The effect of past shocks on the retail sector and what this may tell us about a post COVID-19 environment
In this special COVID-19 release, we look at what happened to retail sectors during past shocks. Although this time is different, past performance will provide an indicator of possible future performance.
Historically, the hardest-hit sectors were those linked to property and construction and large capital expenditure. Hardware, building and garden supplies sales fell 43% over the two years immediately following the GFC, with furniture, floor coverings and textile goods starting their decline six months later and falling 19% over a three-year period. Motor vehicle and parts retailing was also significantly hit, with sales falling 27% over 18 months.
Those sectors that suffered the least were food and beverage services, accommodation, apparel and pharmaceutical and supermarket retailing. This time is different however, with food and beverage and accommodation severely impacted by physical distancing and a total shut-down of international tourism, while pharmaceutical and supermarket retailing has benefited from this shock.
Apparel is the hardest sector to predict. On the one hand, it was only mildly impacted in past shocks, falling less than 5%. Consumers may maintain smaller discretionary spending on items such as clothing despite economic challenges to make themselves feel good. However, this is also a sector with very low profit margins, where a 5% or 10% fall in sales can be enough to make some apparel retailers uneconomic, requiring concessions from landlords to avoid insolvency.
We also look at macro-economic indicators and the forecasts from Treasury and the banks. These forecasts suggest the economic impact of COVID-19 will be considerably greater than past shocks, with much higher unemployment and lower GDP.
We hope that this information will assist retailers, landlords and financiers in forecasting potential scenarios and therefore considering post-lockdown strategies. If you would like specific information about specific sectors, such as how long the declines took, and how long it took to get back to pre-GFC levels, please contact one of the authors.
How did each sector perform peak-to-trough in past shocks?
The chart below shows spending by retail sub-category for the past three economic shocks: the Asian Financial Crisis (AFC), dotcom bubble and the Global Financial Crisis (GFC). Although the circumstances of the COVID-19 crisis are different, we can infer some key observations by learning from the past.
Retail sales by sector % change peak-to-trough
Source: Stats NZ seasonally adjusted quarterly sales, change between peak and trough
The sectors most impacted were hardware, building and garden supplies, motor vehicle and parts retailing, and furniture, floor coverings and textile goods. This is consistent with consumers delaying large discretionary purchases such as vehicles and home improvements during times of economic uncertainty. These sectors also cater to business consumers, particularly the construction industry, which was hit hard in prior shocks, especially the GFC when building activity fell by 28% (residential 32% and non-residential 15%). As a result, hardware, building and garden supplies spending began falling from Q1 2007 and took two years to reach the bottom, down a huge 43% from peak. Furniture, floor coverings and textile goods began their decline six months later, falling 19% over the next three years. The hardware sector at least benefited from a pre-lockdown boost in spending as consumers prepared to make use of their downtime.
As fewer new vehicles were required, motor vehicle and parts retailing fell 27% over 18 months. This category was already in decline pre-COVID-19 in New Zealand, with new and used vehicle sales down 12% and 16% respectively since January 2018 due to falling confidence and is likely to fall considerably further.
Recreational goods, specialised foods, department store and electrical goods retailers were among the next most impacted. These sectors rely on consumer discretionary spend budgets, which are likely to be more immediately hit by COVID-19 and the widespread wage cuts businesses have made, before continuing to be hit by longer-term unemployment effects. Recreational and electronics retailers also benefited from a pre-lockdown spending boost as consumers prepared.
Clothing, footwear and personal accessory retailers were, perhaps surprisingly, only mildly affected by past shocks, with a consistent c.5% decrease in sales during each shock. It appears that consumers may maintain smaller discretionary spending on items such as clothing, but sacrifice larger capital purchases such as electronics and home renovations. Apparel retailers have also historically relied heavily on brick and mortar presence and we expect that those that have not built strong e-commerce offerings will experience a longer tail of depressed sales. Consumers will emerge from lockdown both more experienced online and perhaps hesitant to be in stores, particularly so for elderly customers. We therefore expect in-store sales to fall further than past shocks, only partly offset by e-commerce sales growth. This has also been a sector that has suffered from low growth compared with other sectors that benefited from booming residential prices and construction and consequently has had very low margins to date. Even a small fall in sales will cause some apparel retailers to become unviable.
