Will the death of US retail be the next big short?

https://www.ft.com/content/d34ad3a6-5fd3-11e7-91a7-502f7ee26895?mhq5j=e1Please use the sharing tools found via the email icon at the top of articles. Copying articles to share with others is a breach of FT.com T&Cs and Copyright Policy. Email licensing@ft.com to buy additional rights. Subscribers may share up to 10 or 20 articles per month using the gift article service. More information can be found here.
https://www.ft.com/content/d34ad3a6-5fd3-11e7-91a7-502f7ee26895?mhq5j=e1

Will the death of US retail be the next big short? In the first of a series looking at the rise of online shopping, the FT assesses how damaging the ‘Amazon effect’ could be for traditional retailers Share on Twitter (opens new window) Share on Facebook (opens new window) Share on LinkedIn (opens new window) 212 Print this page July 16, 2017 by: Robin Wigglesworth For a small band of hedge funds that slapped down prescient bets against the tottering US housing market, the financial crisis was the biggest money-spinner in generations. Some investors think they have now found the next “big short” in the retail industry. The reshaping of how Americans shop by the internet is accelerating. The US retail industry faces a growing headache, with 10 companies pushed into bankruptcy already in 2017, according to Standard & Poor’s. Even Sears, a once mighty department store chain founded in 1886, is now tottering. “We think the magnitude of this short could be bigger than subprime,” says Stephen Ketchum, the head of Sound Point Capital, a hedge fund that manages more than $13bn in assets. “Go to the Amazon website and type in ‘batteries’. What you see is just the tip of the future iceberg. And retail is the Titanic.” Share on Twitter (opens new window) Share on Facebook (opens new window) Share this chart The relentless rise of online shopping is posing a huge challenge for US shopping malls, developers and investors who own shares and bonds in household names. The core problem is a dramatic overbuilding of stores, coupled with the rise of ecommerce, Richard Hayne, Urban Outfitters’ chief executive, told analysts on a conference call earlier this year. “This created a bubble, and like housing, that bubble has now burst,” Mr Hayne said. “We are seeing the results: Doors shuttering and rents retreating. This trend will continue for the foreseeable future and may even accelerate.” The impact is far-reaching. Credit Suisse estimates that as many as 8,640 stores with 147m square feet of retailing space could close down just this year — surpassing the level of closures after the financial crisis and dotcom bust. The downturn is hitting the largely healthy US labour market — the retail industry has lost an average of 9,000 jobs a month this year, according to the Bureau of Labor Statistics, compared with average monthly job gains of 17,000 last year. Amazon's fulfilment centres employ far fewer people than the equivalent retail space © Getty $477bn Amazon’s market capitalisation. Its shares make up a third of the S&P 500 retail index 0.9 Employees required for every $1m of sales for online stores, compared with 3.5 for a physical store Shuttered shopping malls and struggling department stores are the most visible example of what analysts have termed “the Amazon effect”, as spending migrates from bricks-and-mortar shops to the online realm dominated by the likes of Jeff Bezos’s internet retailing giant. But it is also likely just the first stage, with some investors predicting that every corner of commerce is about to experience a painful burst of creative destruction as shoppers migrate online. “There’s a big shakeout in how people consume goods,” says another big hedge fund manager. “It will have a massive economic impact . . . It is already a bad year, and it feels like it has the momentum to become something bigger.” When Amazon swooped for the Whole Foods grocery chain this summer, it sent shivers down the spines of many investors. Traditional supermarket chains like Walmart and Kroger in the US, Tesco and Sainsbury in the UK and Carrefour and Metro in Europe were long thought to be relatively insulated from the online retailing wave, but their shares all slumped as investors reappraised that assessment in the wake of Amazon’s acquisition. “Buying patterns are permanently changing,” says Wayne Wicker, chief investment officer of ICMA-RC, a pension fund for US public sector workers. “These things creep up on you, and suddenly you realise there’s trouble. That’s when people panic and run for the exit.” Share on Twitter (opens new window) Share on Facebook (opens new window) Share this chart So far the S&P 500’s retailing index has held its head above water, climbing more than 10 per cent this year. But the only reason it is not doing much worse is because Amazon makes up a third of the gauge, and its shares have climbed more than 33 per cent already this year. The online giant’s