For a small band of hedge funds that slapped down prescient bets against the tottering US housing market, the financial crisis was the biggest money-spinner in generations. Some investors think they have now found the next "big short" in the retail industry.
The reshaping of how Americans shop by the internet is accelerating. The US retail industry faces a growing headache, with 10 companies pushed into bankruptcy already in 2017, according to Standard & Poor's. Even Sears, a once mighty department store chain founded in 1886, is now tottering.
"We think the magnitude of this short could be bigger than subprime," says Stephen Ketchum, the head of Sound Point Capital, a hedge fund that manages more than $13bn in assets. "Go to the Amazon website and type in 'batteries'. What you see is just the tip of the future iceberg. And retail is the Titanic."
The relentless rise of online shopping is posing a huge challenge for US shopping malls, developers and investors who own shares and bonds in household names. The core problem is a dramatic overbuilding of stores, coupled with the rise of ecommerce, Richard Hayne, Urban Outfitters' chief executive, told analysts on a conference call earlier this year. "This created a bubble, and like housing, that bubble has now burst," Mr Hayne said. "We are seeing the results: Doors shuttering and rents retreating. This trend will continue for the foreseeable future and may even accelerate."
The impact is far-reaching. Credit Suisse estimates that as many as 8,640 stores with 147m square feet of retailing space could close down just this year — surpassing the level of closures after the financial crisis and dotcom bust. The downturn is hitting the largely healthy US labour market — the retail industry has lost an average of 9,000 jobs a month this year, according to the Bureau of Labor Statistics, compared with average monthly job gains of 17,000 last year.
Shuttered shopping malls and struggling department stores are the most visible example of what analysts have termed "the Amazon effect", as spending migrates from bricks-and-mortar shops to the online realm dominated by the likes of Jeff Bezos's internet retailing giant. But it is also likely just the first stage, with some investors predicting that every corner of commerce is about to experience a painful burst of creative destruction as shoppers migrate online.
"There's a big shakeout in how people consume goods," says another big hedge fund manager. "It will have a massive economic impact . . . It is already a bad year, and it feels like it has the momentum to become something bigger."
When Amazon swooped for the Whole Foods grocery chain this summer, it sent shivers down the spines of many investors. Traditional supermarket chains like Walmart and Kroger in the US, Tesco and Sainsbury in the UK and Carrefour and Metro in Europe were long thought to be relatively insulated from the online retailing wave, but their shares all slumped as investors reappraised that assessment in the wake of Amazon's acquisition.
"Buying patterns are permanently changing," says Wayne Wicker, chief investment officer of ICMA-RC, a pension fund for US public sector workers. "These things creep up on you, and suddenly you realise there's trouble. That's when people panic and run for the exit."
So far the S&P 500's retailing index has held its head above water, climbing more than 10 per cent this year. But the only reason it is not doing much worse is because Amazon makes up a third of the gauge, and its shares have climbed more than 33 per cent already this year. The online giant's shares are now worth $477bn, more than half as much as the rest of the listed US retailing world. Without Amazon, the index's market capitalisation has largely flatlined since early 2015.
"So far, groceries have been very resilient to digitisation, but Amazon is trying to systematically break this consumer dependence: shift staples to digital; create a network of small brick-and-mortar stores to service perishables," says Trevor Noren, analyst at 13D Research. "If Amazon or someone else succeeds, it will eliminate one of the primary reasons people still go to shopping centres."
Shopping malls and department stores are the biggest losers from this shift, and the pain is worsened by a flurry of construction in the decades leading up to the financial crisis. PwC estimates that there is about 24 sq ft of retailing floorspace per person in the US, compared with 11 sq ft in Australia — the only other developed country that comes close to the US — and between 2 and 5 sq ft in Europe.
Bank of America Merrill Lynch estimates that US retail floorspace is down 10 per cent since 2010, while department store sales are down 18 per cent. "The department store industry I think is largely in a death spiral," Bill Ackman, the Pershing Square hedge fund manager, said at a conference in May.
The pace is accelerating. So far this year, the shuttering of 76m sq ft of retail space has been announced, according to CoStar, a data provider — almost as much as the eight-year high of 82.6m during the whole of 2016. PwC estimates that at least 90m sq ft will be closed this year, but Credit Suisse estimates that based on current trends it could be a record-smashing 147m sq ft.
"It's a slower bleed than the housing crash, but that was a cyclical story. Retail is different because it's slower, but secular," says Nadeem Meghji, head of North American real estate at Blackstone, the world's biggest investor in property.
