American Consumption

The U.S. consumer is in a foul mood, and the effects on investors and the economy are likely to be harsh.

The Conference Board said on Oct. 28 that its consumer confidence index has dropped to an all-time low, from 61.4 in September to 38 in October. Americans were partly reacting to what they saw on the news in the past month: A plunge in the stock market, the dysfunctional credit markets, the failure of major financial firms, passage of a $700-billion bailout package in Washington, and a Presidential campaign focused on the economic crisis.

But consumers' fears aren't entirely a media creation (BusinessWeek.com, 10/28/08), economists say. Consumers are starting to feel the economic squeeze where they live.

Keith Hembre, chief economist at FAF Advisors, identifies three main culprits "conspiring to substantially depress household confidence": deteriorating asset markets, credit markets, and labor markets.

Asset market problems would include the quarterly retirement plan statements that showed a big drop in many people's net worth from declining investment—on top of the increasingly apparent impact of falling home values. Credit problems mean consumers can't borrow as easily to make purchases, from washing machines to houses. And the deteriorating job market is a result of falling profits in a variety of sectors, not just the financial industry. "With good reason, they're concerned about their jobs and the value of their homes and 401(k)s," says Stuart Hoffman, chief economist at PNC Financial Services (PNC).

The impact on the economy from this crisis of confidence may be even more doom and gloom. "When people believe there will be a recession, there will be a recession," says Jerry Webman, chief economist for OppenheimerFunds (OPY).

Americans can be expected to cut back on spending and to augment their savings accounts for tough times ahead. But that saving, however virtuous, will rob the rest of the economy of important revenue. That's a phenomenon economist John Maynard Keynes called the "paradox of thrift."

For almost two decades, Americans, known as the world's shopaholics, have spent freely. Consumer spending has increased steadily for 17 years ever since a mild decline in the last quarter of 1991.

But because of declining confidence and other factors such as the tough job market, many economists say they expect consumer spending to fall by 3% or more in the third quarter of 2008. That would be the worst drop in consumption since 1981.

Hardest-hit may be the makers and sellers of more expensive items, says Michele Gambera, chief economist at Ibbotson Associates, a unit of Morningstar (MORN). "Depressed consumers do not purchase anything big ticket because they have to beef up their precautionary savings, their rainy day funds," he says. Appliance maker Whirlpool (WHR), for instance, sharply reduced earnings estimates on Oct. 28 and said it would cut 5,000 jobs by the end of 2009 because of the economic conditions.

The timing of the recent market turmoil couldn't be worse for U.S. retailers, which are highly dependent on the holiday season. "It's going to be a tough holiday season," Hembre says. "Every indication is that people are not inclined to spend," Webman adds. The stocks of department stores Macy's (M) and Nordstrom (JWN) have lost nearly half their value in the past month, partly reflecting those holiday worries.

Discount stores such as Wal-Mart (WMT) and Target (TGT) also have taken their lumps, with Wal-Mart down about 9% in the past month and Target off 25%. "We continue to expect consumers to migrate toward discounters, off-price, and mass-merchant retailers during the upcoming holiday spending season. However, we believe that even these retail segments will experience slower trends relative to recent month run-rates," wrote Brian S. Postol, senior retail analyst at Jesup & Lamont (JLI) earlier this month.

At the end of one of the most fearful months in modern U.S. economic history, are there reasons for hope when it comes to the nation's consumers?

Hembre pins some hope on a stimulus package that could be approved by Congress and the next President in early 2009.

Hoffman points out that gas prices are falling fast, from above $4 per gallon during the summer to below $3 now. "One silver lining is that gasoline is going to save people a lot of money in the next couple months," Hoffman says.

The reality of smaller fuel bills didn't show up in the Oct. 28 consumer confidence survey. Fuel price declines take away a main driver of inflation, but consumers in the survey actually expressed more worries about inflation. "Though seemingly irrational, this propensity to provide pessimistic answers to all survey questions may capture the toxic combination of fear and anger that is rippling through the system," said Action Economics in an Oct. 28 report.

Many economists point out there is one positive effect of Americans cutting back spending. Yes, the short-term effects on the economy could be destructive, but Americans do need to save more. "In the long term, if consumers were trying harder to live within their means, we would have a more solid economy," Gambera says.

But Americans can't save more if they're not bringing home paychecks. With credit markets frozen, bank financing is scarce and unsolicited credit card offers aren't showing up in the mail as often. "It's going to be hard for consumers to borrow their way out of weak consumption," Webman says. Instead, the formerly free-spending American will have to earn his way back into shopping mode.

Unfortunately, the labor market may not cooperate. Economists expect the October unemployment rate to rise from 6.1% to 6.3%. Ironically, by saving their hard-earned money this holiday season, Americans could push that jobless rate even higher in coming months. The consumers' winter of discontent could grow colder and gloomier.

Source - Business Week