Restaurants Serve Investors Red-Plate Specials

How’s the American economy doing? According to the Commerce Department … not good! The Commerce Department released the first-quarter GDP numbers last week. And they showed that the American economy grew at a snail’s pace of 0.7% in Q1 2017.

That’s the weakest growth in three years, and it’s below the 0.9% that Wall Street was expecting.

I don’t care how bullish you are, it is pretty hard to find any positive spin on those numbers. As always, the devil is in the details, and those details showed a very troubling picture of struggling American consumers.

How struggling? The consumption part of the GDP number shows a paltry 0.2% annualized rate of growth. That is the smallest increase since the end of 2009, but some parts of the consumer-spending food chain are doing worse than others.

This may surprise you, but the spending slowdown isn’t because Americans are getting paid less. In fact, the employment cost index, a measure of the costs of wages and benefits to American labor, rose by 0.8% in the first quarter, the highest reading since Q1 2008.

So, what parts of the American economy are struggling the most and should you avoid as an investor?

For a start, restaurants that will make you fat!

According to restaurant industry watchdog, Black Box Intelligence, same-store sales for the restaurant industry fell 1.6% in the first quarter, marking the fifth consecutive quarter of negative results.

Traffic dropped by an even larger amount, 3.6%.

Conditions didn’t pick up in March, either, as sales and traffic again declined on a year-over-year basis, sales by 1.1% and traffic by 3.4%.

Moreover, the first-quarter drops are on the heels of a very disappointing 2.4% sales drop in the fourth quarter of 2016.

Get this; same-store sales have been negative in 11 out of the past 12 months as well as five quarters in a row, the longest stretch since the 2008-09 financial crisis.

The National Restaurant Association reported that its proprietary Current Situation Index, which measures current trends in four industry indicators (same-store sales, traffic, labor and capital expenditures), was below 100. Readings above 100 are positive and below 100 are negative.

This is the fifth month in a row that the Current Situation Index has been below 100.

Between February 2016 and February 2017, only 27% of restaurant operators reported an increase in customer traffic, while 57% reported a decline in customer traffic.

This is the worst tailspin in the restaurant industry since 2009. And it’s a bright, flashing warning sign that the previously spendaholic American consumer is tapped out.

Oh, and all those recent minimum-wage increases are only going to make things worse for people who own, manage or invest in restaurants – especially via restaurant stocks.

Heck, even though Wall Street is birthing new ETFs at a furious pace, an ETF that focused on the restaurant industry – The Restaurant ETF (BITE) — shut down in December 2016.

Never fear, Wall Street created another ETF to replace it: USCF Restaurant Leaders Fund (MENU).

MENU breaks restaurants into two categories – “quick-service” or “full-service.” Seventy percent of the index is invested in full-service restaurants while the other 30% is in quick-service, aka fast food.

MENU’s top holdings include Starbucks, Restaurant Brands, McDonald’s, YUM Brands, and Arco Dorados Holdings.

Since inception, MENU has done fine; going from $15.30 on November 8, 2016 to $18.11 last Friday. That’s an impressive 18.3% return.

However, that performance has more to do with the rising-tide-lifts-all-boats rule than with solid sector growth. So if you own any restaurant stocks, you should consider selling them before the bad fundamentals catch up with restaurant stock prices.

Best wishes,

Tony Sagami