shares are now worth $477bn, more than half as much as the rest of the listed US retailing world. Without Amazon, the index’s market capitalisation has largely flatlined since early 2015. “So far, groceries have been very resilient to digitisation, but Amazon is trying to systematically break this consumer dependence: shift staples to digital; create a network of small brick-and-mortar stores to service perishables,” says Trevor Noren, analyst at 13D Research. “If Amazon or someone else succeeds, it will eliminate one of the primary reasons people still go to shopping centres.” Shopping malls and department stores are the biggest losers from this shift, and the pain is worsened by a flurry of construction in the decades leading up to the financial crisis. PwC estimates that there is about 24 sq ft of retailing floorspace per person in the US, compared with 11 sq ft in Australia — the only other developed country that comes close to the US — and between 2 and 5 sq ft in Europe. The Oculus shopping mall in New York, which opened in 2016 © Bloomberg Bank of America Merrill Lynch estimates that US retail floorspace is down 10 per cent since 2010, while department store sales are down 18 per cent. “The department store industry I think is largely in a death spiral,” Bill Ackman, the Pershing Square hedge fund manager, said at a conference in May. The pace is accelerating. So far this year, the shuttering of 76m sq ft of retail space has been announced, according to CoStar, a data provider — almost as much as the eight-year high of 82.6m during the whole of 2016. PwC estimates that at least 90m sq ft will be closed this year, but Credit Suisse estimates that based on current trends it could be a record-smashing 147m sq ft. “It’s a slower bleed than the housing crash, but that was a cyclical story. Retail is different because it’s slower, but secular,” says Nadeem Meghji, head of North American real estate at Blackstone, the world’s biggest investor in property. The concern is that this could cause collateral damage to the broader commercial and even residential real estate market, as shuttered shops, malls and stores are redeveloped for other uses. Jay Sellick, senior managing director of 13D, predicts this will be the “next stage of this crisis”, weighing on the $4tn worth of mortgages in the commercial real estate market, which already “appears overbuilt and over-indebted”. Yet the decline of the iconic American shopping mall is only the most visible aspect of a far broader revolution that is upending the entire world of commerce. Online-only purchases account for just over 10 per cent of all US retail sales, but the share is growing quickly, says Credit Suisse. Across the board, consumption patterns are evolving, especially among younger Americans who are much more comfortable with an online-only experience than their parents. A nearly empty shopping mall in Milford, Connecticut, earlier this year © Getty 10 Bankruptcies in the US retail sector so far this year 90m sq ft PwC’s estimate of US retail floorspace that could be closed this year. Credit Suisse says it could hit 147m sq ft 9,000 Average number of jobs lost each month this year in the retail industry Even dedicated turnround investors are sitting on their hands. Private equity firms and hedge funds that specialise in corporate upheaval — so-called distressed debt investors that snap up struggling companies, taking them over in a restructuring and hopefully engineering a recovery — are largely shunning traditional retail, wary of the immense challenges, according to restructuring advisers. Victor Khosla, founder and senior managing partner of Strategic Value Partners, a $6bn distressed debt hedge fund, says the list of troubled retailers his firm now monitors is “extraordinarily long”, but he is staying well away. “Trying to figure out the bottom is hard. We have spent a lot of energy understanding these businesses, and have concluded that the vast majority of them are uninvestable,” he says. “Many of these were great businesses at some point in time, but the internet and changing consumer habits have destroyed them.” Share on Twitter (opens new window) Share on Facebook (opens new window) Share this chart Some retail chief executives who have managed to build relatively successful digital operations complain that their share prices are too low and are unfairly punished for the broader industry malaise. That may be, but “I remember hearing homebuilders say the same in 2006”, one hedge fund manager recalls, pointing out that even for traditional retailers the shift will be painful, given that people tend to make less impulsive purchases on the internet. “A lot of incidental consumption doesn’t happen online. Most people don’t wander the digital aisles,” he says. A dollar spent in a shop in practice only translates to 80-90 cents online, even though costs are lower. Data released on Friday showed that core retail sales in June fell for a second