Here Comes the Pain
By Chris Puplava, October 22, 2008
“Reaping the Whirlwind”
Rounds I and II – the asset bubbles breaking and the credit crisis – will soon be mostly behind us, but the effect on the real world of economic output lies, unfortunately for all of us, almost entirely ahead. Employing our usual historically loaded armchair technique, we have been writing for several quarters that global economic weakness will be substantially worse and will last substantially longer than the official forecasts. We maintain that view even though official forecasts have dropped considerably…
I am sure the market does not yet get the full extent of future earnings and economic disappointments, nor does it easily accept how low trend line P/Es are. (Oh yes, I remember now. P/Es should be higher because of much improved stability and better economic management!) In fact I believe it will take at least another year for the truly dreary global outlook to be fully appreciated and priced in.
Jeremy Grantham
GMO Quarterly Letter, 10/2008
Last Wednesday came the release of September retail sales, which were down right horrible, and this before the big October market swoon that will certainly weigh on consumer sentiment going forward. For most of this year the weakness in retail sales has been concentrated to housing-related industries and the auto sector, with the only significant strength in retail sales coming from gasoline stations and food & beverage stores. While weakness in retail sales was confined to the two predominant sectors mentioned above, it appears that consumers are indeed retrenching as weakness is spreading to other retail sectors. For example, electronic & appliance stores, as well as clothing & accessory store retail sales showed a negative year-over-year (YOY) rate of change in September. The breakdown of current retail sales on a YOY rate of change basis is shown below, with negative rates of change shown in red.
Table 1. Retail Sales (Y/Y % Chg)
| Sep-08 | Aug-08 | Jul-08 | Jun-08 | May-08 | Apr-08 | Mar-08 | Feb-08 | |
| Retail & Food Services | -1.0 | 1.5 | 2.0 | 3.1 | 2.0 | 2.8 | 2.3 | 2.7 |
| Ex Autos | 3.6 | 5.2 | 5.6 | 6.2 | 4.8 | 5.4 | 4.0 | 4.4 |
| Ex Auto Ex Gas | 1.6 | 2.9 | 3.1 | 3.8 | 3.3 | 3.6 | 1.8 | 2.3 |
| Motor Vehicle & Parts Dealers | -18.5 | -12.7 | -12.5 | -8.9 | -8.7 | -7.2 | -4.1 | -3.7 |
| Furniture & Home Furnishing Stores |
-10.7 | -9.2 | -7.6 | -5.9 | -4.9 | -5.7 | -5.6 | -5.4 |
| Electronic & Appliance Stores | -2.0 | 0.3 | 3.3 | 4.9 | 5.1 | 3.8 | 2.3 | 1.9 |
| Building Material Dealers | -2.8 | -2.1 | -0.7 | -0.9 | -3.7 | -1.7 | -7.0 | -3.3 |
| Food & Beverage Stores | 5.1 | 6.8 | 5.4 | 6.0 | 5.4 | 6.1 | 5.6 | 4.3 |
| Clothing & Accessories Stores | -0.4 | 2.4 | 1.2 | 1.8 | 0.8 | 2.6 | -0.7 | 0.9 |
| General Merchandise Stores | 3.4 | 4.1 | 4.8 | 5.7 | 5.6 | 4.5 | 2.8 | 4.5 |
| Food Services & Drinking Places | 2.2 | 3.8 | 3.6 | 4.3 | 4.8 | 4.5 | 3.3 | 4.2 |
| Gasoline Stations | 17.8 | 21.4 | 23.5 | 22.5 | 14.7 | 18.1 | 20.1 | 19.8 |
| Nonstore Retailers | 3.1 | 5.5 | 5.5 | 8.0 | 8.0 | 7.0 | 6.0 | 1.2 |
Source: Bureau of the Census
There are only four sectors of retail sales that are growing at a 3%+ YOY rate of change, with half of the sectors representing non-discretionary items (gasoline station sales and food & beverage store sales). The other two pockets of strength are general merchandise (3.4%) and nonstore retailers (3.1%). The strength in general merchandise is coming from strength in warehouse clubs and superstores (Wal-Mart, Costco), where general merchandise sales ex warehouse clubs and superstores, which is essentially department store sales, came in at -2.93% in September, revealing that consumers are shifting their spending towards lower cost producers. The strength in nonstore retail sales is from a consumer shift towards online sales, a trend that has been in place for years. Select retail industry charts are given below, both of which show marked deceleration.
