Is The Spending Spree Over?
The notion that the U.S is in a housing bubble is starting to get some attention, but too many economists and officials fail to see the mounting evidence. Just today, Chicago Fed President, Moskow, said that he did not think the U.S. is in a housing bubble. Of course most people didn't see the bubble in telecom and technology, although there was plenty of anecdotal evidence of a bubble way before it popped. Perhaps the most noticeable was the telecom engineers who were fighting off recruiters and capital markets were throwing money at the industry in all forms. There was a massive amount of debt raised so these companies could build out networks fast enough to keep pace with the exponential growth of Internet traffic. Of course we know that projections for growth of data were off by a huge factor as there is a huge glut of capacity. Now, there is similar evidence that a housing bubble is underway. The Wall Street Journal ran a story discussing how appraisers are getting fired for not assessing the value of the home high enough for homeowners to extract equity. Of course homeowners are only trying to extract housing inflation and not built up equity. The LA Times reported on the fast growing interest in interest only loans (pardon the pun). These interest only loans play into the speculative nature of the current market. Using these loans, homeowners need continued housing appreciation or they will owe more than the home is worth when they sell or refinance it. Financial journalists spin the interest only loans as a way to save money. This is too idealistic. The main reason these loans exist is to allow home buyers to buy a more expensive home.
I live within 15 minutes of Telecom Corridor and have a few neighbors and friends in the telecom industry. From this ringside seat, I have been able to watch the unfolding bubble. Monday's Wall Street Journal carried a story detailing the human side of the collapsing telecom bubble in the area. While the article's main focus detailed how a couple of engineers are dealing with the protracted downturn, it mentioned that there is an estimated $160 billion of excess telecom equipment. To put that number in prospective, the combined sales of Nortel, Lucent, and Cisco was $57.7 billion last year. Telecom is perhaps the best example of how quickly the excesses can be wrung out and the pain that ensues. Since the bubble popped in 2000, the number of workers in the communication equipment sector has fallen by 24%, to levels well below pre-bubble levels. In fact, digging around on the BLS website revealed that the number of workers in telecom had been declining until 1994. At the end of 1993, there were 240,000 workers in the communication equipment industry. Over the next seven years the industry added 50,000 workers, or 21%. This has now fallen to under 220,000 workers, almost 10% below the level before the boom. This shows how bubbles become destructive. Just for kicks, I checked to see what has happened to employment in the mortgage banking/broker industry. The growth in mortgage banking has been phenomenal. The industry more than doubled during the 1990's. After pausing a bit in 2000, employment shot up again and is up 24% since the end of 2000.
Last week, we noted that several retailers reported that July sales fell off a cliff. This week has provided a plethora of additional evidence that confirms the retail sector is becoming ground zero for the slowing economy. The Bank of Toyko-Mitsubishi UBS Warburg chain store sales index fell 0.8% last week. Likewise, the Instinet Research Redbook showed sales fell 0.2% last week compared to the same week last year. The Instinet Research Redbook has been trending downward since early July, which matches what the retailers are saying. This latest reading marked the first time this year that retail sales were below the year ago level. It is important to remember, last summer was not the hotbed of economic activity.
Following last week's announcement by Best Buy, Radio Shack said, "Sales softened abruptly in August and despite some promotional activities to stimulate business, we have been unable to overcome the falloff in consumer demand." Radio Shack is probably an even better indicator of the over health of consumer spending across the nation. It has over 7,100 stores nationwide, and frequently mentions that 94% of Americans live or work within five minutes of one of its stores. Additionally, after lowering same store sales guidance last week to 4% to 6%, Wal-Mart now says that same store sales will be on the low side of that guidance.
Gadzooks, the teen apparel retailer, said the second quarter ended with a small negative in same store sales and July sales dropped by 10.2%. In earning a one cent per share versus last year's $0.14/share loss, Gadzooks was helped tremendously by easy comparisons to last year. I know it does not seem like a year ago, but last year the economy was slowing and retailers were discounting substantially in order to move merchandise. The heavy discounting pushed gross margins to 19% for Gadzooks last year.
Staples' comps were flat. Consumables were up 7%, but weakness in technology pulled down overall performance. PC comparable sales were down 24%, and that was an improving trend!
BJ's Wholesale Club was another retailer that said operations were negatively affected by a slowdown in July. BJ also said they are seeing an increase in the use of credit cards by consumers. The increased use in credit cards could be influenced by the improvement in the gas business, which is more prone to be paid by a credit card. But, it is worth noting.
Toys R Us held back on a portion of its advertising budget during the second quarter and continued to institute cost cutting measures.
Federated Department stores announced that "Through the first two weeks of August, comp store sales continue to be very disappointing and are running below our plan."
Gap could start a price war in denim. It started a $10 off every pair of jeans campaign in August. If retail sales remain weak, more discounting will be inevitable.
Without fail, the consumer again lined up at the refinance window as interest rates dropped last week. While that might be able to save the retailers again, it is much less probable. We continue to believe that consumers will recognize their growing debt burden and will begin the painful process of getting their financial house in order.
Elsewhere in the economy, Navistar lowered guidance for the next two quarters. Analysts' first EPS estimates for the current quarter (Navistar's fourth fiscal quarter) were near $1.00 and were as high at $0.50 just two months ago. EPS estimates for the current quarter are now for a $0.22 loss. In a research note today, CFSB noted that part of Navistar's earnings miss was due to lower gains from the sale of receivables. Evidently, Navistar did not sell some of its receivables as analysts had anticipated. The company maintains this is a timing issue, but we remain skeptical. One of the major themes we see playing out is the seizing up of the asset backed securities (ABS) market.
If the ABS market is experiencing enough stress for companies to delay securitizations, it will not be long until the consumer is cut off from additional credit. Once consumers are unable to get financing, the economy will really begin to roll over.