month running for the first time since early 2015. Some investors are unconvinced that traditional players have what it takes to compete with their online rivals, given the latter’s advantages in technology and data. “[In] whatever area they are competing for shopping dollars, it is like the old-world retailers are bringing a knife to the fight, and the tech companies are rocking a heat-seeking missile,” says another hedge fund manager. Still, hedge fund managers stress that the “retail big short” is going to be fundamentally different from the housing downturn — far more halting and slow — which makes it hard to carry out anything other than tactical, opportunistic trades. Moreover, it will not entail the global, systemic dangers that the subprime-triggered financial crisis did. Some of the damage is already priced into the bonds and stocks of retail companies, and the slowness of the shakeout makes it tricky and expensive to make outright bearish wagers on what some analysts are calling a “retail-mageddon”. “Because it is such a slow bleed, it is important to get both the direction and the timing right,” Mr Ketchum says. “We are focused on shorting the companies that have reached a tipping point for one reason or another.” Some hedge fund managers are more sceptical. David Tawil, president of Maglan Capital, says: “Although it is a good short, I don’t think that, at this point, it is the short, nor is it a big short.” Share on Twitter (opens new window) Share on Facebook (opens new window) Share this chart In addition, retail is not going away, and as some chains go out of business the survivors will pick up some of their customers. Most economists expect wage growth in the US labour market to pick up in the coming years, helping to support consumer spending. “Websites cannot give you goosebumps, and that is where physical stores still have an advantage,” says Byron Carlock, head of PwC’s US real estate practice. “I don’t see consumers shying away from consuming. Good retailers will figure it out.” But what looks like a slow-moving train wreck could speed up should American consumers — who at the moment are enjoying low interest rates and subdued unemployment — suffer another shock. For example, in the unlikely event that the Federal Reserve embarks on aggressive rate rises and pushes the economy into a recession, retailers could be hit both by higher borrowing costs and consumers tightening their belts. The impact of the retail sector’s problems on the fabric of the US labour market is likely to be severe. Goldman Sachs estimates that ecommerce companies only require 0.9 employees per $1m of sales compared with 3.5 for a bricks-and-mortar store, and the sector is on course to lose about 100,000 jobs this year. This may be small compared with the overall retail economy — which employs almost 16m — but it is likely only the beginning of a broad, accelerating trend as even more shopping migrates online. “The social and economic consequences are going to be huge,” warns Mr Meghji. “It’s a massive secular change to how our economy and society operates.” A chart on labour intensity was updated on July 18 to correct an errant data point Online agencies’ growing sway in the travel industry The internet is reshaping retail, but even industries that benefit from the still-healthy demand for “experiences” are scrambling to confront a rising tide of digital challenges. Take the hotel and travel sector. Priceline and Expedia are now valued at a combined $114bn, almost as much as all the hotels and hospitality groups in the S&P 500, or the airlines. That is beginning to worry some investors that depend on the health of the traditional travel industry, such as real estate investors that rent out properties to the big hotel franchises. “What happens if Priceline and Expedia have all the data, and drive all the customers to their own hotels? Then brands wouldn’t matter,” says Rob Hays, chief investment officer of Ashford Investment Management, which specialises in real estate. “It would be a death blow to the hotel industry as we know it.” The online travel agencies currently account for about 10 per cent of all customers of hotels that lease properties from Ashford, but for some hotels it can be as much as 60 per cent, Mr Hays estimates. That gives the online agencies growing power over the hotel industry. The American Hotel & Lodging Association, which includes chains like Marriott and Hilton, is lobbying the Federal Trade Commission to say the two big agencies are monopolistic, according to Bloomberg. With additional pressure from the likes of Airbnb the industry faces a challenging time. Copyright The Financial Times Limited 2017. All rights reserved. You may share using our article tools. Please don't copy articles from FT.com and redistribute by email or post to the web. Share on Twitter (opens new window) Share on Facebook (opens new window) Share on LinkedIn (opens new window) 212 Print this page

