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Dude, Where’s My Retirement?

At the end of 2007, the average 401k balance was $65,500. The median 401k balance was $19,000. This divergence shows there are a few people with huge 401k balances, while the majority has virtually no retirement savings. These balances were at the end of 2007. Balances are likely to be 40% lower today. Almost 20% of 401k participants had borrowed against their 401ks at the end of 2007, with an average loan balance of $7,500. With plunging markets and home prices, the number of loans probably soared in 2008. A 45-year-old couple with an $11,000 401k balance and an entire net worth of $110,000 and annual income of $62,000 is in a precarious position. They would have to be living in complete denial if they think they will have a comfortable retirement.

Americans bought into the lie that their homes could fund a glorious retirement of cruises, golf, and traveling the world. That illusion has been shattered. It will likely take 10 years to get back to breakeven on the losses they’ve experienced in the last 18 months. Anyone who has retired in the last five years or has plans to retire in the next five years has had their plans upended. They will have to go back to work or work longer, if they can find a job. There are 1,000 Americans per day turning 65. Only an insane person, after experiencing the losses of the last few years, would continue to spend on electric gadgets and luxury cars. If they don’t start to save at a rapid clip, they will experience a miserable stress filled old age.

Deleveraging and How I Learned to Love It

Men, all this stuff you've heard about America not wanting to fight, wanting to stay out of the war, is a lot of horse dung. Americans traditionally love to fight. All real Americans love the sting of battle. When you were kids, you all admired the champion marble shooter, the fastest runner, big league ball players, the toughest boxers. Americans love a winner and will not tolerate a loser. Americans play to win all the time. I wouldn't give a hoot in hell for a man who lost and laughed. That's why Americans have never lost, and will never lose a war... because the very thought of losing is hateful to Americans.

George C. Scott – Patton

Americans have gotten soft over the last few decades. It is time to fight and prove that we still have a backbone. The next decade will not be pleasant, but it will build character. The priorities of the country must be changed and it will be American consumers who will force the change. They have already begun the long trek back from a losing spending strategy to a saving strategy that could result in being a winner. The drop in retail sales in the last few months is the most dramatic in U.S. history. This is not a momentary blip in a long term uptrend. This is a paradigm shift.

From 1952 through 1982, consumer spending as a percentage of our economy ranged between 60% and 64%. The United States ran trade surpluses and manufactured things that other countries wanted. Since 1982 we’ve lived above our means, consumed 4% more per year than we produced, and borrowed the money from foreigners to live this way. In 2008, this ratio topped out at close to 71%, or $10 trillion of our $14 trillion economy. Since this was an unsustainable trend it will revert to the mean over the next decade. The reversion to 62% of GDP will reduce consumer spending by $1.3 trillion annually going forward.

To paraphrase famous American admiral John Paul Jones, we’ve only just begun to de-lever. When you accumulate debt over three decades, you don’t get rid of it in two years. Multi-decade expansions of debt are followed by a multi-decade deleveraging. The last time consumers pulled back for longer than one month was 1975. The consumer is in the process of collapsing. There will be false starts in a positive direction, but the overhang of consumer debt, relentless decrease in housing and stock values, and looming retirement funding will force Americans to dramatically cut their spending for decades. The retail industry will be devastated by this paradigm shift.

Knock, Knock, Knockin' on Heaven’s Door

The managements of most retailers in the United States are not prepared for $1.3 trillion less consumer spending per year. Their little expansion models were built upon an existing over inflated demand extrapolated at 5% or greater growth for eternity. We know how well bank models worked out. The good news is that retailer expansion models will not bring down the financial system. The bad news is that thousands of retailers will go bankrupt because they planned their businesses based upon false assumptions. Any retailer that used leverage to expand based on faulty pie in the sky assumptions is headed to retail heaven.

Retail top management is notorious for copying the strategy of other successful retailers. Wal-Mart (NYSE:WMT) created the concentration strategy of dominating a market with multiple stores. Every retailer in America dreamed of replicating Wal-Mart’s success. Home Depot (NYSE:HD), Bed, Bath & Beyond (NASDAQ:BBBY), Target (NYSE:TGT), and Lowe's (NYSE:LOW), among others, have followed this same strategy. Every retailer does the same thing. They know how many households are in a market and they multiply that number by the expected spending per household. There are three major errors that have been committed by every retailer in America. They failed to recognize that the spending per household was 30% over inflated due to debt financed demand. They then extrapolated the spending per household using a 5% to 10% growth rate. Lastly, they ignored the fact that their competitors had the same strategy.

