Consumer spending accounts for about 70% of US GDP, so the performance of the retail sector in the second half of the year is critical to an economic recovery. However, growing unemployment may make a rebound in retail difficult. For more on this, see the following article from Money Morning.
Retail investors had a rough go of things in the first half, but since the March lows of all the markets, the Standard & Poor’s Retail Index is showing progress toward its 52-week high of 427.13.
But don’t expect that to last. A slump in consumer spending and soaring unemployment could both pose a significant threat to retailers going into the 2009 holiday season.
The U.S. unemployment rate hit 9.5% in June and could eclipse 10% by the end of the year, sending the economy into a “jobless recovery.”
In a speech to Congress on May 9, Federal Reserve Chairman Ben Bernanke cited a lack of consumer spending could serve as a constraint on hiring. This could create a paradoxical effect as employment obviously plays a key role in consumers’ spending habits.
Even for the employed, the lessons learned from the worst economic downturn since the Great Depression will resonate with consumers. That has already been evidenced by the U.S. savings rate, which has climbed above 4% for the first time in more than a decade.
In addition to taking money out of the hands of potential customers, soaring unemployment could lead to higher lending standards. As unemployment rises, so too will credit defaults and the cost of credit will increase accordingly.
In the past, consumers have counted on attractive financing promotions for the purchase of big-ticket items such as high-definition televisions and kitchen appliances. But that won’t be the case with tighter credit
“Consumers were also able to spend more because of the easy availability of credit, most notably through mortgage equity withdrawal and they responded by buying more items,” said Deloitte Strategic Advisor Richard Hyman. “These conditions underpinned retail growth for the past 10 years but have now disappeared. However, it’s worse than that. They will clearly not return once the recession is over.”
Of course, tighter credit isn’t just a problem for consumers.
A Brick & Mortar Inventory Crunch for the Holidays?
The potential bankruptcy of commercial lender CIT Group Inc. (NYSE: CIT) could be a major tipping point for businesses that rely heavily on credit. Vendors for retail giants such as Wal-Mart Stores Inc. (NYSE: WMT) and Target Corp. (NYSE: TGT) rely on CIT for factoring – an old form of finance in which the lender pays the vendor for its accounts receivable. If the retailer fails to pay for the goods, the lender assumes the responsibility to pay the vendor.
“Right now our industry is preparing for the fall and winter season,” Kevin M. Burke, president and chief executive of the American Apparel and Footwear Association told The New York Times. “A lot of these orders are going to come to a grinding halt if there is no capital.”
A CIT bankruptcy would be a “double whammy” to stores whose suppliers have already cut the amount of merchandise they are making to better align inventory with the drop in consumer spending, said Burke. If those suppliers lose their sole source of capital, what little merchandise retailers originally ordered might never arrive.
The timing of CIT’s woes is “terrible,” Al Ferrara, a partner in retail and consumer products business of consulting firm BDO Seidman LLC said in a Reuters interview. “Retailers now are basically gearing up for the back-to-school and the fall season.”
An inventory crunch at brick & mortar retailers would give a competitive advantage to online retailers, which have more flexibility and already account for about a third of holiday retail sales.
For brick & mortar retail businesses, managing inventories during the holiday season is a delicate balancing act in which managers must walk a fine line between over- and under-ordering stock.
If retailers overstock, they will be forced to offer even steeper post-holiday discounts than they would like in a desperate bid to unload inventory. But if they don’t stock enough merchandise to meet demand they risk not only missing out on sales, but driving potential customers to online retailers, such as Amazon.com Inc. (Nasdaq: AMZN) whose warehouses are not restricted by the display racks and checkout counters found in brick & mortar stores.
This doesn’t mean brick & mortar retailers will sit idly by this holiday season as Amazon siphons off customers via the Internet. All of the nation’s biggest retail players have their own websites too, but the gap between Amazon and the No. 2 online retailer, Staples Inc. (Nasdaq: SPLS) is huge: Amazon generated $19.2 billion in online revenue in 2008, while Staples generated less than half of that in the same year: $7.7 billion.
While half of the top 10 online revenue generators came from traditional stores, notably absent were brick & mortar discount giants Wal-Mart and Target.
And even Best Buy Co. Inc. (NYSE: BBY), which displays in-store signage promoting an “expanded assortment” of products online for consumers who did not find what they were looking for in the store, came in at just No. 10 on the list.
Shopping for a Silver Lining
While a continued slump in consumer spending would benefit no one, certain retailers are better positioned than others, and could ultimately use adverse economic conditions to turn a profit.
For instance, the aforementioned Amazon.com, which is the world’s largest online retailer, could see a sizeable boost in its web traffic as consumers comb the Internet for bargains.
Companies that have a consumer-friendly economical brand, such as Wal-Mart, will also benefit.
Wal-Mart’s “Save Money, Live Better” slogan is already resonating with consumers, and The No. 1 retailer in the world has gone to great lengths to cement its reputation as the affordable choice for shoppers.
The company has set up a “Save Money, Live Better” website (complete with testimonials of what people are doing with the money they save by shopping at Wal-Mart) and a “Live Better Index,” which includes an interactive map of the United States to show how much money people have saved in each state by shopping at Wal-Mart.
The result of Wal-Mart’s efforts? Holiday sales grew 7% last year, according to the Advertising Research Foundation.
Similarly, same-store sales are consistently rising at discount houses such as Family Dollar Stores Inc. (NYSE: FDO), and Ross Stores Inc. (Nasdaq: ROST), the latter of which has the “Dress for Less” slogan right under its name at every store. On the flip side, stores like Macy’s Inc. (NYSE: M) and Saks Inc. (NYSE: SKS) have reported consistent declines in same-store sales over the past few quarters.
“Needs-driven spending will gravitate towards retailers able to tick the most important consumer boxes like price and convenience,” said Deloitte’s Hyman. “Although it will remain the engine of retail growth, wants-driven spending will slow and consumers will be much more choosy.”
This article has been republished from Money Morning. You can also view this article at Money Morning, a investment news and analysis site.