2017 has turned into the year of the ‘retail apocalypse’. A Google search on the phrase will turn up plenty of results. It’s the name being given to the carnage being wrought on the bricks and mortar retail sector – and the US, with its landscape of shopping malls and tradition of rampant consumerism, is ground zero.
While US chains have opened around 3,000 new shops this year, they’ve closed nearly 7,000. Several well-known names have fallen on hard times, with Toys R Us filing for bankruptcy in September – the third-biggest retail bankruptcy in US history. The obvious culprit is the rise of online shopping, and Amazon – rapidly turning into the destroyer of all traditional industries – in particular. And yet, as Bloomberg recently reported, it’s not that simple.
There are many reasons for the state of the US retail sector, and it’s not all about online competition. It’s also a legacy of private equity owners loading these cash-generative groups up with debt and then leaving them to fend for themselves (UK budget retailer Peacocks was a classic example of what happens when a leveraged buyout goes wrong). There is also simply far too much retail space in the US – a report from Morningstar from this time last year noted that the US has nearly 24 square feet of retail space per head, far ahead of the 16.4 square feet for second-placed Canada, and 11.1 square feet for third-placed Australia.
In other words, traditional retailers in the US have too much capacity and too much debt. Meanwhile, we are moving from one of the most forgiving environments imaginable for a retail business (low interest rates, high consumer confidence, cheap labour) to a potentially much harder one of rising interest rates, and far tighter labour markets (and thus higher wages and staff costs).
The logical implication for investors is simple – sell out of the old-school retail businesses with their massive legacy costs, and invest in the lean, mean online businesses who are eating their lunch, dinner and breakfast. It’s a very compelling story, and now there’s a highly convenient pair of exchange-traded funds (ETFs) that will allow you to implement the trade with a minimum of fuss.
Last month, ProShares released the US-listed ProShares Decline of the Retail Store (EMTY) and the ProShares Long Online/Short Stores ETF (CLIX). These two ETFs do what they say on the tin. EMTY is short the Solactive-ProShares Bricks and Mortar Retail Store Index, an index of 56 traditional retail stocks. CLIX meanwhile is 100% long online and “nontraditional” retailers (including Amazon and China’s equivalent, Alibaba), and 50% short the old-style retailers.
It sounds like a no-brainer. And that’s the problem. The retail apocalypse story has already had a great run as an investment theme. For example, Amazon has seen its share price gain around 55% in the year to date. The SPDR S&P Retail ETF (XRT), meanwhile, is flat, and has been heavily shorted all year (and this ETF isn’t even a pure play on the bricks and mortar stores).
Is there much juice left in the trade? The launch of the ETFs suggests that, if nothing else, it’s due a pause. The thing you need to remember about these sorts of ETFs (and the same goes for funds in general) is that they are only launched when an idea has become popular enough for a large enough group of people to want to invest in it. It’s no coincidence that tech fund launches peaked during 1999, just ahead of the dotcom bubble bursting.
If you are an individual investor, it’s great to be early to an investment theme. You get to ride it higher while everyone else is still wondering what’s going on. But as a fund issuer, there’s no point in being early to the party. No one will be interested in your fund. And in any case, by the time you get the fund to market, the idea is no longer new. So ideally, you want to launch when there’s enough white heat in the idea to attract as many investors as possible. That’s how you make a profit.
The problem is, if enough people know about the theme to be excited about it, then most of not all of the gains are probably priced in. And if you look at what’s happened in the retail sector, this looks as though it could well be the case. The aforementioned SPDR S&P retail ETF actually bottomed out in mid-August (the 21st to be precise) and has rallied by more than 10% since. Meanwhile, it’s notable that Wal-Mart – perhaps the ultimate bricks and mortar retailer – recently reported soaring online sales, sending its share price to a fresh high.
I’m not saying that this theme is finished. But it certainly needs to take a break. And the truth is that right now, as a more contrarian bet, I’d probably be more interested in taking the other side of the trade, and betting on a comeback for the traditional players. For example, XRT has drawn a lot of new money in the last week or so and has risen strongly over the past month.
The carnage is likely to continue in traditional retail. Plenty of chains are over-indebted and over-stretched. But if you really want to profit from the trend, the truth is that you probably have to do your homework and separate the genuinely over-indebted distressed companies from the ones who are already adapting – and right now, there isn’t an ETF available that does that kind of legwork.
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