True the recession had its share of casualties as strip malls lost once high-flying tenants such as Borders Books, Circuit City and Linen’s & Things. The carnage has yet to end as electronics retailer Best Buy has plummeted 60% from its 52-week high. The reason most cited is consumers shifting their shopping online and consequently using physical retailers as showrooms for items to be purchased later from the likes of Internet juggernaut Amazon. The premise is reflected in that firm’s share price, which sits only 10% below its 52-week high and 44% above its low for the same period. Although this transition is logical, analysts clearly don’t take into account technophobe luddites like me who cannot buy an electronic toothbrush without having a sales clerk walk me through every step of the instructions. I guess I am in the minority.
The more important take-away is that the overwhelming growth of retail space during the early 2000s is yet another sign of excess capacity built up that must now be absorbed piecemeal into a (slow) growing economy. Although the overhang in housing supply gets all the headlines, both are products of the same go-go credit binge. After all, easy home equity loans and subprime credit cards were key components in funding purchases of everything from autos and home theaters to restaurant-quality appliances and naughty trips to Vegas. Just as ground should never have been broken on many housing developments, several retailers survived (and thrived) only because of the loose financing offered to both their customers and to themselves, the latter of which compensating for a level of cash flow insufficient to merit such growth.
The Long Shadow of Keynes
One of the many ideas bestowed upon the study of economics by John Maynard Keynes was the paradox of thrift. While it is personally beneficial for an overextended individual to pull back on the credit reigns, it is detrimental for everyone in an overleveraged society to do so at the same time. The result would be a precipitous drop in consumption, just when the economy likely needs a boost to growth. The U.S. is acutely exposed to such a phenomenon given its reliance on personal consumption (70% of GDP). A recent report by Transunion shows that the balances the average borrower carries on his/her credit card fell 23% from its peak in early 2009 to the recent trough in 2011. Since then balances have clawed back 7%, just nipping $5,000. (We shall save for another day the insanity of carrying such a balance on a source of financing with notoriously high interest rates).
A slight bump in credit card balances may cause economists worried about Keynes’s paradox to sleep a touch more easily, but other evidence shows deleveraging may continue to provide headwinds to economic expansion. At its peak, the rate of household debt to disposable income reached north of 130%. Economists believe 100% is the maximum sustainable level, and the U.S.’s long-term average is in the neighborhood of 70%. Recent government data pins the current rate at just above 100%. Should consumers either desire to cut down on debt further, or not be approved for additional credit, then the economy will need to find another source of growth to compensate for tepid personal consumption. A banking survey conducted by the Federal Reserve shows that after a period of extreme increases in lending standards for products like credit cards, banks have slowly begun to loosen requirements, although they remain much tighter than during the credit boom.
The mentality of the consumer is especially important as the retail sector is immersed in its most important period of the year. Retailers may need a stellar holiday season to account for what has otherwise been a lackluster year when compared to earlier stages of the recovery. Year-on-year growth in retail sales (ex-autos) have been mired below 5% for the past seven months. In 2011, every month registered YOY gains greater than 5%.
Despite this record, retailers continue to outperform the broader stock market. Yes the boost in credit demand and availability may be positive signs, as is a robust post-Thanksgiving weekend (despite the inevitable muggings, tramplings, and knife-fights over video game consoles), but during each holiday season of this mediocre recovery, store managers are faced with the tough decision of garroting profit margins in an effort to lock in early sales or risk losing market share to cutthroat competitors, especially those of the online variety.
If these themes sound familiar, it is because they are the forces the economy has been dealing with since 2009, as it attempts to return to historical growth rates (I’ve all but given up on experiencing a period of above-trend growth to compensate for pent-up demand delayed during the recession). Consumers hesitate to ramp up credit-fueled spending. Construction, both residential and commercial (think big-box), likely won’t be a strong contributor given the excess capacity of space in both segments. And corporations, by sacrificing profitability for the sake of simply moving product, will have to cut expenses somewhere and it’s a good bet headcount is a likely candidate, as it always is. Furthermore, contracting profit margins will inevitably spook investors thus offsetting any of the heady wealth-effect that the Fed so desires to create with its torrent of easy money searching for a home, often the stock market. On top of these question marks, should a deal not be reached, consumers stand to get whacked with brutal tax increases come January 1st. Such an outcome….which is within the realm of plausibility….would quickly undo the marginal gains the economy has made over the past several quarters. Stay tuned. And maybe brush up on canning vegetables.
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