We
anticipate that the economy will continue to remain weak for most of
the summer and into the fall, with a bottoming out of downward pressure
occurring later in the year. Look for a slow, moderate recovery to
begin to exert itself during the first-half of 2009. As a result, we
anticipate both back-to-school and, more importantly, the 2008 holiday
shopping season, will be disappointing. Our current forecast is for the
2008 holiday selling season to come in at a weak 2.7-2.9% growth rate
(see Chart 1), below last years 3.0%. For a change the industrial,
rather than the consumer, sector will lead the US out of this slowdown.
In addition, we anticipate that energy prices will return to
“normalized” levels, that the housing market will reach its bottom, and
that credit availability will expand. Longer-term, we believe that the
current economic slowdown will have a major structural impact on
consumer spending trends.
CHART 1. Source: Chicago Tribune. (Click to Enlarge) |
In
the fourth quarter 2007 edition of PRI Quarterly Retail Analytics, we
advanced that the US economy entered into a recession in
October-November 2007. In hindsight, we may have been early in
selecting this particular demarcation point, at least according to
classical economic definitions, which call for two consecutive quarters
of negative GDP growth (see Chart 2, and note the recent downward
revision of 4th quarter 2007 GDP from 0.6% to -0.2%). Triggers for us
were, among other things, our view that employment growth was leveling,
with a downward bias (see Chart 3), as well as an inverted yield curve
early in 2007, indicating an overly stimulative environment. For many
additional reasons we forecast a weak 2007 holiday season which turned
out, in fact, to be the slowest in five years.
CHART 2. Source: State Street Global Advisors. (Click to Enlarge) |
CHART 3. Source: Bureau of Labor Statistics. (Click to Enlarge) |
Going
forward, the prospects for an economic recovery occurring later in 2008
remain unlikely. Credit availability is still restricted (see Chart 4;
for the June ended quarter, bank credit has contracted at a 5.8%
annualized rate). Energy prices, despite falling demand, remain high.
Global demand for food will further accelerate food price inflation.
The housing market continues to remain extremely weak. Expert forecasts
call for a peak-to-trough housing recovery discount of 25-30%. To-date,
price declines approximate 15%, indicating continued downward price
pressure until a bottom is finally achieved. Weakness in the auto,
airline, and financial services industry will lead to layoffs that will
further pressure employment. Finally, looking at one of the few bright
spots in the economy - robust export growth; this too may now face some
resistance (see Chart 6, which illustrates a projected slowdown in
global GDP). Emerging countries, such as Brazil, Russia, India, and
China will continue to perform well and fuel US export growth, though
inflation and the policy making reactions in response thereto remain a
concern.
CHART 4. (Click to Enlarge) |
CHART 5. Index based on total US housing starts. Source: Census Bureau. (Click to Enlarge) |
CHART 6. Source: State Street Global Advisors. (Click to Enlarge) |
Now
for a quick reality check. Despite the headlines proclaiming that the
world is coming to an end, we are impressed by the resiliency of the US
economy. And we think that the Federal Reserve should be credited for
avoiding what could have become a global credit crisis (we are not so
generous in our opinion of Congress and its misguided stimulus plan).
Consider that core consumer inflation (inflation sans gas and food) is
at manageable levels (see Chart 7). This does not help relieve consumer
stress, as we all need to buy food and gas, but it does demonstrate
that inflation is, for now, being reasonably contained. Slowing wage
growth also indicates that inflation has not crept into the system.
While we are concerned about trends in unemployment, by historical
standards, employment is holding up well at this point in an economic
downturn. Interest rates remain low relative to past periods of
economic stress as well, though the availability of credit remains
challenging. Throw in the worst housing slump since perhaps the Great
Depression and yes, we believe that it could be much worse. Recall that
an oil embargo in 1973, among other things, was alone a major
contributor to rapid inflation and a recession.
