year, accounting for 53% of Thanksgiving Day traffic, while Black Friday sales were up 33% from 2015, marking the first time mobile sales exceeded $1B in a single day. Cyber Monday surpassed that level and broke another record for mobile-based transactions. While eCommerce commands less than 9% of total sales, it has been rapidly gaining ground and will almost surely command a larger share of consumer spending in future years and be dominated by mobile transactions. We remain wary of brick-and-mortar plays and prefer consumer goods suppliers and retailers that connect more effectively with customers.
- Devouring data. Smartphone and tablet sales may be slowing, but the increasing use of those devices for a wider variety of activities indicates that internet data flows will continue to grow strongly and that will require further upgrades inside those devices, at the world’s data centers, and in network infrastructure. In addition, cybersecurity will need to evolve to meet new threats as more financial transactions take place digitally. We see upside for well-positioned technology innovators, financial tech providers and cybersecurity players.
- Leveraging low gas prices. As we have been expecting, consumers are finally starting to recognize that low gas and home heating costs are likely to remain for quite some time. This has finally allowed consumers to see a long-term improvement in household budget constraints, which has materialized in stronger consumer spending. Even though the holiday season coincided with big news from OPEC as oil ministers finally agreed to cut production and oil prices moved higher, pump prices are still considerably lower than they were a couple of years ago. Moreover, history tells us that OPEC cuts rarely survive the temptation for cheating among members. When the cartel starts to deteriorate (and oil inventories once again grow), oil prices could sink back towards $40. This reinforces our view of a strong consumer in 2017, but also paints a cautionary picture for energy investing. We continue to prefer certain MLPs, integrated oil players with fastidious cost-control measures, and E&Ps with strong balance sheets located in the lowest cost basins, and strong long-term prospects.
Finally, let’s not forget that the prospects for many U.S. firms depend also on the global consumer. Europe remains in earlier stages of its economic recovery, relative to the U.S., emerging markets are seeing some relief as commodity prices rebound, and China consumer spending continues to rise as a share of China GDP. While those offer potential tailwinds for U.S. firms serving foreign consumers, several risks put international demand on a rockier path. The U.K. will begin to extricate itself from the EU and this may disrupt jobs and spending on both sides of the channel. Commodity prices recovered a bit last year, but industrial activity is still on a downward trend in China, so the foundation for commodity price recovery—and the spending prospects in emerging markets—remains weak. China’s consumers may offer the strongest prospects for spending growth outside the U.S. While perceptions of China investments became wobbly over the last couple of years, the spending power of China’s consumers stands out when contrasted with US holiday shopping figures. China’s 2016 Singles Day (Nov 11) saw $17.8B spent online while US shoppers spent $12.8B over the five day Thanksgiving/Black Friday/Cyber Monday period. China growth may be slowing, but the middle class is growing and so is that group’s spending power. Provided the Trump administration refrains from erecting costly trade barriers, U.S. firms should benefit not only from a strengthening U.S. consumer, but also as Chinese consumers increase spending on household conveniences, travel and leisure, cars, and electronics in the years to come.
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