Unpacking a Mainstream Index, the NASDAQ 100

http://horizonkinetics.com/wp-content/uploads/Q2-2017-Commentary_APPROVED_FINAL.pdf

The Looming Energy Shock

http://www.talkmarkets.com/content/us-markets/the-looming-energy-shock?post=140595&page=3

Practically No Discoveries

There is one hard and fast rule in the oil business: Before you can pump it, you have to find it.
The growing problem here is that oil discoveries were horrible in 2016, really bad in 2015, and terrible in 2014. That recent three year stretch is the worst in the data series:

(Source)

Again: you have to find it before you can pump it. And around the world, oil companies are just not finding as much as they used to.
Remember that blue dotted line on the oil investment chart above?Here’s its counterpart, showing discoveries over the same time frame -- it’s just a straight slump downwards:
Now it's clear why the oil companies pulled back their investment dollars so rapidly when prices slumped:  They were spending more and finding less throughout the 2009-2014 period, so they were already feeling the pain of diminishing returns. When the price of oil cracked below $100 a barrel, they wasted no time reining in their investment dollars.
Should we be concerned about this record lowest level of oil project funding in 70 years?Why, yes, we should.Everyone should:

"Our analysis shows we are entering a period of greater oil price volatility (partly) as a result of three years in a row of global oil investments in decline: in 2015, 2016 and most likely 2017," IEA director general Fatih Birol said, speaking at an energy conference in Tokyo.
"This is the first time in the history of oil that investments are declining three years in a row," he said, adding that this would cause "difficulties" in global oil markets in a few years.
(Source)

To give you a visual of the process, here’s a chart to help you understand why it takes years between making an initial find and maximum production:

(Source)

This bears repeating: Oil is the most important substance for our economy, we’re burning more of it on a yearly basis than ever before, and we just found the lowest amount since the world economy was several times smallerthan it is now. And all this is happening while we're reducing our efforts to find more at an unprecedented rate.

If you really want to understand why I hold these views, you need to fully understand and digest this next chart. It shows the amazingly tightly-coupled linear relationship between economic growth and energy consumption:

(Source)

This chart above says, if you want an extra incremental unit of economic growth you're going to need to have an extra incremental unit of energy.More growth means more energy consumed.
And today, oil is still THE most important source of energy. It's the dominant energy source for transportation, by far.A global economy, after all, is nothing more than things being made and then moved, often very far distances. Despite what you might read about developments in alternative and other forms of energy, our dependency on oil is still massive.

Plunging Investment

Resulting from the start of oil's price decline in 2014, the world saw a historic plunge in oil investments (exploration, development, CAPEX, etc) as companies the world over retracted, delayed or outright canceled oil projects:

(Source)

In the chart above, note the two successive drops in oil investment from 2014-2015 and then again into 2016.  So far 2017 is shaping up for another successive decline, which will mark the only three-year decline in investment in oil's entire history.So what's happening here is actually quite unusual.
This isn’t just a slump. It’s an historic slump.
We don’t yet know by how much oil investment will decline in 2017, but it’s probably pretty close to the rates seen in the prior two years.
Next, take note of the dotted blue arrow in the chart.See how far oil investment climbed during the years from 2009-2014?Not quite a doubling, but not far off from one either.Remember those years, I’ll return to them in a moment.
The key question to ask about the 2009-2014 period is: How much new oil was discovered for all that spending?
Turns out: Not a lot.

There’s no way to speed up the process of oil discovery and extraction meaningfully, no matter how much money and manpower you throw at it.It simply requires many years to go from a positive test bore to a fully functioning extraction and distribution/transportation program operating at maximum.
In Part 2: Preparing For The Coming Shock we provide the evidence that shows why by 2019, or 2020, oil prices will have forced a new crisis upon the world.
More economic growth requires more energy. Always has and it always will. Oil is the most important form of energy of them all. But everyone assumes -- especially today when it appears as if we're "awash" in it given the current supply glut -- that we will always have access to as much as we need.
That's not going to be the case soon. And you are one of the few to understand why.
You get to use that awareness to make conscious decisions about your own life right here and right now. You can position yourself for safety, as well as to take advantage of what are likely to be once-in-a-lifetime investment opportunities.
But you also need to prepare for those in your life, like most other people today, who lack the ability, insight, or capability to join you at this early stage.

