Why you shouldn't go shopping in the retail sector

published 9 August 2006

After reporting slowing growth for much of last year, conditions on the high street seem to have picked up. Official statistics show that retail sales rose for the fifth month in a row between May and June. For the three months from April to June, sales were 2.1% ahead of the previous quarter. That's the highest quarterly growth rate since February 2004. So is this a cue to buy back into the retail sector?

Investing in retail: a short-lived revival

I don't think so. I'm far from convinced that the apparent revival on the high street can be sustained.

For one thing, much of the pick-up seems to be down to the World Cup effect. Sales of beer and snack food have risen prominently. And the tournament was particularly good for electrical retailers. Kesa Electricals recently reported that like-for-like sales that is, excluding new or refurbished stores - at its Comet chain rose 8.6% in the six months to July 18th. Sales were boosted mainly by strong demand for flat-screen TVs in the build-up to the games.

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The problem with relying on football to perk up sales is that once someone has bought a new state-of-the-art TV, they won't need another one for quite some time. All the World Cup has done is taken sales from the future and brought them forward. That suggests we can expect to see a drop-off in sales in the second half - particularly at electrical retail shops.

Investing in retail: consumers are indebted

Football or no, the main problems facing retailers haven't gone away. Consumers are still massively indebted and facing a serious squeeze on their disposable incomes. Domestic bills, from council tax to energy costs, are soaring. British Gas owner Centrica has just reported that it plans to hike gas bills by 12.4% and electricity bills by 9.4% from September - thats the second price rise this year.

EDF Energy is also raising gas bills by 19% from August, and Scottish Power is set to charge customers more too. And with the UK's gas supply situation remaining precarious, a third round of rises before Christmas is not out of the question, say analysts.This energy squeeze comes at a time when consumers are already carrying record levels of debt. Even though we actually repaid a net £0.7 billion on our credit cards during the first half of 2006 according to the British Bankers' Association, the UK's total debt burden has risen to just under £1.2 trillion.

Investing in retail: where's the money coming from?

So if we're not spending on our credit cards, then where's all the money for flat-screen TVs coming from? Look no further than the housing bubble. Mortgage equity withdrawal (MEW) - that is, money taken out of housing which is not then re-invested in another house or renovations - rose to £12.5 billion in the first quarter of 2006. That's nearly double the £6.5 billion taken out the year before. So the fall in credit card lending isn't down to people tightening their belts. They've just switched funding sources from their plastic cards to their mortgages.

There are several drivers behind this move to putting it on the house'. One is that finance companies are making it more difficult to take out unsecured borrowing, such as credit cards and personal loans. That means the indebted are forced to turn to secured lending as the only option open to them. Another is that sheer levels of indebtedness mean that people are being forced to extend their debts over longer periods of time in order to shrink their monthly payments.

This trend has become particularly pronounced as most lenders have stopped offering 0% interest rates on credit cards. Consumers are suddenly finding that debts, which had been shifted from interest-free card to interest-free card over a period of years in some cases, are suddenly starting to accumulate interest. Unable to afford the monthly payments, such borrowers take out 'consolidation' loans. These are loans secured against their homes, which are then used to pay off the short-term debts. In the long term of course, it means paying far more interest on the debt - not to mention the risk of losing your home.

Investing in retail: serious problems ahead

In this context, consumer groups are warning that continuing energy bill inflation could mean serious problems for the overstretched. The Consumer Credit Counselling Service (CCCS) says its average client is spending £32 a month more on utility and council tax bills than in 2003. "For those on the brink of debt problems, any substantial increase in utility bills or council tax can have dire consequences and push them over the edge," said Malcolm Hurlston at the CCCS. Perhaps retailers would be a good bet if the economic environment was set to improve. But the squeeze on household finances seems sure to continue for the foreseeable future.

The retail sector: trouble at No 11

Gordon Brown is under increasing pressure to push up taxes. UK public finances had their worst June ever last month, with government borrowing rising to £7.3 billion from £6.2 billion the year before much worse than the £6.5 billion expected by analysts.

Mr Brown has now spent £16.4 billion this year. That's nearly halfway to the £36 billion he plans to borrow between now and next April and we're only three months into the current financial year.

The retail sector: retailers are feeling the heat

And of course, consumers aren't the only ones facing higher taxes and soaring energy bills. Retailers have to light and heat their premises too. They also have to pay rates, and deal with rising minimum wage bills. As Marks & Spencer chief executive Stuart Rose warned earlier this month: "Costs in the business are going up quite considerably costs of rent, rates, fuel and cost of employees, so businesses are under a bit of stress."

But Mr Rose added that the retail sector may no longer be prepared to keep absorbing rising costs - and that could mean higher prices for customers. "We are seeing a decline in deflation so there won't be the same deflationary pressures as you had in the past. Indeed, there may well be some small inflationary pressures."

That might be good for retailers in the short term. But in the longer term, higher prices will just leave the UK consumer even more overstretched. And that means competition on the high street for the few pounds of disposable income left over will become even more brutal. Suffice to say, I'm not scouring the sector for bargains just yet.

First published on MSN Money (28/07/06)

John Stepek is a senior reporter at Bloomberg News and a former editor of MoneyWeek magazine. He graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.