U.S. Holiday Retail Outlook: Both Naughty and Nice

Strong consumer spending driven by rising wages, low unemployment and high confidence should bode well for 2018 holiday sales growth, but the loss of one shopping week and the possibility of poor weather could potentially add some chill.

While department store sales will likely slip versus last year, eCommerce could end the year strong, with the sector claiming almost a quarter of all retail sales by year-end. Prospects are also good for the biggest retailers, and off-price brands are poised to grab a larger share of incremental sales; the remaining retailers will be forced to fight over any leftover consumer spend.

In all, Morgan Stanley’s equity analysts covering U.S. retail and internet are conservative in their overall forecast for holiday sales growth, noting mounting cost pressure for retailers could buffet earnings flow-through. Their top picks for this year: Off-price retailers over their department store peers, and activewear over general apparel.

“Heading into the holiday season, we see a number of factors that could both support and detract from fourth-quarter sales growth,” says Kimberly Greenberger, who covers North American specialty apparel and department store retailers for Morgan Stanley Research. The macroeconomic climate is bright, with 4.8% year-to-date growth in consumer spending, and wage growth expected to accelerate in the fourth quarter to 3.1%, from the year-to-date average of 2.7%.

Low unemployment and high consumer confidence could help boost consumers’ willingness to spend in the spirit of the holidays, while slightly cooler temperatures, forecasted for many parts of the U.S., could spur sales for coats and winter gear. An extra day between the Thanksgiving and Christmas shopping period could also prove a gift for retailers.

However, other factors could put the Grinch in results: difficult fourth-quarter sales and traffic comparisons; the loss of one holiday shopping week (the first week of November landed in third quarter this year, meaning 13 weeks of holiday revenue this year vs. 14 weeks in 2017); and projected snow and rain that could hinder store traffic in favor of eCommerce. Furthermore, while wage growth is good for spending, it could also raise labor costs for retailers.

The outlook is guarded for the softlines category—comprising department stores, off-price and specialty retail—but a number of factors favor sales growth. Among them, first-half 2018's strong sales performance (+8.6% year-to-year average) helped by easy sales and traffic comparisons, a favorable calendar shift, a healthy consumer spending backdrop, and first-half 2018's 14.7% average flow-through (incremental retail sales dollars/incremental earnings before interest and tax dollars).

“A boost in average hourly earnings combined with lower tax withholdings could lift discretionary income and, thus, spending this holiday, further driving consumer-spending growth," says Greenberger.

Still, the report offers a mixed bag of holiday comp forecasts for softlines: a rise of 1.9% for off-price retailers and 0.6% for specialty retail, and a decline of 1.7% for department stores. Off-price retailers also outperformed last year, with a 4.5% increase. Morgan Stanley analysts continue to view off-price retailers as long-term structural winners, given their compelling value proposition and relative protection from eCommerce disintermediation.

The report also favors athleticwear (active apparel and footwear) over general apparel and footwear, driven by a growing share of incremental sales, and even forecasts 4% growth in North America activewear sales over the next five years.

Still, the impact of wage growth, eCommerce and weather could blunt softlines holiday sales growth. In addition, Greenberger acknowledges the risk from further tariffs on China imports, though her estimates excluded incremental tariffs.

The holiday season could be a mixed bag for hardlines and broadlines, which comprise consumer electronics, home appliances, tools and toys, among other nonclothing categories. The segment could see healthy sales but weaker flow-through. With the continuing favorable macro backdrop into the fourth quarter, Morgan Stanley analysts forecast 4.2% growth in 2018 for consumer spending at hardline/broadline retailers, compared with 3.9% in 2017. The report predicts upside momentum, despite tougher comparisons for around 60% of the sector. Meanwhile, recent retailer bankruptcies could drive incremental market-share gains that may bode well for the sector's remaining stores.

Each year, eCommerce bites off a bigger share of the retail pie, and this year may mean more of the same. Continued mobile adoption and shifts in consumer behavior are helping to drive eCommerce's expanded penetration.

Of the approximately $2.5 trillion spent on core retail in the U.S. (excluding building materials, gasoline stations, motor vehicles and nonstore retailers), online sales account for around 20%. The report expects the shift toward eCommerce to surpass last year's gains, especially in the fourth quarter. While the sector's top name, with about 30% of all U.S. eCommerce purchases, still continues to grow its market share, that growth rate is slowing. Notably, Christmas 2018 falls on a Tuesday, instead last year’s Monday, which favors eCommerce over store sales.

Finally, it’s worth noting that the highest-profile shopping day, continues to lose importance. Deep discounts are no longer limited to Black Friday—the day after Thanksgiving—and post-Thanksgiving sales are no longer as important as they used to be for retailers and consumers.

Indeed, shoppers now expect super sales year-round. Many major retailers are putting their Black Friday deals online the Monday and Tuesday before Thanksgiving—or for the full holiday week. And this year continues the trend of major national retailers staying closed on Thanksgiving, with at least 70 planning to shut their doors.

That said, eCommerce is still expected to see significant sales growth over the Black Friday week.

For Morgan Stanley Research on retailers, ask your Morgan Stanley representative or Financial Advisor for the full report, “2018 Holiday Outlook: Holiday Sales Could Be Nice, Profits May Be Naughty" (Oct. 31, 2018). Plus, more Ideas from Morgan Stanley’s thought leaders.