Creative Destruction is effect of technological innovation, when something new kills the older incumbent. We’ve gone from horse and buggy to railroads to cars, etc. A new innovation dramatically changes, if not outright kills, the old way of doing things. It’s constantly occurring but usually happens so slowly that we don’t notice it unless we step back and look at things over a long time horizon. This week offers some very telling examples of Creative Destruction.
Amazon is great. You can shop for almost anything, find a good price and have it delivered (usually for free) to your door within days. The dark side of Amazon (and how the internet in general has changed things) is that it is absolutely crushing the old way of doing retail business (brick and mortar). This transition has been going on for years now but this week illustrates how bad it has become for retail in particular:
- Gap warns big first quarter sales, earnings miss ahead – Gap is the owner of Gap, Old Navy and Banana Republic clothing stores, all of which have seen sales continue to fall and the company is talking about closing stores
Gap (GPS) – 2 years
- Macy’s Slashes Forecasts as Sales Slump Accelerates – Macy’s is one of the best run retailers in the business. Doesn’t matter.
Macy’s (M) – 2 years
- Federal Judge Blocks Staples, Office Depot Merger – The government doesn’t recognize online retailers as direct competitors. Classic government… Now both companies have said they’ll have to cut costs and close stores, and Office Depot has said it might have to look for strategic buyers to sell parts of the business.
Staples (SPLS) & Office Depot (ODP) – 1 year
These are only the latest issues following a very long string of retail trouble. Here are some Chapter 11 bankruptcy filings over the last year: Cache, Inc., RadioShak, Anna’s Linens, Quiksilver, American Apparel, Wet Seal, Sports Authority, Pacific Sunwear, Vestis Retail Group and Aeropostale. All of this will have continued negative effects for malls and commercial real estate.
The most concerning thing that I see right now is that the bonds of many retailers, especially mall based retailers, are trading at very low prices, indicating bankruptcy is not far off for many more. It goes to show that the concerns in the high yield (aka “junk”) bond market are not just energy related. (As a side note: Bloomberg had a very interesting article on the junk bond ETF’s. I don’t think we’ve seen the worst of it in junk bonds yet and with the big boys using these funds as a place to temporarily stash cash, the inflows and outflows are only going to increase volatility and trading costs, and lower returns. There are so many ETF’s these days that investors need to be careful and fully understand what they own.) The fact that so many retailers are struggling WITH energy/gas prices as low as they are says something much bigger is going on here. To be fair, retailers aren’t struggling solely because people are shopping online and not in stores. It has also been well documented that rising healthcare costs have more than eaten up the savings from lower gas prices.
The “winner take all” effect continues to be at play and the divide is only widening. I am all about free market capitalism but I don’t see how this many companies filing for bankruptcy can in any way be positive economically in the short-term (e.g. higher unemployment, unless all these people can get a job with Amazon…). And then throw on top of this the political pressure to raise the minimum wage. We’re still fighting the killer-D’s of Debt, Demographics and Deflation, and it takes a long time. Unfortunately it means the lethargic economic transition continues (low growth, low inflation and low interest rates), supporting the case for long-term bonds despite the Fed trying to kill that market as a viable investment.
Moral of the post: when it comes to investing in stocks, know what you own, why you own it and what could disrupt the business model in the long run.
Nick