Changing fortunes for retail

Australian retailers have have had it tough for nearly four years. Nominal retail sales growth has averaged from 2 per cent to 3 per cent since 2010, which is less than half the 6 per cent annual pace of the previous decade.

Initially this was not a disaster for the overall economy as mining investment was booming and demand for consumer services was holding up well enough.

Recently it has been more of a problem for the broader economy as mining investment has started to soften – as has overall consumption growth.

However, there are signs of light at the end of the tunnel for retailers and hence for the broader economy.

Drivers of the slump

Several factors have driven the retail slump of the past four years, including: cautious consumer attitudes towards debt and savings post the GFC; weakness in household wealth on the back of house prices and share markets; the impact of the strongly rising $A; a surge in the cost of necessities such as electricity and health; a slowdown in household income growth; and job insecurity associated with more cost conscious corporates, particularly since 2010.

Outlook

In the short term the rising trend in unemployment will act as a drag. However, a range of factors suggests that retail sales growth will pick up pace a next year.

First, while consumer caution clearly remains it appears to be fading a bit. The household savings rate is no longer rising, having stabilised at around 10 to 11 per cent, but more interestingly the proportion of Australians nominating paying down debt as the 'wisest place for savings' has fallen to its lowest since 2007.

Second, the combination of now very low interest rates and strongly rising household wealth on the back of rising share markets and rising home prices is very positive for household finances and is likely a big factor behind fading consumer caution.

Third, the housing recovery is likely to lead to a solid pickup in housing construction during the year ahead, which will help drive a pick-up in demand for household items.

Fourth, reflecting some of these factors along with the change of government, consumer confidence is well up from its lows.

Fifth, the fall in the $A from its highs (with further to go hopefully) will over time help slow the momentum towards offshore holidays and online purchases from foreign sites.

Sixth, the surge in the price of electricity looks to be slowing after five or so years of 10 to 15 per cent gains. Over the year to the September quarter it had slowed to a 6.1 per cent gain and it could even go backwards by 5 per cent or so in 2014-15 if the carbon tax/ETS is abolished.

Finally, the rise in unemployment over the next six months may not be as much of a drag as feared as falling workforce participation of older workers takes the edge off the rise in the headline unemployment rate.

Implications for investors

First, the prospective recovery in retail sales growth combined with the housing recovery already under way is a positive sign for profit growth in the year ahead and this is in turn supportive of the outlook for shares.

Second, the likelihood of stronger profit growth and hence a further rise in the local share market highlights that cash rates and bank term deposit rates of now 4 per cent or less are unattractive for investors looking to grow their long-term wealth.

Finally, while consumer discretionary shares have run hard – up 40 per cent over the past 12 months – they should be reasonably supported if retail sales start to pick up as expected.