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Wednesday, February 2, 2011

Consumer Spending Will Make or Break This Recovery (published in November of 2009 in the SB News Press)

We are a society of consumers.  Let’s face it; we like to spend money, especially on discretionary items—the fun stuff.  Consumer spending represents about 70 percent of total economic activity in the United States, so it is absolutely critical to any recovery in the economy.

According to U.S. Census Bureau data, national retail sales in September fell 1.5 percent from August, although core retail sales (excluding autos, gas, and building supplies) rose 0.5 percent. Total retail sales were dragged down by a 10.5 percent decline in auto sales from August to September, reflecting the conclusion of the Car Allowance Rebate System (CARS) program, also known as the “Cash for Clunkers” program.  Retail sales overall remained well below year-earlier levels but have decreased at a slower rate for the past five months. 

The Commerce Department reported that September personal incomes were flat, while personal savings spiked to almost 5 percent during the second quarter, including a 6.9 percent jump in May, rising by the largest percentage since 1993 and the largest dollar amount since 1959 when they first started tracing savings data.  Third quarter personal savings fell slightly, but still rose by more than 3 percent.  What this data shows is that, not only are we experiencing the worst unemployment in decades, but those with jobs are shoving their money in their mattresses, and not spending it.

Retail sales were down almost 11 percent from December of 2007 to December of 2008, reflecting a dramatic drop in consumer spending on Christmas and related goods and services last year.  A key question is: Will consumers spend this Christmas season, given the high level of unemployment?

Nationwide, unemployment stands at 10.2 percent, and there is no reason to believe that it has peaked.  Unemployment is a lagging indicator, meaning that it continues to trend up (worse), even after the economy has begun to recover from a recession.  California’s unemployment rate ticked down slightly from August to September, from 12.2 percent to 12 percent.  I would expect national unemployment to rise to 11 percent, or higher, while California’s unemployment rate will likely rise to 13.5 percent or higher.

Here in Santa Barbara County, unemployment has been significantly lower than the state and the country as a whole, and is currently at 8.5 percent, slightly lower than August’s 8.6 percent reading. 

Unemployment is important because consumers who lose their jobs do not tend to consume as much.  More significant is the fact that, even those who have a job are concerned that they may become unemployed, and therefore do not want to spend any money either.  The accompanying loss of equity value in real estate has further reduced consumers’ available spending power, and thus has stifled consumer spending.

Consumers may spend at a higher rate this holiday season than they did last year, if they believe that the economy is recovering.  If one looks at the recent gains in the commodities and stock markets, it would seem that investors at least are feeling much more optimistic.  Historically, a higher stock market tends to mean a good holiday spending season.    However, there are some reasons for concern.

First, not to beat a dead horse, but unemployment is at levels we have not seen since 1983, and at that time, we were already clearly recovering from the 1981-82 recession, which was one of the worst since the Great Depression, although not as bad as the one we are in today.  Second, the drop in real estate values has been dramatic Ands sustained, and the resultant damage that has been done to the banking industry has left lenders short of cash, and gun-shy about providing credit to consumers (or anyone else).  The median home price in Santa Barbara has fallen 42 percent (so far) from its peak in October 2007.  Finally, the dollar is weak against most major currencies, making goods produced abroad even more expensive, and therefore even less desirable to U.S> consumers. 

Mark Schniepp of the California Forecast tracks retail sales for Santa Barbara, and relates that retail sales have been trending steeply lower since early 2005, and were down 2.7 percent in the first quarter of this year, and by another 2.1 percent in the second quarter of 2009.  There are no clear signs so far that consumer spending is going to improve in the near-term, according to Schniepp.

Retailers have gotten the message, and are already offering discounts and sales, even before Black Friday, the official start to the holiday buying season, which comes on the Friday after Thanksgiving.  Not only are there sales everywhere already, but the level of discounting and the breadth of items offered at discounted prices is unprecedented.  Neiman Marcus, for example, has their cosmetics on sale, which I have never seen before, especially at this time of year.  Closer to home, one need only walk down State Street to see the comprehensive nature of this phenomenon. 

In California, the combination of very high unemployment, cratering real estate values, and a large (and growing) budget deficit, leaves little room for optimism about a strong holiday retail season or consumer spending improvement on the national or state level. 

Jedlickas is not cutting prices on anything, but will be running their normal amount of advertising.  They have not laid-off any employees during this recession either.  Sales are still off for the year, but not by a meaningful amount.   Si Jenkins, owner of Jedlickas, is expecting a good holiday season and has maintained his inventory levels to ensure that customers can get the merchandise they want in the correct sizes, etc. Last holiday season was good for Jedlickas, despite the overall weakness in the economy, and Jenkins expects a consistent selling season this year as well.  

Marty Bebout, Co-owner of Blue Bee, states that last year, retailers had a knee-jerk reaction to the falling stock market and weakening economy.  Bebout relates; “We have had two years of weaker sales, allowing retailers to adjust inventories down to reflect lower demand.”  He has seen a lot less discounting this year, as compared with last, and feels that the consumer has adjusted to discounts, taking them for granted and expecting the discounts, which can be difficult for retailers.  Bebout considers this the “new normal,” and advises that those retailers who have planned appropriately, and have controlled inventories well, should benefit this holiday season.

Blue Bee did not offer any discounts on Black Friday last year, and experienced strong sales.  They has recently relocated to 911 1/2, 923, 925 State, their original locations.  This year, in the morning, between 7 a.m. and 10 a.m., they will offer a special, but have not decided exactly what that promotion will be.  This will be their tenth Black Friday, and according to Bebout, it is always their best sales day of the year.  “This is the time of year when shoppers indulge their desires for those luxury items that they really want and have waited to buy.”  He does feel though, that Santa Barbara has been hit especially hard by the recession and by the fall in property values, especially our wealthy residents. 

We will have more data after Black Friday, and will be able to gauge the overall holiday season spending patterns a bit better.  It seems likely that retail sales will not be brisk, although compared with last year we may see some improvement, or at least perhaps not a further decline. 

From an investment perspective, my concern is that companies, just as they did last year, will have to discount so much that their earnings will be weak or non-existent.  If this is the case, and if we simply do not see consumers spending money, I do not see how the economy can stage a robust recovery.  With weak corporate profits, resulting from weak consumer spending, the current valuations for stocks will be difficult to justify, meaning we are at risk for a sizable correction. 

For our local economy, my hope is that we continue to experience stronger employment and consumer spending compared with the state and the country.  Once we see how the holiday season shakes-out for our local retailers in comparison to the country as a whole, we can better understand our chances for better economic times to come.

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