Food and beverage services and accommodation were also only mildly affected by past shocks. This time is different however, with physical distancing and a total shut-down of international tourism already severely impacting these sectors.
What happened to macro factors in past shocks and what is forecast for COVID-19?
The chart below shows how key macro-economic factors were impacted by previous shocks and how Treasury and the banks think COVID-19 may impact the economy. Significantly worse GDP and unemployment is predicted than past shocks. We consider below how COVID-19 might be different.
Source: Stats NZ, RBNZ, Treasury Scenario 1, Westpac McDermott Miller, the bank average is calculated using the Westpac, BNZ, ANZ and ASB forecasts where available; no forecasts were obtained for building activity and only ANZ has released consumer confidence statistics during COVID-19; figures are the change between quarterly peak and trough, except for building activity, which is annual, and unemployment, which is peak unemployment.
Note: Treasury has forecast multiple scenarios based on the varying time New Zealand spends in Alert Levels 1-4. The data used in the above chart is based on Treasury’s best-case Scenario 1, which assumes one month at Alert Level 4, one month at Alert Level 3 and ten months at Alert Levels 1-2, the most similar to what has transpired. Treasury’s Scenario 3 is the “worst-case” scenario and assumes six months at Alert Level 4 and six months at Alert Level 3. Under this scenario, unemployment is forecast to rise to almost 26% and GDP is forecast to drop by almost a third.
Impact of the lockdown
This is the first shock where we have effectively hit pause on most of the economy, taking away revenue from companies but leaving costs accruing. Economists from the Treasury and banks therefore predict a peak to trough % change for Quarterly GDP in the range of 13% to 23%, far greater and more immediate than previous shocks. The impact on annual GDP is forecast at 9% to 14%, as the impact of the lockdown is offset partially in subsequent quarters. However, the annual impact is many times greater than past shocks. Much of the lost revenue in the June 2020 quarter will not be able to be recaptured by hospitality and accommodation retailers and all other retailers to a lesser degree.
When we come out of lockdown
There is likely to be an immediate scramble of catch-up purchasing and protest purchasing post-lockdown at Level 2 and 1. Smaller discretionary items such as eating out to socialise, buying a new set of clothes, and personal grooming should see a spike in spending as consumers seek validation. Larger discretionary items however such as motor vehicles, home renovations and expensive electronics are unlikely to see an uplift as consumers’ concerns about long-term financial stability delay large capital decisions. This is what we saw in the GFC, which experienced a similar consumer confidence drop, when building activity fell 28% and retailers reliant on this sector suffered significantly.
Medium to longer-term
Economists consider this shock as somewhat of a blip due to the extreme nature of Government enforced lockdown. While significant ripple effects are expected, the overarching expectation is that Government and RBNZ intervention will to some degree mitigate the long-term effects of this crisis, allowing for a quicker recovery than experienced following the 1987 global market crash and the GFC. The 0.25% OCR and removal of LVR restrictions is expected to bolster house prices in the coming year, with a lower fall forecast by the banks than experienced in the GFC. In contrast to this comparatively optimistic view, we consider that the long-term impacts on the economy from the lack of tourism and increasing unemployment, especially as wage subsidies expire, will be worse than the GFC for all retail categories (other than essentials).
What should retailers and stakeholders be doing now?
Retailers should be forecasting what might happen under high, medium and low scenarios and preparing plans to be put into action when the outcome crystallises. The level 4 and 3 lockdown impact will be permanent, and we believe the medium scenario should be at least in line with the GFC. Landlords and stakeholders should be considering what they consider reasonable compromises to avoid mass closures of retailers and vacant properties.