The retail sector is facing massive head winds despite a relatively benign economic environment according to Landon Whaley, who asks what will happen to retail when economy turns South?

The way retail stocks shot out of the gate to start 2019 was as if investors completely forgot the plight of the U.S. retailer. However, retail stocks are now beginning to realign with their bearish Fundamental Gravity reality, and there is a massive amount of downside for U.S. retailers from here.

It’s All About the Consumer

In last month’s update, we discussed the downright recessionary decline in both headline retail sales and the far more important retail sales control group during December. Well, when January’s retail sales number was released during March (due to the government shutdown delay), December’s numbers were revised even lower. The official, official December retails sales growth rate hit a paltry +1.6% and the control group’s growth went below 1%, hitting +0.9%. Both data sets did manage a small bounce in January, but these one-offs don’t change the downtrend that began last summer when sales growth peaked.

Retail sales isn’t the only data set painting a dismal picture of the U.S. consumer. It appears as though consumers’ heavy debt load and the rising interest rate environment are starting to catch up. Interest rates on credit cards have jumped to the highest in over two decades. Auto loan interest rates are now the highest since 2011, making the average monthly auto loan payment the highest ever. But it’s not just filthy credit cards and auto loans; the aggregate household interest payment has increased 15% over the last 12 months. The current data isn’t quite at “there’s going to be a recession tomorrow” levels, but the proportion of U.S. household spending that’s going towards interest payments is currently sitting at its highest percentage since the 2008 credit crisis.

This shifting tide in the U.S. consumer is not just a problem for U.S. retailers, it’s a global growth issue. The U.S. consumer represents 17% of the world’s economy. The U.S. consumer has a larger chunk of the world’s economic pie than even China, and a larger chunk than Japan, Germany, the United Kingdom and Italy combined! Bottom line, we buy a lot of stuff and the global economy has come to depend heavily on our willingness and capability to open our wallets.

Retail-iation Coming to a Shopping Center Near You

Last month we discussed the wave of retail store closures over the last few years and the fact that closures were picking up steam in 2019. This month you can add Dollar Tree Inc. (DLTR),  which is closing 390 stores after announcing a $2.3 billion loss in Q4 2018 and Charlotte Russe, which filed for bankruptcy and is closing 94 stores to the long list of retailers who have too much debt and can’t compete against a backdrop of e-commerce competition and declining foot traffic. Even "disruptor" Tesla (TLSA) announced its move to online sales, which means the closing of its retail locations.

Keep in mind that these retail failures are occurring despite the second-longest expansion in U.S. history, during which time retail sales growth hit a seven-year high and the labor market was the best it’s been in 50 years.

We’ll pose the ultimate Retail-iation question again: If retailers can’t sell enough stuff (at a decent enough margin) to stay in business against that backdrop, what’s going to happen to America’s retail industry when the next recession finally comes crashing in?

The Bottom Line

While the demise of the retail industry is readily apparent to anyone with a pulse, this bankruptcy-laden reality was not reflected in the price action of retailers in January and February. That said, this macro theme has generated some alpha since the SPDR S&P Retail ETF (XRT) peaked on March 1 and has since declined -3.8%. XRT’s Quantitative Gravity is becoming more and more bearish with each passing day, and a decisive close below $41.98 will accelerate the down move. The playbook remains the same: be opportunistically short of U.S. retailers, or out entirely.

Please click here and sign up if you’d like to receive April 1 edition of Gravitational Edge, which contains an update for all five macro themes as well as full breakdown for all 14 markets we believe are providing the best opportunities right now, bullish and bearish. By signing up, you will also receive the latest edition our research reports as well as to participate in a four-week free trial of our research offering, which consists of three weekly reports: Gravitational Edge, The 358 and The Weekender.