Consumers on the Ropes

One plank that the bulls have built their optimistic outlooks on is the notion that despite high debt loads, the bursting housing bubble, rising energy prices, stagnant wages, and a host of other problems, the American consumer, who accounts for more than two-thirds of the economy, will keep doing what he or she has been doing -- spending. In "Consumers May Be Getting Tired," the Wall Street Journal notes developments that just might call that view into question.

Signs are emerging that American consumers may be getting tired of carrying the economy. How much they pull back will be a major factor in whether the U.S. economy keeps slowing or whether the pace of growth perks up.

Consumer purchases of goods and services increased at a robust 4% inflation-adjusted annual clip in the past two quarters. But economists and retail executives now see signs that the anticipated slowdown is at hand. Gasoline prices are pinching, the housing slump continues and the labor market, which has provided significant support, is showing signs of fatigue.

Yet stock prices are buoyant, increasing the wealth of households that own shares and offsetting some of the drag from the housing market.

Amid concern about consumers' habits, big retailers issue April sales reports tomorrow, and the Commerce Department follows on Friday with its estimate of retail sales in April. Yesterday, Redbook research said its index of chain-store sales in April fell 4.1% from March. The International Council of Shopping Centers said its measure of chain-store sales last week was running only 1.7% higher than a year ago, the weakest ICSC reading since early March, when the index matched a nearly four-year low.

Bad weather and rising gasoline prices were early explanations, but now there is evidence of a lasting slowdown, said Michael Niemira, chief economist at ICSC. "Over the last two weeks there's been a little more unease that some of this weakness is broader based. The worry level is higher."

'Sort of Cautious'

Sears Holdings Corp. last week said it would miss earnings estimates for its first quarter ended May 5. Chairman Edward Lampert said, "I'm sort of cautious about the economy." That added to downbeat assessments from Wal-Mart Stores Inc. and Target Corp., which has said same-store sales in April were "much weaker" than initial expectations. Circuit City Stores Inc. has cited weak demand for flat-screen televisions, and Talbots Inc. and Bebe Stores Inc. noted lackluster sales of apparel.

Consumer spending accounts for 70% of all spending, so a slowdown is always significant, but even more so now with business investment sluggish. Spending by households was one bright spot in the first quarter at a time when other forces pulled economic growth down to a 1.3% annual rate, the slowest pace in four years.

A new survey of economic forecasters by WSJ.com anticipates a substantial slowing in growth of consumer spending in coming months. After the first-quarter increase of 3.8% at an inflation-adjusted annual rate, the economists, on average, expect spending to grow by only 2.2% in the current quarter and then recover a bit to 2.7% growth in the second half of the year.

Asked to name the biggest risk to consumer spending going forward, 39% of respondents said housing poses the biggest challenge. Another 32% pointed to weakness in the job market, and 18% cited high energy prices.

"Energy prices are hitting consumer income and spending hard," said Chris Varvares of Macroeconomic Advisers. Average gasoline prices are now $3.04 for a gallon of regular unleaded, up from $2.76 a month ago, according to AAA. The Energy Information Administration yesterday revised its forecast upward by 14 cents a gallon, saying a gallon of regular will average $2.95 this summer, compared with $2.84 last year.

Gasoline prices would likely have to rise even higher to spur a significant change in driving habits, but higher prices may impact spending on other items. Charles "Chip" Rosencrans, president of Stuckey's Corp., said sales of the company's pecan log rolls are doing better at groceries than at roadside retailers. "Tells me that gas prices are continuing to steal sales from discretionary purchases by travelers," he said in an email.

There are some bright spots on the economic horizon. Manufacturing is showing signs of a rebound, and a recent pickup in capital-goods orders suggests business investment may bounce back from a soft stretch. Most economists also think the trade picture and government spending will provide better contributions to growth in the second quarter. Federal Reserve officials will weigh these cross-currents, and the inflation outlook, when they meet today to ponder the near-term trajectory of interest rates. No immediate rate move is expected.

Labor Pains?

A major new reason for concern about a deceleration in consumer spending is the labor market, which is showing the first signs of softening. A strong job market with low unemployment has kept consumer incomes rising and that has helped fuel spending. A weakening job market would have the opposite effect.

While apparel, auto and new-home sales are flat or falling, some other areas are doing better. McDonald's Corp. yesterday reported a 3.5% year-over-year gain in same-store sales in the U.S. last month; drugstore chain CVS/Caremark Corp. reported a 7.5% jump in same-store sales for April.

