Retailing

U.S. consumption is the strongest economic link. Consumers are benefiting from low fuel costs, historically cheap borrowing rates and increasing capital availability. Wage growth is outpacing nominal GDP growth, consumer income expectations are climbing, underscoring that the barriers to increased consumption are gradually falling. In particular, retailers should benefit if Treasury yields stay subdued and U.S. currency appreciation reduces the cost of imported consumer goods and boost purchasing power. However, it is instructive to dig beneath the surface. Not all retail sales categories are experiencing positive momentum, with some suffering from more acute deflationary pressures than others, and a homogenous recommendation on retailers is no longer appropriate. Broadly, retail sales at discretionary stores are contracting, while growth is evident at non-discretionary stores, and non-store sales continue to boom. The chart highlights our favored retail categories, which generally have positive sales momentum. Bottom Line: a selectivity bullish stance is warranted on retailing equities, please see yesterday's Weekly Report for more details. bca.uses_in_2016_08_30_002_c1 bca.uses_in_2016_08_30_002_c1

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There is a strong incentive for homeowners to invest in their own homes, as existing home prices have eclipsed pre-crisis peaks. Mortgage credit is also readily available and growing again after a multiyear contraction, which will aid in the resale process. There is significant scope for mortgage credit to grow, which implies a long sales runway for home improvement retailers. The latter had battened down the hatches following the housing crisis, closing stores and curtailing investment. Low construction spending is supportive of near-term same-store sales performance, and also implies that the industry can shift back into expansion mode at some point. If so, then historically appealing relative valuation levels have room to expand. We recommend moving back to an overweight stance in this group. Please see yesterday's Weekly Report for more details. The ticker symbols for the stocks in this index are: BLBG: S5HOMI- HD, LOW. bca.uses_in_2016_07_06_002_c1 bca.uses_in_2016_07_06_002_c1

The decline in global bond yields and negative interest rates outside the U.S. represent a windfall for U.S. housing, to the extent that U.S. mortgage rates are pushed below levels warranted on U.S. fundamentals alone. With a fully functioning banking system, and a willingness to extend mortgage credit, the housing sector should accelerate in the second half of the year. By extension, the S&P home improvement retailing index is poised for liftoff. The group has corrected laterally in recent months, ignoring the bullish signal from the plunge in Treasury yields (shown inverted, top panel). There is already evidence that lower mortgage rates are stoking housing demand: mortgage purchase applications are gaining traction after a long slumber, and refinancing activity is perking up. Mortgage rates have declined sufficiently to make refinancing a viable option for many homeowners. As housing-related financing becomes more readily accessible, the means and incentive to undertake renovation projects should accelerate. The NAHB remodeling survey has been grinding lower, but a reversal is likely given rising mortgage demand and a high level of pending home sales, a catalyst for home improvement projects. Importantly, there is a long runway for growth ahead, please the next Insight. The ticker symbols for the stocks in this index are: BLBG: S5HOMI- HD, LOW. bca.uses_in_2016_07_06_001_c1 bca.uses_in_2016_07_06_001_c1

Housing activity should accelerate in the back half of the year given the drop in Treasury yields. Buy home improvement retailers and add to long homebuilding positions.

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The overall retailing sector is still struggling with aggressive price discounting, as the retail price deflator hit its lowest level since the 1990s. Consumers have a high propensity to save, which is making it difficult for traditional retailers to manage and budget. The contraction in intermodal railcar shipments and rising retail inventory-to-sales ratios reinforce that conditions remain extremely difficult. However, there are some bright spots. Yesterday's retail sales report showed that pharmacies are enjoying a boom in top-line growth, while hypermarkets are finally regaining traction. On the flipside, restaurants continue to lose sales momentum, which bodes particularly ill for profitability given that labor costs are running at a high-single digit inflation rate (please see Monday's Weekly Report for more details). We are negative on retailers, with the exception of hypermarkets and retail drug stores, both of which warrant above benchmark status. bca.uses_in_2016_06_15_002_c1 bca.uses_in_2016_06_15_002_c1