Durable Goods vs. Consumer Confidence
Tuesday's release of July's durable goods orders grew 8.7% from June was better than all economists estimated. The median estimate called for growth of 1.5%. Just as economists were finishing up their analysis that the strong durable goods report put a "double dagger" in the double dip forecasts, the consumer confidence report had confidence heading for a second dip. Consumer confidence for August dropped to 93.5, the lowest level since last November. The lower consumer confidence is noteworthy and evidence supporting out view of surprising economic weakness going forward. Before, lower consumer confidence was associated with terrorist attacks or corporate scandal. Now, most of that is behind us. Consumers now might actually be concerned about the economy and pondering the possibility that we may be facing more than a short and shallow downturn. The recent drop in retail sales can be explained by this fall in confidence.
Retailers continue to experience disappointing sales. Last week, chain store sales fell 0.3%, after declining 0.8% last week according to the Weekly Chain Store Sales Snapshot from the Bank of Tokyo-Mitsubishi & UBS Warburg. Backing up the report were announcements from several of the large retailers indicating that their sales are weak during the crucial back-to-school period. Wal-Mart again announced its sales are running at the low end of plan. Federated is still running below plan, and Target said its same store sales will be below its plan of 2% to 4% growth. I can only think of JC Penny as the only big retailer that has announced that its sales are running above plan.
Earlier this week, Merrill Lynch downgraded about half the hardline retail group. Merrill's report details what is happening to the consumer, and why they moved to a defensive position on retailers. Following September 11, consumers spent considerably less on travel and leisure and more at retail stores, especially home-related, as consumers entered exhibited a "bunker mentality." This pushed up general merchandise expenditures as a percent of total consumption, culminating at all-time high of 5.3% in April 2002. Merrill also noted that "sales have deteriorated sharply in July…there appears to be an underlying slowdown in consumer spending." Adding more uncertainty to the retail picture this year is the fact that the Christmas shopping season will have six fewer days this year and will be the shortest since 1996.
Since the bursting of the tech bubble, retailers have enjoyed strong relative profits. As technology earnings imploded, retailers have been able to continue growing earnings. This was followed by the spending spree after September 11. All this strong relative profit growth led to relative stock out performance as investors were running to sectors that were doing the best. Merrill now thinks that the anniversary of September 11 will be problematic as retailers face difficult year-over-year comparisons, while the rest of the S&P 500 will have easier comparisons.
We have long discussed how the current economic and financial climate has no historical comparison, and those that employ various models to forecast will not be able to capture the dynamics of this unique environment. Merrill Lynch hinted at this in its research report, "We believe retail stocks have entered a new phase that has no historical parallel and therefore we can't use history as a guide." This unusually candid analysis is applicable to many sectors, as well as the financial markets and general economy.
As the second half recovery fails to materialize, companies are starting to announce more layoffs. Last week, the Bureau of Labor released its mass layoff report for July. There was very little said about it anywhere. However, we think it is quite telling of how companies view the remainder of the year. During July, companies initiated over 2,000 layoff announcements involving 245,457 workers. This was more than a 50% increase from June and was the highest since January. Interestingly, while durable goods orders increased 8.7% in July, the number of manufacturing workers laid off in July jumped 220% to 135,392.
It does not appear things will be improving anytime soon. Today, Nortel announced it is laying off another 7,000 workers. Just scrolling through this week's headlines: "TriQuint fires 7% of workforce", "MetaSolve eliminates 10% of staff, or 80 workers to cut costs", "Bassett Furniture to cut about 200 jobs", "Culp Inc. to cut 350 jobs in Tennessee", "HP on target for10,000 job cuts by end of year", "More than 6,000 seek Weirton Steel jobs", "Navistar unit confirms the layoff of 1,100 emplyees", "Computer Sciences to cut 450 banking, insurance jobs". Just to end it on a brighter note, "Northrop Grumman: Center to add 1,000 jobs by end of decade."
Craig Barrett, CEO of Intel, commented, "We haven't seen much improvement in the computing environment because companies are not investing." Carly Fiorina, CEO of Hewlett-Packard, echoed the same sentiment: "We're in a delayed global economic recovery with continued weakness in IT spending. The tech sector is under enormous pressure, and we believe that will continue after economies rebound."
There is a good article from the International Herald Tribune, Corporate cost cuts imperil U.S. recovery. It was posted on our homepage, so many may have already read it. While I don't agree with everything said in the article, it serves as a reminder of why it is so important not to let the economy get to the state it is currently in. Also worth reading is a story from the Chicago Tribune, Zero percent was big part of economy's power. With the carmakers' anniversary of the huge incentives of last year, year-over-year comparisons will now be very difficult. Compounding the difficult comparisons, the Financial Times reported that GM plans to stop offering zero-percent financing early next month. Ford and Chrysler extended their incentives until the end of September. If this is really the end of the auto boom, and car sales have been pulled forward, the economy appears especially vulnerable to disappointment.