Tuesday, November 18, 2008

Retail Woes Foretell The Recession

Beginning with its November 7 edition, the Wall Street Journal has published a number of articles describing the evolving and steadily increasing weakness in US retailers.

The November 7 Journal headline article, "Global Push to Beat Economic Downturn," was accompanied by a picture of an unemployment line in Spain.

In that edition's Marketplace section, the lead piece was entitled, "Retailers Wallow and See Only More Gloom."

The lead in the article stated,

"U.S. retailers reported the worst monthly sales decline in more than three decades, prompting them to resort to steeper discounts and earlier promotions as they try to salvage the coming holiday season.

Sales by department stores and upscale retailers slid 11.7% overall from a year ago, led by a 17% decline at Saks Inc., while J.C. Penney Co's sales fell 13% and Kohl's Corp.'s slid 9%. All three said customers just weren't walking in the door.

Upscale retailer Neiman Marcus said its same-store sales fell a staggering 28% while catalogue and Internet purchases plummeted 23% compared to a year ago.

Once again, the exception to the dire data was Wal-Mart Stores Inc., whose reputation for lower prices has siphoned off shoppers from other retailers. Wal-Mart's sales at stores open at least a year rose 2.4%, well above its prediction of a 1% to 2% gain.

Retailers has been braced for a slow holiday season, and most thought they had planned for the worst by paring back inventories. But since September, sales slowed far more than expected. Retailers now have pinned their hopes on heavy discounting."


The piece goes on to cite more gloomy statistics and provide background anecdotes and details which reinforce that there is now a serious cutback by US consumers in spending on clothing, appliances, and the general assortment of goods at the nation's larger retail chains.

Many conclusions may be drawn regarding the US economy's imminent performance, and that of financial markets, based upon these numbers and comments.

First, ironically, Wal-Mart's senior management may actually be better off due to the failure of its failed strategy to move upmarket several years ago. More on that can be found among the "Wal-Mart" labeled posts on this blog. Suffice to say, Wal-Mart's experience demonstrates why companies move in and out of periods of long term, consistently-superior total return performance.
The nearby, Yahoo-sourced price chart for the past year for Kohl's, Wal-Mart, Penney's, Sears, Target and Abercrombie & Fitch, and the S&P500 Index, for comparison, clearly indicates how Wal-Mart has sailed through the current economic difficulties almost unaffected.

By contrast, three of the retailers included in the chart fall below the S&P500 curve for the past year, with Kohls and Target basically holding even with the index.
This can briefly be interpreted as Wal-Mart's being well-positioned, despite any actual strategic designs the chain may have, whereas Kolhs and Target tend to continually be among the best-managed of retailers.

A closer look at the chart, however, and another Journal article, spell more trouble. Yesterday's edition reported on "sharp earnings declines" at Penney's and A&F, as well as "forecasts that fell shy of Wall Street expectations."
Penney's profit fell 52% quarter-on-year-ago-quarter, with sales down 10% at stores open at least a year.
A&F's profit declined 46%, with a 14% same-store sales decline.
To me, the key phrase 'Wall Street expectations,' signals that analysts and, probably, investors, are not really paying attention to current consumer behavior, and the degree to which it will affect both coming economic growth, and equity market valuations.
Due to the cascading economic effect of last summer's mark-to-market-based financial services crisis, consumers have now begun to lose jobs, home equity wealth, and confidence in the next few years of US economic health.
The retailers, being on the front line of everyday consumer spending that is not necessary, e.g., food, are seeing plummeting sales, traffic, and equity valuations. And the latter is probably not low enough, yet.
Wal-Mart's position as one of the nation's larger food chains has providentially insulated it from the sole vagaries of discretionary consumer spending in this unfolding weak economy.
In retrospect, Brian Wesbury (see labeled posts) has been correct to refrain from calling the US economy 'in recession' as recently as this summer. However, I have little doubt that in January, or perhaps late next month, he will write a Journal editorial confirming that, as of December, the entire country is in a recession.
As my friend B wrote me last year, pertaining to the Democratic presidential candidate's constant drumbeat of assertions that we were in an economic situation that was 'the worst since the Great Depression,' accompanied by countless pundits and media personages, most of whom are not economists, sagely assuring one and all that the US was in a recession as of mid-2007,
'If enough people keep saying we are in a recession, then we'll soon have one.'
Touche, B. That's exactly what happened. Consumer confidence is a fragile thing. Take a financial sector beset by a stupid, narrowly-defined valuation principle, add the subsequent evaporation of several hundred billion dollars of equity value, follow that with consequent declines in lending, job losses, and falling home and personal equity portfolio values, and you will create a recession.
I suspect the retailers' equity price trends are going to continue for at least a few more months. The news and data are there for everyone to see. Retail is clearly weakening, consumer sentiment is not good, and spending is simply going to decline, with discretionary purchasing becoming increasingly hard to stimulate.
That's why, among other reasons, my partner and I continue to expect a declining S&P500 for several more months. The consumer behavior measures tell us that real economic weakness is just beginning, and will probably cause unexpected equity valuation declines.
Couple this with a change in federal administration from a market-based approach to governmental intrusion to a political/fiat-based one, and you have a recipe for a milder and, hopefully, shorter rerun of FDR's lost decade of the 1930s, marked by inept and ineffectual governmental interference in economic and capital markets.

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