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Posted on MAY 15, 2017

Johnson Bank Wealth Weekly Investment Commentary | Monday, May 15

This is part of an ongoing series of Weekly Commentary articles published by Johnson Financial Group.
This week's issue is written by Brian Andrew, SVP, Chief Investment Officer.

Going to Prom

It's prom season. When I went to prom, it included a nervous invitation, dinner “in the city,” and then the dance along with a remonstration to be home by midnight (I am sure I am dating myself). Now, the internet is full of stories about the crazy things that people have done to ask a date to prom, asking a celebrity to prom, or how much they paid for their outfits. Prom seems like it's more about creating a viral video and social media splash than it is just asking someone to a dance. The fact that the online experience is as important as the actual one reminds me of what is happening to retail sales as well.

Retail Sales Data

Last Friday, the Census Bureau reported retail sales for April. The numbers showed a positive uptick over the data received for the first quarter. In fact, sales were up .4% during the month, besting the first quarter’s .3% rise, which was the slowest quarter since 2009. One of the brightest spots in the sales data was building materials and garden equipment, up 1.2% during the month and over 9% from the previous year. This suggests continued growth in the housing market, which could be a key driver of economic growth going forward.

Two areas that showed a decline were general merchandise stores, where sales were down .5%, and department stores, which have declined by almost 4% since the beginning of the year. Much like the prom experience, sales have moved online, and that data is not included here.

Online Sales

Online retail sales are up nearly 12% since the first of the year and 20% over the same period last year. In fact, sales reached over $100 billion during the first quarter. This is the first non‐holiday quarter to reach that benchmark, indicating just how much total sales have moved online. While prom attendees are busy using Instagram and Snapchat to share their experiences, they must also be shopping. Consumers using a mobile device to make an online purchase represent 22% of total sales so far this year. While traditional merchandise store sales remain flat, online sales suggest consumption growth is very healthy. Given that the economy is nearly 70% driven by the consumer, this trend bears watching.

With low unemployment, rising wages and strong consumer confidence, we should continue to see better consumer spending growth online.

Consumer Health

With unemployment moving down to 4.4% in May, we are reaching the point of “full” employment. That suggests a tighter labor market and acceleration in the rate at which wages grow. While this might be negative for corporate earnings later this year, it suggests that consumer health will continue to rise.

These conditions have led to an improvement in consumer sentiment. Last week, the University of Michigan released their first May update for their sentiment index; it rose .7% for the month and 3.2% over last year. The improvement in sentiment reflects consumers' positive outlook for the future. However, there are some cracks in the sentiment data. For example, vehicle buying conditions have slipped to a three‐year low. The increase in interest rates has reduced the market favorability rating for home buyers as well. We will continue to monitor these issues, as they could be precursors to weakness later in 2017 or early 2018.

One potential reason for this weakness could be that low unemployment, faster wage growth and accelerating consumption could lead to higher inflation, which would result in higher interest rates. We don't currently believe that inflation will move significantly higher during 2017, but the lower unemployment goes, the more closely we'll have to watch it. (Speaking of inflation, according to Promgirl.com, the average cost of prom this year is between $175 and $2,100, for an average over $1,000. I am fairly certain that I was all in for less than $75 back in the day!)

Amazon's Role

You can't really talk about the movement of retail sales online without talking about Amazon, the 800‐pound gorilla in the online space. In the last 10 years, Amazon's sales have gone from less than $20 billion annually to almost $160 billion this year. By contrast, the annual sales of Nordstrom, Kohl's, Macy's, JC Penney and Dillard's have remained stagnant at around $80 billion combined.

Amazon's site provides ease of price shopping, product comparison and fast delivery. Their success in retail and their other businesses has led to the stock going from near $100 in 2010 to over $960 today. As an example, Kohl's price has moved from $55 to near $36 in the same period of time.

The chart below shows Amazon's dominant position versus other online and traditional retailers. It plots the number of smart phone users who have the Amazon app and the number who have it on their home screen.

Smartphone Graph
Source: Deutsche Bank and comScore, Inc.

The question today, with the stock trading at a very high multiple, is what kind of prom king will it be: The kind who peaks junior year or the one who goes on to a long, successful life? Given Amazon's dominant position, it would appear the latter is more likely.

The point of all this is that when we review each week's economic data, we must look at it through our market and business cycle lens as well as our secular lens. Long‐term trends affect the data in ways that take time to discern. The changes can affect the way we think about valuation and the allocation of our capital. Oftentimes, government data services take time to adjust to the new trends, so greater examination is warranted.

As online sales evolve, we need to pay more attention to the impact this change has on the way data is reported and dig deeper into the online data to understand future consumer trends. There is one benefit of my offline prom experience. It wasn't saved for posterity on the internet for all time. That is probably a good thing.

Brian Andrew
As Chief Investment Officer, Brian Andrew leads Johnson Financial Group's investment strategy
to provide consistent, actionable investment solutions for our clients.

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