Sean McCarthy, CFA, Southwest
Marc Doss, CFA, California, Nevada
Michael Serio, CFA, Mt. Northwest
David Roda, CFA, Southeast
Cam Hinds, CFA, Great Lakes
William Keller, CFA, Mid Atlantic
Kei Sasaki, CFA, Northeast

In this Monthly Market Advisor:

  • Retail store closures are up this year, which appears to paint a bleak picture for retail; on the other hand, investors often overlook the significant number of openings.
  • The U.S. consumer is healthy, and we are observing records in employment, hourly earnings, and household income, which may bode well for the future.
  • The increase in distressed U.S. retailers may create an opportunity for alternative strategies such as private debt and event driven hedge funds for qualified investors.

Download the report (PDF)

“When one door closes, another opens; but we often look so long and so regretfully upon the closed door that we do not see the one which has opened for us.” – Alexander Graham Bell

Alexander Graham Bell was not speaking about what has been called the “retail apocalypse” in 2017, though his words ring relevant today. The case for the apocalypse was fueled recently when Toys ‘R’ Us hit the headlines announcing that it had filed for Chapter 11 bankruptcy protection in an effort to restructure its debt obligations. In this case, Toys ‘R’ Us emphasized that its roughly 1,600 locations worldwide will continue to operate as usual ahead of the holiday season. At least this situation has not yet added to this year’s retail store closures, which surpassed 6,100 in mid-October; closures are on pace to surpass those of 2008 and be the highest number recorded in a calendar year.1

To be fair, there have been more than 3,400 store openings as well. Further, the Fung Global (FGRT) data that traditionally provide these numbers have a heavy focus on parts of retail that have been more greatly impacted, for example, apparel and department stores. In an article on its website, the National Retail Federation points to a different IHL Group study this year that broadens the retail view. It goes deeper into food and drug categories and covers other areas the FGRT data miss, for example, convenience stores, fast food, and restaurants. This broader data set estimates a net increase in store openings of more than 4,000 in 2017 (Chart 1).

Chart 1. Estimated Store Openings in 2017


2017 projected net store growth. Contact your relationship manager for more information.

Source: IHL Group, 10/17

This information seems more consistent with overall retail sales in the U.S. According to the U.S. Census Bureau, for the first nine months of this year, retail sales are 3.8 percent higher than the same period in 2016.

The consumer is healthy as we observe these records from September data releases:

  • Overall civilian employment level more than 154 million
  • Average hourly earnings $26.55/hour, up 2.9 percent over the past year
  • Real median household income finally surpassing 1999 level

Healthy Consumer May Bode Well for Future

One might argue that while employment and incomes are at record levels, so too is debt, which should restrain spending. Household debt has surpassed the last cycle’s peak of $12.68 trillion in the third quarter of 2008. As of June 30, 2017, total household indebtedness was $12.84 trillion. While this may seem alarming, the prior peak represented 85 percent of U.S. gross domestic product (GDP). The current level is lower at 67 percent of GDP. Moreover, spending has not been as constrained because low interest rates make servicing the debt more manageable. Service payments as a percentage of disposable income are near historic lows at below 10 percent (chart 2). This is an indicator we will keep an eye on as interest rates rise. For now, the consumer is still delivering positive growth considering the retail sales data referred to earlier and personal consumption expenditures that include all goods and services. This consumption measure is up 3.9 percent for the 12-month period through August.

Chart 2. Household Income and Debt at Record Levels


Graph comparing household debt service payments as a percentage of disposable personal income to real median household income in the United States. Contact your relationship manager for more information.

Sources: Board of Governors Census, St. Louis Fed, 6/17

There are certain categories of retail that have experienced negative sales growth, including electronics and appliances, sporting goods, and department stores. These have been more than offset by other areas with particularly stronger sales for motor vehicle dealers, building material and garden suppliers, gasoline stations, and the dominant nonstore category. Nonstore, or online, sales are more than 10 percent higher so far this year versus the same period last year. Technology continues to influence consumer behavior and is forcing retailers to adjust rapidly. Where they are not ready, willing, and/or able to change quickly enough, store closures have been a result. As these doors close, others should open.

An Investment Door Opens

Ratings firm Moody’s Investors Service notes the number of distressed U.S. retailers has more than tripled since the Great Recession of 2008-2009. This may create an opportunity for alternative strategies such as private debt and event driven hedge funds, which may be able to take advantage of these situations. With $5 billion worth of retailer debt maturing over the next four years, the opportunity set appears poised to expand. Beyond retail, there are other industries exhibiting distress. Default rates remain elevated for energy and have been increasing in areas like transportation and utilities, according to Wells Fargo Investment Institute.

Chart 3. U.S. High Yield Default Rates (June 2017 versus June 2016)


Chart comparing the high-yield default rates of June 2017 to June 2016. Contact your relationship manager for more information.

Sources: Wells Fargo Investment Institute, Bank of America Merrill Lynch, Bloomberg: 6/17.

Across all domestic sectors, volume is up 53 percent for riskier leveraged loans like those that forced the Toys ‘R’ Us bankruptcy. This year is on pace to surpass the decade-old record of $534 billion for leveraged loans. There is similar lending growth beyond U.S. borders. In Europe, 70 percent of the region’s new leveraged loans have been covenant-lite, i.e., having fewer restrictions on collateral, payment terms, and income levels. This percentage is more than triple the number four years ago.

Today, the opportunities are limited to specific industries and companies. The acceleration of global economic growth should keep overall default levels low for a time and limit widespread negative impact from the current lending boom. As we get later in the expansion and market conditions change or the economy slows, the investment opportunities in distressed debt are likely to increase. Where appropriate, adding alternative strategies with the ability to potentially profit from such an environment can provide a diversification benefit to one’s portfolio.


1 Fung Global Retail & Technology (FGRT), 10/17