Looking
ahead, the consumer will not rescue the economy this time. We believe
that the industrial sector, powered by exports and investment spending,
will. As a result of a low value dollar and booming demand in emerging
markets, US exports since the second quarter of 2007 have made an
impressive positive impact on GDP (see Chart 8). In addition, capital
investments are anticipated to build, also contributing to a recovery
(see Chart 9; although the last few quarters have been weakening, see
Chart 10). The fact that Durable Goods Orders rose by 0.8% in June,
versus a 0.1% increase in May; as well as Durable Goods Shipments
increasing by 0.5% in June, versus a decrease of 1.2% in May, supports
this view (see Chart 11, indicating that non-defense capital goods
shipments, ex. aircraft, rose at an annual rate of 5.9% for the second
quarter, versus a 0.4% drop in the first). In addition, energy prices
are also starting to moderate (see Chart 12), and the pace of decline
in the housing sector is slowing.
CHART 7. (Click to Enlarge) |
CHART 8. Source: Federal Reserve Bank of New York. (Click to Enlarge) |
CHART 9. (Click to Enlarge) |
CHART 10. (Click to Enlarge) |
CHART 11. (Click to Enlarge) |
CHART 12. Source: State Street Global Advisors. (Click to Enlarge) |
The
current economic downturn may best be viewed as a consumer recession.
This may help explain why the general public feels so stressed about
the economy, despite the fact that the slowdown’s severity is moderate.
In this regard, several indicators of the current economic state of
affairs, and consumer inclination to spend, are noteworthy. First
consider the Consumer Confidence Index. While steady in July, it now
stands at 51 (see Chart 13). While we do not believe that consumer
sentiment is a great predicator of the direction of the economy, nor
consumer spending per se, it is darn good at indicating if the US is,
in fact, in a consumer recession. As the following Chart 14 indicates,
in past recessions (indicated by the gray vertical bars), consumer
sentiment has proven to be a reasonably gauge of indicating a
recession. Another view of the consumers’ mood these days is gleaned by
considering the PNC Household Economic Stress Index. This Index
considers the combined impact of inflation, unemployment, and real
estate values on consumer outlook. As the following Chart 15 indicates,
the Index reached a low-point (a positive read) in 2005, and today is
well above the level reached during the 2000 recession, but not yet at
the level achieved during the 1990-1991 downturn.
CHART 13. Source: Conference Board. (Click to Enlarge) |
CHART 14. Source: Wachovia Economics Group. (Click to Enlarge) |
CHART 15. Source: PNC Bank. (Click to Enlarge) |
Retail
sales rose 0.1% in June, following May’s increase of 0.8%. Retail sales
rose 4.5% year-on-year for the trailing three months, and 3.0% over the
last year. Excluding the volatile auto and gas categories, retail sales
rose 0.2% in June, following May’s increase of 0.8%. On this basis,
retail sales rose an impressive 8.3% year-on-year for the trailing
three months, and 3.5% over the last year (see Chart 16). Retail sales,
ex. auto and gas, were better then we expected in the second quarter.
Yet this 3.5% year-on-year increase is still less than the 4.1% clocked
in 2007 and 6.2% in 2006. Further, general price inflation has severely
masked the true weakness in retail sales. On an inflation adjusted
basis, retail sales have been declining for three quarters
year-on-year, falling by 2.6% in the second quarter. Another negative
view of retail sales is gleaned by excluding the inflation impacted gas
and food prices segments, as well as the housing-induced weak building
materials category. On this basis, quarter-on-quarter, retail sales
fell at an annual rate of 1.5% in the first quarter, and 0.2% in the
second (see Chart 17).
CHART 16. Source: Wachovia. (Click to Enlarge) |
CHART 17. Source: Northern Trust. (Click to Enlarge) |
Longer-term,
we believe that a structural shift in spending is a likely outcome from
the current consumer-led economic downturn. An important lesson learned
from the mortgage mess is that the ability to service a debt is not
enough itself when accessing credit risk. That is, what was not
understood by many lenders during the recent housing cycle, for which
consumers are now bearing the result of this reckless lending, is the
realization that the value of assets, like houses, can go down. Going
forward, as consumers access the state of their household balance
sheets and their related ability to spend, this new reality will have a
negative impact on consumer spending. This will not help retailers in
general.