Morgan Stanley Research analysts see a strong start following Black Friday but question whether the short shopping season will hurt retailers.

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Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver, Morgan Stanley's U.S. Thematic and Equity Strategist.

Simeon Gutman: I'm Simeon Gutman, U.S. Hardlines, Broadlines, and Food Retail analyst.

Alex Straton: And I'm Alex Straton, North America Softlines, Retail, and Brands analyst.

Michelle Weaver: Thanksgiving and Black Friday are behind us; and now that the holiday shopping season is in full swing, we have some interesting new data we wanted to dig into. We also recently concluded Morgan Stanley's Global Consumer and Retail Conference in New York, and we'll share some key takeaways from that.

It's Friday, December 6th at 10am in New York.

I was recently on the show to talk about our holiday shopping outlook and survey takeaways, and noted that overall, we're expecting stronger spending this holiday season relative to last year. Inflation's cooled, and U.S. consumers are more positive on spending this season versus the past two holiday seasons. Now that we've got Black Friday in the rearview mirror, Simeon, within your space, how's holiday season tracking so far?

Simeon Gutman: Better. And the three key metrics – traffic, physical store sales, digital sales – all seem to be tracking better. The question is the magnitude and the length of ahead that the entire industry is – and what does that give us through the rest of the season? As we all know, the holiday season, shopping season is shorter; with the later fall of Thanksgiving, we're losing a weekend. The tone at our conference affirmed all of this, all the data points we heard were pretty upbeat. And it seems like the weather couldn't have broken at a better time, which is different from the October lead up to holiday.

So, it seems like we're off to a pretty healthy start. I think there's some questions of what do we make up in the last three weeks in this final push. Some companies at our conference sounded good on that. Some were a little bit, call it cautiously optimistic about the rest of the season.

Michelle Weaver: And what are you expecting for the rest of the holiday season?

Simeon Gutman: In theory, and as we do our models what the good start typically portends a pretty good finish. There will be like a frenetic, frantic rush till the end. And because we lose that last weekend, you know, we might just lose some days. That's what history has told us. And those couple of days, it could end up being a couple of points or a couple hundred points of growth. That's understandable. I think the market knows that. And if that were to happen, as long as the underlying tone of business is healthy, I think it's pretty excusable because it's either made up in the subsequent months, and it'll especially be made up in the following year.

Michelle Weaver: Great. And then Alex, in your space with Black Friday now behind us, were there any surprises?

Alex Straton: The headline on Black Friday out of the apparel and footwear space was very positive. That's the message everyone should hear. I think I'll break down how we thought about – and what we observed – into two buckets. One being what we saw on demand, and the other being what we saw on promotional or discounting activity.

Now, starting with demand, I think context is really important here, and we had a pretty lackluster September and October trend line in the space. To us, this was a function of adverse weather; it was much hotter than usual, really deterring apparel spending. We also had high hurricane activity, which deterred overall discretionary spending. And then also we had the election overhang upon consumers, which can, you know, deter spending as well.

So as a result, we had fall apparel spending not necessarily as robust as many retailers would have liked. We've seen that in third quarter earnings reports. And we viewed Black Friday as, almost this very powerful potential catalyst for pent up demand. It was very weather dependent, though, and Simeon mentioned this briefly. We got a cold front across the country, and I think that created this important catalyst to kick off the holiday season. So, demand was strong.

Just to put some numbers around it. Our line counts were up 30 per cent year-over-year. That's a data set that typically grows mid-single digits. So, speaks to, you know, outstanding demand. It doesn't capture conversion, so it's not perfect, but it gives you a sense for our confidence and how strong it was.

The second piece that I wanted to cover is just promotions. And what we saw there was consistent activity year-over-year. That was a positive surprise for me. We were braced for discounting to be higher across the group because we exited both the second quarter and out of the early third quarter reporters with some excess inventory. So, we thought they might look to clear it.

We had seen a recent uptick in promotional activity in October across the group. And then also, we're facing down a pretty competitive fourth quarter set up because of a number of the dynamics that Simeon mentioned. So, the fact that we didn't see retailers, kind of, push the panic button on discounting and promotions to drive that strong sales result, I think further underscores how strong it was; and also tells you retailers are willing to wait later for the consumer, similar to how they behaved last year.

Michelle Weaver: In your outlook for holiday shopping this year, you cautioned about some potential headwinds. What were they and have they been playing out as you expected?

Alex Straton: Yeah. So, since the start of the year, there's been a number of dynamics that we're going to weigh on the fourth quarter, no matter what. The first is that it's companies in my coverage most difficult year-over-year comparison quarter from both the sales and a profitability perspective. The second is that we have a compressed holiday shopping period, five fewer days, one less weekend; that’s very impactful for these retailers. And the last thing is that most retailers are lapping an extra week last year. They have a 53rd week calendar dynamic that reverses out this week. So, think about it as one last less week of sales opportunity.

And so, I could have sat here in January and told you all of that. What we've learned since is that these retailers are now also facing incremental freight headwinds in the back half. Some of which are just repercussions from the Red Sea dynamic. And then second, this inventory build that I mentioned that started to show up in the second quarter and some of these earlier third quarter reporters. So, all of those headwinds, I'm putting them on the table.

I think the good news is that the market seems to now mostly appreciate those. There's not really high bars as we think about fourth quarter results expectations or even sentiment more broadly. So, while it is a very challenging set up, I feel like it's mostly appreciated.

Michelle Weaver: Great. And final question for both of you. What are some of your key takeaways from the fireside chats you hosted at the conference that just closed?

Simeon Gutman: A few thoughts. First on the tone of holiday, I'll reiterate again: companies that are most exposed to holiday, in my coverage – ones that have weather exposure, ones that have seasonal exposure, ones that have large Black Friday promotions and into Cyber Monday – sounded good. There was a sense of relief that we're making up sales, especially on cold weather categories, and there's momentum that's being carried into the rest of the year.

Second, in our chats with some of the largest companies, a discussion around how starting from a retail point of view and leveraging into Omnichannel has actually been beneficial, because now as these companies gain scale and leverage, the economies of scale in Omnichannel are actually more beneficial for profits than they thought; and in some cases that's just getting started. So, an interesting dichotomy, or almost an irony for the way that these businesses were positioned about 10 to 15 years ago.

Third inventories – building; companies acknowledge that, but generally feel good. That reflected underlying optimism on sales trends and buying good inventory they think the customer will respond to. And then lastly, on housing; acknowledgment that the backdrop and the rebuild will be slow and steady, but at the same time that the industry is bottoming.

Alex Straton: Yeah, on my end, I would underscore what Simeon said on demand in the holiday. Clearly a strong start in terms of the weather finally turning around this big initial event with Black Friday.

Secondly, on inventory we're asking our companies the same question is – how do they feel about this build that we're seeing? And they attributed to a little bit of a pull forward of receipts in advance of holiday. Some also pulling forward even further than normal to offset some of the freight expense, or they were worried about some degree of freight disruption that could have impacted the receipts. So they have explanations for why that's the case, but we're monitoring it nonetheless.

And then lastly, the one magic dynamic we didn't mention yet is tariff, of course, and what the outlooks are there. I would say most companies in my space feel that they have a number of levers that they can pull to offset any potential incremental tariff next year. But the reality there is that apparel is a deflationary category. There's no pricing power. So I'll be really interested to see how this plays out next year.

Michelle Weaver: Simeon and Alex, thank you for taking the time to talk. And to our listeners, thanks for listening. If you enjoy Thoughts on the Market, please leave us a review wherever you listen to the show and share the podcast with a friend or colleague today.