OPEC can’t save oil market alone—the U.S. has to step in, says Morgan Stanley

OPEC can’t save oil market alone—the U.S. has to step in, says Morgan Stanleyhttp://www.marketwatch.com/story/opec-cant-save-oil-market-alonethe-us-has-to-step-in-says-morgan-stanley-2017

 

OPEC and other major oil producers have taken on an ambitious battle to rebalance the oversupplied oil market, but despite the best intentions their efforts aren’t enough, Morgan Stanley warns.
In a Thursday research report, the Wall Street bank called on U.S. shale-oil producers to join in efforts to tackle the global supply glut that has pummeled prices since the summer of 2014.
“If OPEC doesn’t balance the market, the oil price will have to force it somewhere else, most likely in U.S. shale. For a chance of a balanced market in 2018, the U.S. rig count can no longer grow and possibly needs to contract ~150 rigs. Given current break-evens, this requires WTI between $46-50,” the Morgan Stanley analysts said in the report.
Cementing their downbeat assessment of the oil market, they significantly downgraded their 2017 forecasts for both West Texas Intermediate and Brent. They now see WTI trading at $48 a barrel at the end of the year, down from $55 expected previously. For Brent, they cut their forecast to $50.5 from $57.5.

Morgan Stanley

Crude oil for August delivery most recently traded at CLQ7, -2.37%  $44.81 a barrel on Thursday, while Brent for September LCOU7, -2.31%  was at $47.45 a barrel.
Oil prices have been volatile in recent months, even as the Organization of the Petroleum Exporting Countries and other major producers—including Russia—have eased output. They initially agreed to a six-month pact running from January until the end of June, but as prices remained stubbornly low, they extended the accord into the first quarter of 2018.

–– ADVERTISEMENT ––

The OPEC and non-OPEC members have signed up to cut output by a collective 1.8 million barrels a day, hoping it will bring global oil inventories to a five-year average. The Saudi Arabian and Russian oil ministers have even pledged to do “whatever it takes” to balance the market.
However, there may be a limit to “whatever it takes,” according to the Morgan Stanley analysts.
“Although compliance has been healthy, OPEC’s production cuts have so far made little dent in inventory levels, which are still roughly as high as a year ago,” they said.
“To support prices in the mid-$50s, OPEC-12 would probably need to lower production by another 200,000-300,000 barrels a day and extend the output agreement to end-2018. We find this unlikely,” they added.

Morgan Stanley

Out of the 14 OPEC members, only 12 are included in the output restrictions. Libya and Nigeria are exempt because production in those countries has been hit by internal conflicts. Supply from both nations, however, has risen recently, seen as partly scuttling OPEC’s efforts to bring down inventories.
Additionally, U.S. shale producers responded to the higher prices that came after the OPEC deal by ramping up production rapidly, helping to offset the global production cuts.
There have been green shoots in the market, however. According to the International Energy Agency’s monthly report, demand outstripped supply in the second quarter, and that shortfall should be “significant” in the second half of 2017.
But unless someone does something, that trend could quickly turn again, Morgan Stanley warned.
“The combination of little impact on physical balances, but a strong signal to invest has meant that the OPEC cuts have had a perverse effect: on current trends, the oil market would be oversupplied again in 2018,” the analysts said.
That is why U.S. producers need to stop some pumps too, they said. Ideally the number of rigs need to fall by 120-180, according to Morgan Stanley, to constrain output to a level that doesn’t flood the oil market.
The weekly Baker Hughes rig count last Friday showed a decline in active oil rigs for the first time in 24 weeks. The number of rigs fell by two to 756.
“If the U.S. rig count were to stabilise, it would impact production relatively quickly. However, perhaps still not as fast as is generally perceived. Even U.S. shale does not respond instantly,” the analysts said.
Not everyone is as downbeat on the oil market, though. UBS commodity analyst Giovanni Staunovo said earlier this week that both Brent and WTI could rally more than 20% before the end of 2017. That is partly because he believes demand will continue to outstrip supply, and partly because he sees a chance U.S. production will disappoint.
“If the market outside the U.S. is already in a deficit, the U.S. is not immune to that. It’s a global market, so it will also affect the U.S,” he said.
“You’ve had reports indicating [the U.S.] can even produce at $20 a barrel. But let’s see if last week’s rig count is a start of a trend or not—if it’s the start of a trend it shows that they also have some issues producing at these price levels.”

-07-06