FYI | Dec 13 2007
By Greg Peel
Santa’s got his feet up in the corner, enjoying his pipe. Some of the elves are hard at work, but there are a lot just sitting around playing Lapland Hold ‘Em. There was a flurry of activity just before Thanksgiving, but a quick glance at the order book suggests it could be a quiet couple of weeks before the usual late rush. At least it gives the maintenance team a chance to put the new reversing alarm on the sleigh.
The Friday after thanksgiving is known in US retail circles as Black Friday. It’s an unfortunate name, but it actually refers to the fact that most retailers don’t actually see a profit for the year (get into the black) until this major shopping day is counted. With the growth of the internet, the following Monday has been dubbed Cyber Monday, as that’s the day the Amazons of the world release their Christmas specials.
These two days this year produced an increase in turnover of 4.8% on 2006, which was heartening for US retailers. However, the numbers showed each customer spent less on average, and this was a reflection of the discounts retailers had to apply in order to get the shoppers through the door. American shoppers are no fools – they know what’s going on in the economy and they’re waiting for the mark-downs they suspect will be coming before they pounce this year.
Legendary investment guru and squillionaire Warren Buffet suggested on CNBC this week that all is currently quiet on the Christmas shopping front, post the initial spurt. Buffet has various investments in the retail sector and he is no passive investor. He’s been receiving the sales numbers from his companies every day. He suggested that apart from those who always leave their shopping to the last minute, American shoppers are turning the screws on the retailers. C’mon – mark it down further.
The importance of Christmas to any retailer in a predominantly Christian country cannot be underestimated. TD Bank Financial Group analysts reveal that on average, US retailers make 20% of their annual profit in the holiday season. For those sectors that are closely associated with gift-giving, such as jewellery, the proportion can be as high as 33%. Even clothing stores rely heavily on Christmas (while underpant and sock sellers must hang at the door praying for a barrage of Grandmas). As you move toward bigger ticket homeware and hardware items, the reliance understandably drops off (notwithstanding those wives who are always thrilled to receive the latest cordless drill).
It’s common knowledge as to why US consumers may this year be expecting to cut back on their Christmas present generosity. Falling house prices, mortgage woes, higher fuel and food prices, and reluctance from banks to extend plastic credit so willingly this year, have all weighed on sentiment. Before Christmas was even on the agenda, some retailers have been hit pretty hard in late 2007.
TD reports US sales of building materials have been down 3% for the year, while furniture and furnishings are up only 2% compared to last year’s 9%. Appliance sales are down 5%. The analysts expect Christmas present shopping to be up only 3% this year in dollar terms, which would be the slowest growth in five years (since the last recession).
But once Christmas is out of the way, US retailers could be facing a rather bleak 2008. At Christmas you’re forced to spend money in the stores, but thereafter there’s no guilt incentive to spend at all. TD notes that between 1991 and 2005 US home prices rose 140%, and the value of household assets rose 185%. Over that period, the contribution of retail sales to GDP increased from 67% to 71%.
And that is why those of us outside the US should pay attention. The US economy currently represents some 28% of the global economy, and retail consumption represents 71% of that. You can see why Santa is keeping a watchful eye on the order inflow coming from the North American line of longitude. It could well determine his asset allocation for next year (Santa uses Golden Sacks as advisors).
US existing house prices are already down 3.5% from the same period last year. With mortgage resets (and potential foreclosures) not set to peak until mid-2008, TD suggests house prices could suffer a further decline of 5-10%. There is a lag effect between falling house prices and consumer spending, but TD suggests “the negative wealth effect is likely to take a noticeable bite out of consumer spending over the course of 2008”.
One of the features of the recent US housing boom was the growth of the “home equity withdrawal”. Australians are equally familiar with this time bomb. Your house has risen in value but you can’t cash in unless you sell it. So why not borrow money from the bank against that equity increase and spend it all today? Because house prices never actually go down again, do they?
It is hard to calculate just how much of any equity withdrawal finds its way directly into consumer spending (as opposed to stock market investment or some other such outlay), but estimates suggest it’s about 50-62 cents in the dollar of withdrawal. Official calculations have put the drop in equity withdrawals at US$100bn between the 2005 house price peak and June 2007. That’s about 1.3% of reduced consumer spending. As the situation is only expected to get much worse, TD suggests there is “a significant downside risk to the outlook for consumer spending in 2008”. But given not everyone has dipped into the equity value of their homes, the overall loss of net wealth has TD predicting a 0.5% reduction in consumer spending growth over the next year.
Now add in the effect from the ominous peak of mortgage resets in mid-2008, and estimations are that the rate jumps will add more than 2% to average debt service payments. This, says TD, works out to about another 0.3% of consumer spending growth, so now we’re up to 0.8% of reduction.
Another factor is an expected rise in unemployment. TD is forecasting 5.3% in 2008 from 4.7% this year. While employment growth will slow, these numbers are historically low and suggest the labour market will remain relatively tight and wage pressures will remain, thus increasing household disposable income by about 2% compared to 3% last year.
Putting it all together, TB believes US real consumer spending growth will slow to 1.7% in 2008. This translates to a likely US GDP growth for 2008 of a “tepid” 1.8%. As TD suggests, it’s not quite a recession, but “it may feel like one to many Americans”.
