Prepare for a Multi-Year Decline in Consumer Spending

The weak results of the holiday shopping season have set the stage for a dismal 2008 for retailers, or rather, holiday season results have forced the retail sector to confront realities around consumers who find themselves financially squeezed. Many retailers, analysts and trade associations were significantly more optimistic a few months back and now have a rather dour outlook for 2008.

The National Retail Federation [NRF] held its annual conference in NYC this week and the predictions from the various analysts in attendance were all rather dire. The CEO of WSL Strategic Retail even went so far as to say that the current situation amounts to “anarchy”; Deloitte provided similarly dour predictions, however they noted that retailers with exposure to overseas emerging markets should be able to offset declining sales in the U.S. The usually optimistic NRF predicts weak sales in 2008 noting that retail sales are likely to rise at their slowest pace in six years; considering that the NRF is usually rather optimistic it could mean that retail sales could be far worse than they expect.

Luxury retailers are seeing a pullback in spending, as retailers such as Nordstrom (JWN), Saks (SKS) and Neiman Marcus all saw tepid sales during the holiday shopping season. American Express (AXP) is seeing a decline in card usage as well as an increase in card delinquencies, and Tiffany (TIF) is seeing lower spending within its U.S. stores. The slowdown in luxury spending is probably due (primarily) to the removal of the “wealth effect” caused by the booming housing market and consumer credit bubble. In other words, consumers aren’t as able to use credit cards and HELOCs to spend above their income level. However I do suspect that some upper income households are tightening their purse strings, as they weren’t immune to abusing mortgages and other forms of credit.

The impact of HELOCs/the housing ATM on luxury spending is something that can’t be ignored. In an earlier post, I referenced a NY Times article that looked at the impact of the HELOCs on consumer spending. The article noted that HELOCs financed roughly $310 million/yr of personal consumption, in states like Nevada and California 20% of all personal consumption was financed by HELOCs. If you’re removing a double digit % of personal consumption from the retail sector on an on-going basis, the result is going to be a significant downturn in retail sales, especially within the luxury segment. Middle class consumers often used their new found housing wealth to purchase items they couldn’t otherwise afford.

At the moment the retail sector is experiencing the deflation of a “consumer spending bubble”, which was financing by the housing ATM and revolving debt. Now that consumers are being forced to only spend in accordance with their income levels, in addition to dealing with higher energy costs, servicing the debt from the excesses of prior years, resetting ARMs, etc, retailers are going to have to reset their expectations. The consumer spending gravy train is over; people can only spend above their means for so long before the bill comes due.

The retail spending downturn all goes back to something I’ve said in the past: “sustainability” needs to be the economic buzzword for 2008. The consumer spending levels of the last couple of years were simply not sustainable, and it was fatuous to expect people to keep spending themselves out of house and home. Furthermore, the naysayers who kept denying the relationship between the housing boom and consumer spending should either be slapped for being willfully ignorant or should pursue different lines of work, as the whole thing was bloody obvious to anyone with half a brain.

Finally, (as I’ve said numerous times) a decline in consumer spending is NOT a bad thing, it’s actually fantastic as it shows that consumers are at least trying to get their finances in order and put themselves into stable situations.

Sources:

Reuters: “Retail in a state of “anarchy” as consumers retreat” – Martinne Geller, January 13, 2008.

Reuters: “2008 retail sales seen up, slowest rise in 6 years” – Nicole Maestri January 14, 2008

Business Week: “Luxury Shoppers Shut Their Purses” – Pallavi Gogoi – January 14, 2008

American Express: “American Express to Take Big Charge as Loans Sour” – Robin Sidel – January 11, 2008

The Wall St. Journal: “Tiffany Outlook Is Lowered On Slowing Luxury-Goods Sales” – Vanessa O’Connell – January 12, 2008

The NY Times: “Homeowners Feel the Pinch of Lost Equity” – Peter S. Goodman, November 8, 2007

Comments

[Reinko]

Hello Markham, good article and I really did not know that HELOC's amounted to 20% of spending in some cases.

I live in Holland and in the nineties we had two years on a row of 4% more 'income' spended on behalf of your house value.

It took us four years to recover from that...

[RichShinnick]

What, you haven't heard, it is your patriotic duty to spend more than you make. Americans must go to the mall or the world will come to an end. You want us to stay home and read books to our kids or something?

[No Moss]

OK, the end of the world is nigh. No, the world is getting richer and the world is getting smaller. In America, the rich are getting richer and there is a divide between the rich and poor like never before. I think that the growth ahead for Amex is extraordinary. The world wants the high-end customers that Amex brings, and high-end consumers is Asia (especially) want the prestige that Amex brings.

How can you really knock Amex, which is a distinct beneficiary of long-term trends? Great brand, even better business.

[Markham]

I was actually referring to evidence that customer spending is slowing over the short-medium term in the U.S., as opposed to discussing Amex's long-term prospects for the future.

Disclosure: I'm long AXP.