The concern is that this could cause collateral damage to the broader commercial and even residential real estate market, as shuttered shops, malls and stores are redeveloped for other uses. Jay Sellick, senior managing director of 13D, predicts this will be the "next stage of this crisis", weighing on the $4tn worth of mortgages in the commercial real estate market, which already "appears overbuilt and over-indebted".
Yet the decline of the iconic American shopping mall is only the most visible aspect of a far broader revolution that is upending the entire world of commerce. Online-only purchases account for just over 10 per cent of all US retail sales, but the share is growing quickly, says Credit Suisse. Across the board, consumption patterns are evolving, especially among younger Americans who are much more comfortable with an online-only experience than their parents.
Even dedicated turnround investors are sitting on their hands. Private equity firms and hedge funds that specialise in corporate upheaval — so-called distressed debt investors that snap up struggling companies, taking them over in a restructuring and hopefully engineering a recovery — are largely shunning traditional retail, wary of the immense challenges, according to restructuring advisers.
Victor Khosla, founder and senior managing partner of Strategic Value Partners, a $6bn distressed debt hedge fund, says the list of troubled retailers his firm now monitors is "extraordinarily long", but he is staying well away.
"Trying to figure out the bottom is hard. We have spent a lot of energy understanding these businesses, and have concluded that the vast majority of them are uninvestable," he says. "Many of these were great businesses at some point in time, but the internet and changing consumer habits have destroyed them."
Some retail chief executives who have managed to build relatively successful digital operations complain that their share prices are too low and are unfairly punished for the broader industry malaise. That may be, but "I remember hearing homebuilders say the same in 2006", one hedge fund manager recalls, pointing out that even for traditional retailers the shift will be painful, given that people tend to make less impulsive purchases on the internet.
"A lot of incidental consumption doesn't happen online. Most people don't wander the digital aisles," he says. A dollar spent in a shop in practice only translates to 80-90 cents online, even though costs are lower. Data released on Friday showed that core retail sales in June fell for a second month running for the first time since early 2015.
Some investors are unconvinced that traditional players have what it takes to compete with their online rivals, given the latter's advantages in technology and data. "[In] whatever area they are competing for shopping dollars, it is like the old-world retailers are bringing a knife to the fight, and the tech companies are rocking a heat-seeking missile," says another hedge fund manager.
Still, hedge fund managers stress that the "retail big short" is going to be fundamentally different from the housing downturn — far more halting and slow — which makes it hard to carry out anything other than tactical, opportunistic trades. Moreover, it will not entail the global, systemic dangers that the subprime-triggered financial crisis did.
Some of the damage is already priced into the bonds and stocks of retail companies, and the slowness of the shakeout makes it tricky and expensive to make outright bearish wagers on what some analysts are calling a "retail-mageddon".
"Because it is such a slow bleed, it is important to get both the direction and the timing right," Mr Ketchum says. "We are focused on shorting the companies that have reached a tipping point for one reason or another."
Some hedge fund managers are more sceptical. David Tawil, president of Maglan Capital, says: "Although it is a good short, I don't think that, at this point, it is the short, nor is it a big short."
In addition, retail is not going away, and as some chains go out of business the survivors will pick up some of their customers. Most economists expect wage growth in the US labour market to pick up in the coming years, helping to support consumer spending.
"Websites cannot give you goosebumps, and that is where physical stores still have an advantage," says Byron Carlock, head of PwC's US real estate practice. "I don't see consumers shying away from consuming. Good retailers will figure it out.
"But what looks like a slow-moving train wreck could speed up should American consumers — who at the moment are enjoying low interest rates and subdued unemployment — suffer another shock. For example, in the unlikely event that the Federal Reserve embarks on aggressive rate rises and pushes the economy into a recession, retailers could be hit both by higher borrowing costs and consumers tightening their belts.
The impact of the retail sector's problems on the fabric of the US labour market is likely to be severe. Goldman Sachs estimates that ecommerce companies only require 0.9 employees per $1m of sales compared with 3.5 for a bricks-and-mortar store, and the sector is on course to lose about 100,000 jobs this year.
This may be small compared with the overall retail economy — which employs almost 16m — but it is likely only the beginning of a broad, accelerating trend as even more shopping migrates online.
"The social and economic consequences are going to be huge," warns Mr Meghji. "It's a massive secular change to how our economy and society operates."