For retailers looking to enjoy a profitable 2017, the economic stars are shifting into happy alignment. Consumers are expected to have more spendable money over the coming 12 months, thanks to anticipated increases in employment and wages. And major drivers of the economy—such as business investment and housing construction—are expected to continue their modest growth.
“The economy should continue to strengthen in 2017,” says Kathryn Asher, Associate Economist in the Research Division of Moody’s Analytics, West Chester, Pa. (economy.com). “The job market is posting impressive gains, vehicle sales have never been stronger, home sales and house prices have largely recovered from the bust, and the stock market is hitting new highs.”
The improved economy should fuel more sales for retailers. “Our view is that 2017 looks better than 2016 for retail sales,” says Scott Hoyt, Senior Director of Consumer Economics for Moody’s Analytics, a research firm based in West Chester, Pa. (www.economy.com). Core retail sales are expected to increase by 5.4 percent, up from the mediocre 4.2 percent increase expected for 2016 when figures are finally tallied. (Core retail sales exclude volatile revenues from auto sales and gas stations.)
Retail results for 2016 were on the weak side of historic norms and were pretty much flat with 2015. Hoyt attributes the disappointing performance to deflationary pressures. “All indices of retail prices, not just energy, showed an unusual lack of pricing power in 2016,” he says. “We did not anticipate that a year ago.”
When deflation is factored out of the 2016 results, says Hoyt, the year’s retail sales increase would be nearly a percentage point higher. And the deflation-adjusted increase for 2017 is expected to compare favorably with periods of healthy retail activity, such as the decade of the 1990s and the years just prior to the Great Recession.
The fortunes of retailers depend largely on a growing overall economy. And for the next 12 months at least, economists expect a vigorous increase in the Gross Domestic Product (GDP), or the total spending on goods and services by consumers and businesses. For 2017, Moody’s expects GDP to grow 2.9 percent. That’s a healthy increase from the 1.6 percent growth expected when 2016 numbers are finally tallied, and the 2.6 percent growth of 2015. (The American economy’s average historic growth rate over the years is 2.5 percent. The lower 2016 GDP rate resulted from two unanticipated forces: a larger than expected inventory correction, and a slide in energy-related investment).
So what’s driving the generally favorable economy? From a retailer’s point of view, perhaps the most important economic factor is the labor market, where increases in employment and wages are expected to fill consumers’ pockets with spendable cash.
“The labor market expansion is in its seventh year, the longest uninterrupted period of job gains in recent history,” says Asher. That expansion is expected to continue, with unemployment expected to decrease to about 4.6 percent by the end of 2017, down from the 4.9 percent recorded in late 2016. (Many economists believe an economy is at “full employment” when the unemployment level dips to 4.7 percent).
The nation is finally starting to see signs of wage acceleration. “A number of large companies, such as Walmart, have announced increases in base pay,” says Hoyt. “That suggests tighter labor markets and issues in obtaining sufficient workers. And that bodes well for wage growth.” Average hourly earnings are expected to grow by three percent in 2017, up from the 2.6 percent increase of 2016, which was itself a healthy rise from the 2.3 percent growth of the previous year.
As Hoyt’s comments suggest, one big driver for wage growth is competition for workers. “Manufacturers are having a hard time keeping this year’s worker with last year’s wages,” says Walter Simson, principal of Chatham, N.J., -based Ventor Consulting (ventorconsulting.com.com). “Smarter manufacturers are going for higher quality workers, lower turnover, and slightly higher wages.”
While job growth continues, the trend is nevertheless moderating. “Job growth slowed in 2016 to an average pace of 182,000 per month, compared with 240,000 in 2014 and 2015,” says Asher. That moderation is expected to continue: “We expect the labor market recovery to persist with monthly gains holding below 200,000 on average over the next year, supported by a strengthening housing market and broad-based service growth. The moderation in job growth should not be alarming, as it is natural for this to occur as an expansion ages and the economy rapidly approaches full employment.”
Housing, another economic sector that helps drive retail sales, is expected to continue to do so in 2017. Here again, though, there is a moderating trend. Moody’s forecasts a 3.5 percent increase in housing starts in 2017, a de-escalation from the 9.7 percent of 2016, a pace which was itself slower than the previous year’s rate of 10.7 percent.
The de-escalation is caused not by a decline in demand but by limitations of supply. “Residential construction has leveled off over the past year amid reports of skilled worker shortages,” says Asher. “There are other supply constraints, including buildable lots and credit access.”
The inventory of available homes remains low as consumers continue to snap up the best deals. At the same time, constraints on mortgage credit availability are relaxing. “Lenders are increasingly comfortable extending credit to borrowers with lower scores and smaller down payments,” says Asher. “This is a result of the solid job market and consistently rising house prices which are closing in on record highs nationwide.” Prices of single-family median homes are expected to rise some 3.8 percent in 2017, a slower pace than the five percent rise in 2016 and the 6.9 percent increase of the previous year.