Figure 1
Source: International Council of Shopping Centers (ICSC)
Figure 2
Source: International Council of Shopping Centers (ICSC)
The shift in consumer spending from higher end stores towards the wholesale club stores like Wal-Mart and Costco was a trend that was seen during the last recession as consumers tried to get more bang for their buck. We are starting to see this same trend again as real GDP has decelerated while wholesale club chain store sales are rising, diverging from the real GDP trend.
Figure 3
Source: Wal-Mart Stores, Inc.
Bureau of the Census/U.S. Employment & Training Administration
As mentioned above, consumers are cutting back on discretionary items while devoting more of their incomes towards essential, nondurable items like food and energy. This can be seen when looking at the ratio of durable goods industrial production (homes, autos, appliances) versus nondurable goods industrial production (food and energy). The ratio typically turns down heading into recessions while its advance indicates healthy consumer spending. The ratio has been trending down for years now, with declining vehicle sales playing a large role in this decline.
Figure 4
Source: Federal Reserve Board/BEA
The ratio is likely to continue to plummet further as consumers continue to hold off plans for automobile and home purchases according to the Conference Board survey. Another key consumer sentiment indicator comes from the ABC News/Washington Post consumer index, which showed consumer’s opinion of their personal finances and their attitudes for future spending falling by the wayside in rapid fashion. Mortgage equity withdrawal (MEW), a major driving force for retail sales earlier in the decade, continues to decline with retail sales along with it as consumers are finding it harder to tap into their former housing ATMs, developments that do not bode well for durable goods orders or retail sales overall.
Figure 5
Source: TCB
Figure 6
Source: ABC News/Washington Post Consumer Confidence Index
Figure 7
Source: Federal Reserve Board/U.S. Census Bureau
The above data shows the poor state of the US consumer who is spending more and more to cover the costs of nondiscretionary items like food and energy at the expense of discretionary retail sectors like apparel and department stores. Even the strength in nondiscretionary retail sectors is but an illusion as more and more of what consumers are spending is going towards covering the costs of inflation and does not represent true growth.
Figure 8
Source: BLS/ Bureau of the Census
Figure 9
Source: Bureau of the Census
Figure 10
Source: BLS/ Bureau of the Census
As the analysis above shows, the consumer is proving not so resilient as most pundits were expecting. It is truly different this time. We’ve been warned that betting against the consumer was the wrong trade, however it appears now is the time to do just that. Earlier in the decade consumers tapped their homes to keep them afloat (Figure 7). That door has been shut, and consumers are faced with very few alternatives for additional cash as banks are making loans difficult, and personal stock accounts have plunged this year. It truly appears that the consumer is down for the count, which is a sobering thought as personal consumption expenditures made up 71% of Q2 GDP. Any prolonged retrenchment in consumer spending will be felt across the entire economy, and we will be receiving a glimpse of this as third quarter GDP is to be released next week. The third quarter GDP report will likely signal the kick off to round III, a consumer retrenchment and severe economic weakness. Is this discounted in the market? Let’s hope so!
Chris Puplava
© 2008 Chris Puplava
Contact Information
Christopher M. Puplava
PFS Group
PO Box 503147
San Diego, CA 92150-3147
(888) 486-3939 Toll Free
(858) 487-3939 Tel
(858) 487-3969 Fax
Email
