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August 25, 2005

Consumers Under Pressure
by Chad Hudson

Existing home sales dropped by 170,000 to an annualized rate of 7.16 million. While sales declined from the previous month, July's sales were 4.7% higher than last year. The median price increased slightly from June, but was 14% higher than last year. It is interesting that the median price didn't drop in July considering there was a 7.5% drop in the number of homes sold in the West. This was the largest drop since January 2004. This drop is explained by the 6.1% jump in June. It is also notable that the number of homes available for sales increased from 2.68 million to 2.751 million, or 4.6 months of supply. This was 12.6% higher than last year. The number of home available for sale steadily increased from 2000 to 2003. During 2004 the number of homes for sale did not materially increase and during the end of 2004 and the beginning of 2005 the number of homes for sales was below the previous two years. The past three months have set records for the number of homes for sale.

While existing home sales fell from the previous month, new home sales reached a new record. Homebuyers purchased 1.41 million homes (annualized rate), up 6.5% from the June and up 17.0% from last year. The median price dropped on a sequential and year-over-year basis. The median new home sold for $203,000, 4% below the median price last year. This was the largest year-over-year drop since April 1991. The number of new homes for sale also reached a record. There were 460,000 new homes available for sale, up 15% from last year. Due to the record number of purchases, the number of months supply fell to 4.0 from 4.1 last month and 4.4 last July.

Last week, the Dallas Morning News ran a three-day special discussing the wealth of Collin County, The Price of Prosperity. Collin county is home of the northern suburbs of Dallas. With an average household income of $71,000, Collin County is the richest county in Texas and is in the top 1% in the nation. Not surprising, storefronts have popped up almost anywhere there was vacant land giving residents every chance possible to spend their money. The number of retailers jumped 23% between 1999 and 2004. This wealth But not all that glitters is gold. It also pointed out that residents carried more credit card debt ($4,200), had a lower net worth ($125,000), and had the highest amount due on an auto loan ($19,000), than similar high income counties in the country. Additionally, bankruptcies have doubled in the last five years, outpacing bankruptcies in similar counties. This could be a forewarning on what could happen around other parts of the country.

The two factors that account for the higher debt burden residents of Collin County carry, beside the propensity to overspend, are a lagging housing market and a weak employment market. As housing prices have soared across the nation, some areas have been left out. Dallas housing prices have lagged. In Collin County the median home price has increased 17% from 1999 to 2004, while it has increased 45% for the overall country. Collin County was also home of "Telecom Corridor." There was a large influx of telecommunications companies that moved to the North Dallas suburbs during the late 90s. After the telecom bubble popped there were a lot of people without jobs and when they gained employment, it was at a reduced salary. Too many people were not able to adjust their lifestyle to match their new income and unlike other parts of the county, homeowners were not able to extract equity out of their house to help make ends meet.

It seems obvious that housing inflation has boosted consumer spending. Housing inflation has either allowed homeowners to borrow against their inflated home value or used the inflated value to ward off financial duress due to a job loss or other financial calamity. When housing inflation stops, a large source of consumption will be lost. Since the savings rate is already close to zero it will be impossible for current income to make up the difference.

In keeping with the tradition of the Dallas Federal Reserve Bank, Richard Fisher, the new Dallas Federal Reserve President, was quoted saying, "Americans will buy anything that walks, moves, looks good, reads well, has a fancy color. We're the greatest consumers God ever put on Earth. It's what we do better than anybody else." It is apparent that he learned the ropes under Robert McTeer who was quoted saying "everything would be OK if we'd all just hold hands and buy SUVs."

Last week, we discussed how the teen retailers might have an inventory problem if sales fail to achieve expectations, especially in denim. Last week, Gap reported that earnings increased 20% from last year, surpassing Wall Street estimates by two pennies. Unfortunately, the retailer announced that August sales were below plan. Citigroup estimates that August same store sales are down 7%-9%. Last week, we briefly discussed the repercussions of falling same store sales. The lower than expected sales will crimp earnings by about a dime. Management guided earnings per share to $1.30-$1.34 from $1.44 - $1.48 caused by a 150 basis point drop in operating margins.

The denim glut appears to be impacting Gap. Bloomberg News reported that Gap cut prices by $10 on its jeans and if offering iTunes downloads just to try on a pair of jeans. The limited has cut prices by $20 according to the article. It also said that retailers bought about 10% more denim this year. David Wolfe, creative director at Doneger Creative Services, a fashion consultant, was quoted saying, "I think that is dangerous [denim buildup]... This one is going to crash and burn."

One theme that we have discussed this year is the weakness in the central portion of the country and the lower income consumers have cut back their spending. Applebee's cited both these trends on Wednesday when it lowered it guidance for the second time this year. Energy prices have continued to escalate and will further crimp lower income consumers and if the record inventory of homes relieves the inflationary pressures in housing, the stimulus that has boosted consumption will erode and leave retailers in a precarious position.

Chad Hudson
Mid-Week Analysis
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