Additionally, federal agencies have recently clarified their regulations, so lenders have felt more comfortable extending credit. “Household formation is building and that benefits retailers,” says Simson. “People with new homes need ‘new everything.’”
The healthy employment and housing sectors contribute to generally positive feelings at large. “Consumer confidence has remained remarkably stable over the last year and a half,” says Hoyt. That’s good for retailers, because confident consumers tend to be aggressive shoppers. And when they want to open their wallets wider, banks are cooperating. “An ongoing support for retailers is the increased availability of credit,” says Hoyt. “We are seeing an acceleration of credit card balance growth, and that that is a positive sign.”
What’s good for the shopper is good for the corporation. Business confidence, a primary driver for the economy, is on the upswing. “Thanks to steadily increasing sales, business people have become more confident and have started to engage in longer term strategic planning,” says Simson. “This is a major change since the years following the great recession when business people were too depressed to even schedule a meeting to plan for the future.”
Which doesn’t mean that business investment, another important driver for the economy, is anything to write home about. “Business investment remains a source of weakness, weighing heavily on overall growth,” says Asher. The reason? A profit picture that is darker than anticipated. “Corporate profits have had a poor run recently because of lower oil prices and appreciation of the U.S. dollar,” says Asher. Corporate profits fell three percent in 2015 and are forecast to drop another 3.5 percent when 2016 numbers are finally tallied.
Manufacturers, in particular, are looking toward 2017 more favorably after coming off a fairly modest year. “Our members are starting to see an increase in sales and are in the process of building inventories,” says Tom Palisin, Executive Director of The Manufacturers' Association, a York, Pa.,-based regional employers' organization with more than 370 member companies (mascpa.org). This comes on the heels of flat or modest growth in 2016, he adds, “due largely to headwinds such as the higher U.S. dollar, regulatory changes in OSHA and overtime pay, and economic turmoil in Europe.”
Margins for larger employers will continue to compress as the tighter job market puts upward pressure on wages. Poor productivity may also continue to pressure margins over the coming 12 months. “Corporate profit growth will remain modest in 2017 as we look for a 1.4 percent gain,” says Asher.
Despite the uninspiring profit picture, Moody’s expects business investment to cease being a drag on growth over the year ahead as inventories get back in line. “In addition, consumer spending will turn more supportive to investment in the next few quarters,” says Asher. “Stronger consumer spending bodes well for industrial production, and as capacity utilization increases, so too will the pressure on businesses to invest.”
Despite the areas of moderation described above, economists do not expect the economy to soften in the foreseeable future. “While job growth will slow, we don’t expect the economy to fall into a recession soon,” says Asher. “Odds are that the current expansion, which is already one of the longest, has a way to run.”
While a good year is expected for retailers, they must also address the challenges of rising labor costs and moderation in the number of consumer shopping trips.
“One of the biggest challenges for retailers is the continuing increase in the cost of business and the resulting pressure on margins,” says Doug Fleener, president of Sixth Star Consulting, Lexington, MA (dougfleener.com). “The increasing competition for workers makes it harder to get skilled and unskilled laborers. The cost of personnel is continuing to skyrocket at the same time that rents are going up. And there is nothing in the future that tells us that the cost of business will not continue to escalate.”
What to do? “First, become more focused on smart hiring and training,” says Fleener. “Second, pay attention to improving execution and staff effectiveness. Those two things have to come together to overcome margin pressure. The slogan for 2017 should be ‘individual productivity.’”
Yet another challenge: Getting more out of every customer visit. “One of the greatest challenges facing retailers right now is the declining number of shopping trips as more consumers buy online,” says Fleener. “This affects even those retailers who are not competing directly with Internet outlets.” Retailers can take steps, he adds, to counter act this trend. (See sidebar: “Create More Traffic”).
As retailers move into the early months of 2017, economists suggest keeping a watchful eye on deflation—that surprise player that so dramatically affected retail results in 2016. “Deflation is the elephant in the room that is hindering sales growth,” says Hoyt. “If you compare recent price changes to what happened since the 1990s, most every retail segment is seeing less inflation or more deflation than what is historically normal.”
Deflation has been caused by two factors, says Hoyt. “Low energy prices have reduced transportation costs, which are a major contributor to the cost of retail merchandise. That has put downward pressure on retail pricing. The second factor is the strength of the dollar, which is important because so much of what we sell is imported.”
Retailers, therefore, should keep a careful eye on their power to control pricing as the year gets underway. The good news is that deflation is expected to experience an adjustment of its own. “We expect deflationary pressures to moderate in 2017,” says Hoyt. “Energy prices are expected to rise more slowly, and the dollar will not rise to the extent it has in the last few years.”
As the above comments suggest, 2017 will bring opportunity and challenge. The successful retailer will keep a watchful eye on the highlighted threats to profit, while taking a new look at the primary means of exploiting change: quality operations.
“Get better at executing what you have learned,” says Fleener. “And that goes from the owner on down to the front line employee. In almost every company there is a gap between the things we say we are going to do and what we actually do. In that gap there is incredible opportunity.”