I consider Lowe's to be one of the best run retailers in the U.S., with beautiful stores and good service. But, its top management was clearly irrationally exuberant regarding its expansion plans. Lowe's has annual sales of $45 billion with approximately 1,500 stores. This averages out to $30 million of annual sales per store. Its operating margin has been 10%. It opened a store in Plymouth Meeting, 20 minutes south of my home. Since it was the 1st store in the market, it likely generated annual sales of $40 million with a $4 million profit. Next it opened a store in Montgomeryville, 20 minutes northeast of my home. This store likely generated $30 million in sales, while reducing the sales of the Plymouth Meeting store by 15%. Next it opened a store in Oaks, 20 minutes west of my home. This store likely generated $25 million in sales, while reducing the sales of the Plymouth Meeting store by 10% and the Montgomeryville store by 10%. Now for the final nail in the coffin. It will open a 4th store in Hatfield, 5 minutes from my home in April. It will cannibalize the sales of all three other stores. Below is an analysis of the likely profit implications for Lowe's.

000’s Omitted

This chart shows that Lowe's likely generated more annual profit with two stores than with four stores. These figures don’t take into account that Lowe's likely spent $20 million to build each of those stores. It has sunk $40 million into building the 3rd and 4th stores, while reducing annual profits. These figures have also not taken into account the future reduction in consumer spending. If Lowe's has replicated this error across the country, their future will not be bright. The hubris and overconfidence of top retail executives will result in thousands of store closings and retail layoffs.

I have experienced the incompetence and shortsightedness of retail executives firsthand. It is amazing to me that supposedly intelligent executives could gamble with a $100 million investment based on ridiculous assumptions and blatant lies. Many retailers have a winning concept, but few have top executives who do not get caught up in their own press clippings. When executives are driven by ego and diversity agendas, while disregarding unequivocal facts, that retailer is destined to fall. Understanding your external environment, your competitors and changing trends are essential to long-term success. These executives forget that Montgomery Ward and K-Mart were once premier retailers. The accumulation of bad strategic decisions by management will eventually bankrupt even the best retail concept. Bad decisions by retail executives destroy the lives of long-time employees when they are forced to close stores and fire staff. I’ve dealt with executives who couldn’t spell strategic let alone think strategically. The retailers listed below have either collapsed or scaled back in the last year. The worrisome fact is that the decline in retail spending has only just begun.

A smart retail executive should be analyzing the current situation with a critical eye. Any executive who is planning for an upturn in spending by consumers next year is in for a rude awakening. The environment has changed forever and if they don’t adapt immediately, their companies will die. Based on the balance sheets and cash flows of the retailers in the following chart, I’ve categorized them according to their risk level. Most of the information is prior to the dreadful holiday sales season. Balance sheets and cash flows continue to deteriorate. Some of the retailers on this list will be a surprise. Those with huge short-term debt obligations run the risk of not being able to rollover that debt. Banks in the U.S. no longer lend money they just beg the government for more capital. Many of these retailers will not be in business five years from now. Others will need to close hundreds of stores to survive.

The words of George C. Scott as Patton describe how retailers and nations sometimes have a limited amount of time on top of the world.

For over a thousand years, Roman conquerors returning from the wars enjoyed the honor of a triumph - a tumultuous parade. In the procession came trumpeters and musicians and strange animals from the conquered territories, together with carts laden with treasure and captured armaments. The conqueror rode in a triumphal chariot, the dazed prisoners walking in chains before him. Sometimes his children, robed in white, stood with him in the chariot, or rode the trace horses. A slave stood behind the conqueror, holding a golden crown, and whispering in his ear a warning: that all glory is fleeting.

All glory is fleeting. The American conquerors have returned from the mall wars pulling carts laden with HDTVs, iPods, Rolexes, and other treasures. There is no more ammunition left to fight another war. Retailers and Nations alike can experience fleeting glory. The question is whether it is too late for lessons learned to be implemented in time.

Source: A Stairway to Retail Heaven (Part 2)