The wealth effect from the booming stock market is countering the negative effects felt by homeowners troubled by stagnant or even declining home prices. That has helped luxury brands and companies that cater to well-paid professionals.

Frank and Roy Dalene, principals of home builder Hamptons Luxury Homes, are launching a $100 million fund to purchase property and rebuild homes to customer specifications at price tags that will likely range between $15 million and $60 million.

"The Hamptons has become a global arrival point for the ultra-wealthy and the famous," said Frank Dalene, who says some 80% of his clients come from Wall Street. "There's no correlation to our market with respect to the rest of the country. The very high-end of the market, $8 million and up, is very strong."

Studies suggest consumers spend only a few cents of every dollar of stock-market or real-estate wealth, but the typical American spends all of his or her after-tax income, most of which comes from wages. While rising stock prices and falling home prices can offset each other on an economywide basis, the effects hit different segments of the population. Stock ownership is more concentrated at the top end than homeownership.

I'm guessing that it's only a matter of time before the wealth effect is gone, too.

Comments

[Brian]

Who's getting squeezed here? I'll tell you who. The middle class lumpen, that’s who, the poor are well, too damm poor. They are already screwed and can’t spend what they don’t have (think minimum wage earners), they can barely pay their $10.00 minimum on their maxed out Macy's card. The rich are just too damm rich and are a small percentage of the population and have more $ that sense. And smack bang in the middle are folks like me who are told that I owe the FED more taxes because I earned too much in 2006!! Too much eh... a family of four living in NJ in a 1500Sq ft cape making $150K, ARE YOU KIDDING ME!! Groceries alone are killing me, my heating oil is killing me, my car insurance is killing me, and gas is killing me. I could stay in bed all day and still get screwed, well you get the picture.

Yes I am squeezed, and yes I am tired of spending money on life necessities when I should be saving money for education, rainy days, and retirement. I can’t even save money for these things which I consider important. Yes we are freaking screwed and yes I am tired. Tired of opening my wallet to be raped by inflation and corporate greed.

Im on a roll today Mike, two posts in one day. As you can see Im especially agrivated today. Take care. Brian.

Ahh...$150K in the Garden State...family of 4..Property taxes creeping up towards $10K. Throw in some interest you want to deduct...good luck bro..Thats AMT country my friend...
Wait til they sell off the Parkway and Turnpike to pay for the pensions..

But wait Brian, at $150k that puts you in the top 10% of all earners in the US? Right?

[Alex Grey]

I think that the strong increase in the stock market averages is holding up consumer spending in the face of declining house prices. A paper by Maki and Palumbo (2001) “Disentangling the Wealth Effect: A Cohort Analysis of Household Savings in the 1990s” (Board of Governors of the Federal reserve System) found that the collapse in the personal savings rate in the late 1990s was largely a result of changes in savings behaviour of the top 20% of income earners. They were the same households that benefited most from the run-up in equity prices at that time. May guess would be that these same top 20% households are also benefiting from the current stock market run-up and that this is what is holding up consumption, which should otherwise be weakening given what is happening in the housing market.

So we won't see a full blown recession until the stock market turns. This may seem a bit paradoxical as you would generally expect an impending recession to cause the stock market to turn. However, the stock market can become disconnected from the economy if it is in a bubble – which I think it is. Margin debt on the NYSE is rapidly increasing is a parabolic increase similar to what was seen in 2000 and this is the key factor driving the stock market. In fact nominal margin debt is above the peak in 2000, while margin debt indexed by the CPI and GDP (neither is ideal, best would be the value of securities on the NYSE) is approaching the 2000 peak. The market seems heavily dependent on increasing margin debt e.g. the weakness in the stock market from late February -mid-March was associated with stabilising margin debt (i.e. no increase). This gives a foretaste of what might happen in the increase in margin debt were to stop.

This leads to the following chain of reasoning:
1) margin debt cannot increase in a parabolic fashion for very long;
2) spikes in margin debt have not been followed by plateaus in the data series going back to 1959 but rather declines;
3) The spikes in margin debt in 2000 and now dwarf all previous spikes;
4) 1) and 2) suggest that the stock market will turn fairly soon unless margin buyers are replaced by other buyers e.g. institutions. This seems unlikely as institutions are not likely to re-enter the market after a substantial gain driven by such a large increase in margin debt. 3) suggests that the turn could be substantial
4) When the stock market falls and it may fall precipitously, there is likely to be a strong reaction on the part of consumers who have been living fairly precariously for quite a while (first depending on home price appreciation for their savings; now switching back to dependence on the stock market). The result will be a rapid descent into a recession.