Consumer Spending: A Mixed Bag

Stocks rose last Tuesday (9/11/07) based on the view that Consumer Spending would keep the economy afloat; this belief was fostered (in part) by strong results from McDonald's (MCD), in addition to GM (GM) reporting that it feels it can now begin to raise the prices on its cars.

From Bloomberg:

U.S. stocks rallied the most this month on growing evidence consumers are weathering an economic slowdown and bolstering profit growth. General Motors Corp., the largest U.S. automaker, posted the biggest advance in the Dow Jones Industrial Average after saying demand is strong enough to charge more for cars. McDonald's Corp., the world's largest restaurant chain, climbed on sales that topped some analysts' expectations.

[…]

General Motors gained $1.33, or 4.6 percent, to $30.54. The company also hopes that the new Malibu model will need less spending to encourage sales, Vice Chairman Bob Lutz said today at the International Motor Show in Frankfurt.

[…]

McDonald's increased $1.61, or 3.2 percent, to $51.76. August sales grew 8.1 percent as customers bought chicken snack wraps and iced coffee in the U.S. and McFlurry desserts in Europe. John Glass, a CIBC World Markets Corp. analyst, estimated August global sales would rise 4.6 percent.

The “consumer spending rally” was also fueled by what many felt were strong retail sales during the month of August:

From Forbes:

“Discount retailers posted strong August retail sales today.

Wal-Mart (WMT) said same-store sales rose 3.1%, beating analyst expectations of a 1.5% rise. Shares of Wal-Mart were up about 1.5% trading at $42.80 in afternoon trading. Wal-Mart had cut prices on about 16,000 back-to-school items to drive sales.

Wal-Mart's rival Target (TGT) saw same-store sales rise 6.1% in August. Target also expects September sales to rise 4% to 6%.

Also shaking up the retail sector is luxury retailer Saks Fifth Avenue (SKS). Saks reported a same-store sales jump of 18.2% on strong demand for designer clothing and shoes. Saks's shares rose 58 cents, or 3.8%, in late trading.

I look at this news and a couple of things immediately come to mind:

1) GM’s sales for the month of August were aided by heavy discounting and incentives for its trucks as it wanted to avoid losing market share to Toyota (TM). In fact, if you go to the web sites of various GM brands (as of the writing of this article), you’ll still find heavy incentives and 0% APR financing for many of the company’s SUVs and pick-up trucks. Whilst I’m sure GM is celebrating a YoY increase of 5% for the month of August, it’s worth noting that it came with a 9.2% increase in incentives per vehicle sold and that for the year to date, sales are still down 7.8%. For the moment, I think it’s a bit too early for GM to assume it can raise prices and for investors to take that claim seriously.

2) Price is also a factor when it comes to McDonald's, as the chain isn’t exactly known for high prices and it’s quite feasible that customers who might taken the family out for dinner at Applebee’s (APPB), The Cheesecake Factory (CAKE) or TGI Fridays are simply going to McDonalds instead. In fact, Applebee’s reported a 0.9% decline in sales for the month of August, and it remains to be seen what the rest of the major restaurant chains will report numbers wise. A broad market rally based on the performance of one restaurant chain is a bit premature.

3) Wal-Mart’s numbers came at the direct expense of its margins, as the retailer announced major price cuts back in August:

From Reuters:

Wal-Mart Stores Inc., the world's largest retailer, set the stage for price wars Monday as it announced its cutting prices on more than 16,000 items starting this week in a bid to turn around sales for the critical back-to-school season.

[…]

Wal-Mart's price cuts, which range from 10 percent to 50 percent, will be backed by a new ad campaign on how to save money as gas prices remain high and kids head back to school. The cuts are deeper and involve even more items than in the year-ago period and top the 11,000 items discounted in advance of last year's holiday season, according to Melissa O'Brien, a company spokeswoman.

[…]

Under Wal-Mart's new pricing plan, $1 will be able to buy 4 wide-ruled notebooks, 2 bottles of Elmer's glue (4 oz.) and a 24-pack of crayons. A $50 budget will be able to purchase a week's worth of school clothes, and $80 will buy two pair of prescription glasses at the Wal-Mart Vision Center.

Considering that investors already went through this with Wal-Mart’s June numbers and the subsequent Q2 earnings report showing compressed margins, why was anyone cheering? Since when has a fire sale been anything to applaud?

On a side note, I still scratch my head at the business press referring to Wal-Mart and Target as rivals. Target’s customers out earn the typical Wal-Mart customer by roughly $20,000/yr, as a result, the two retailers don’t have the same customer base, and can’t be direct competitors.

4) Something which many people ignored, is that retail sales growth is slowing, when you look this past August compared to the same period last year:

The Associated Press via Yahoo Finance:

Same-store sales rose 3.1 percent in August overall, according to the Thomson Financial same-store sales index, ahead of analyst’s expectations of a 2.5 percent increase but below last year's 3.9 percent rise.

Considering that consumer spending growth is slowing, it was only one month and it appears that deep discounts were necessary to generate top-line revenue growth, it certainly puts the rest of the numbers in perspective. In other words, August’s numbers weren’t as strong as some analysts would lead you to believe.

Now, after considering the points I’ve raised on the actual consumer spending data itself, consider the following related to employment and consumer debt:

The FDIC reporting a 10.6% increase in consumer loans that are 90% or more past due

U.S. Banks reporting a 30% increase in credit card payments deemed uncollectible, as well as an increase in late payments

The Fed reporting significant increases in the revolving debt loads held by consumers, with the months of May, June & July seeing increases of 10.9%, 6.4% and 6.6% respectively. The revolving debt increases came during months were retail spending was mixed at best, indicating that credit cards may have been used to finance daily expenses.

The surge in the number of foreclosures; coupled with the high number of ARMs scheduled to reset over the next 18 months.

Job growth declined for the month of August. If job growth continues to decline in the coming months, the only way for consumer spending to remain flat on a YoY basis (let alone grow) is for consumers to get themselves into more debt. Debt fueled spending in the face of job and income losses will only create worse consumer debt and economic problems than we have now.

The real story is that consumer spending is a mixed bag when you juxtapose it against the data surrounding consumer debt, the recent jobs number and the fact that some retailers had to compress margins in order to generate top line revenue growth. Additionally, the market (at the moment) has a tendency to react prematurely to consumer spending news, without considering all the facts or looking at the bigger picture.

Sources:

Bloomberg: “U.S. Stocks Advance; General Motors, McDonald's Shares Climb”- September 11, 2007

Fortune: “Retail News Boosts Modest Market Gains” – September 6, 2007

Reuters: “FACTBOX-U.S. auto sales down 0.6 pct in August”- September 4, 2007

Associated Press: “Applebee's August Same-Store Sales Fall” – September 4, 2007

The Associated Press: “Retailers Report Better-Than-Expected August Same-Stores Sales” - September 7, 2007.

FIDC Quarterly Banking Profile – August 22, 2007

The Wall St. Journal: “Credit Crunch Moves Beyond Mortgages” – August 23, 2007

The Financial Times: “Credit-card defaults on rise in US” – August 27, 2007

Federal Reserve Statistical Release: “Consumer Credit” – September 10, 2007

Disclosure: The Author doesn’t own positions in any of the companies discussed in this article.