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Markets Smell Recovery as Consumers Drive Retail Sales

American shoppers are set to become the economy’s new source of strength.

Economists lifted estimates for consumer purchases in the third quarter after retail sales climbed more than forecast in September and the government said gains in the prior two months were larger than previously reported. Predictions of a 3 percent or more increase by RBS Securities Inc. and 2.6 percent by Morgan Stanley would mean the most robust household spending of the recovery.

“Consumers are taking the baton as a driver of the expansion,” said Dean Maki, chief U.S. economist at Barclays Capital Inc. in New York. “While it is still a moderate recovery, the speed is going to be stronger than many people think.”

His outlook puts him in the minority among his peers: While a Bloomberg News survey of economists this month showed an increase in the median forecast for third-quarter consumption to 2 percent from 1.9 percent, estimates for the fourth quarter and 2011, at 2 percent and 2.2 percent respectively, were unchanged from the previous survey.

The “painfully slow recovery in the labor market” is keeping the expansion “less vigorous” than policy makers would like and may warrant additional monetary stimulus, Federal Reserve Chairman Ben S. Bernanke said in an Oct. 15 speech in Boston.

Even with unemployment stalled near 10 percent, Americans are ready to play a bigger role in the rebound because their incomes are improving and they have been paying off debt and rebuilding wealth, said Maki, who specialized in researching household finances at the Fed from 1995 to 2000 and was ranked the most-accurate forecaster of gross domestic product in a December 2009 Bloomberg News survey.

$4,000 Watch

Brad Shepard, 35, co-owner of an Atlanta management consulting firm, has seen an increase in business recently as new clients seek ways to boost customer service and raise revenue. So two weeks ago, he bought a $4,000 Bell & Ross watch.

“It is a luxury that I had been looking at for quite a while,” he said. “Business has been picking up, and it seemed like time to reward myself.”

Investors are already betting that consumer spending, which accounts for about 70 percent of the economy, will be healthier in the next few months than some economists are predicting. The Standard & Poor’s 500 Retailing Index is up 14 percent this year, and the Consumer Discretionary Select Sector SPDR Fund has risen 17 percent compared with a 6.1 percent gain in the broader S&P gauge.

‘Recovery is Coming’

“The markets can smell a recovery is coming,” said James Paulsen, chief investment strategist in Minneapolis for Wells Capital Management, which manages $342 billion. “We’re en route to accelerating. It’ll make the soft patch seem more like just a soft patch.”

Cincinnati-based Macy’s Inc. may jump 22 percent in the next 12 months, according to the average analysts’ target-share price compiled by Bloomberg News after the stock market closed Oct. 22. Nordstrom Inc., based in Seattle, may rise 18 percent, Kohl’s Corp. of Menomonee Falls, Wisconsin, 16.5 percent, and Minneapolis-based Target Corp., 16 percent.

Jeweler Tiffany & Co. in New York may gain 6 percent; and Apple Inc., the Cupertino, California-based maker of iPads, iPhones and laptop computers, will see a 20 percent gain, the data show.

Paulsen said he’s counting on an improvement in consumer confidence, which has been stuck below pre-recession levels for the past year amid record home foreclosures and the loss of more than 8 million jobs during the slump. He predicts sentiment will recover once the Nov. 2 midterm elections are over, uncertainty about tax cuts is resolved, and company hiring ramps up, providing a boost for next year.

Bullish Forecast

He estimates the economy expanded at least 2 percent in the third quarter, helped by a gain in consumption of about 2.5 percent. Maki is more bullish, projecting growth of about 2.5 percent as spending jumped as much as 3 percent.

Consumer purchases rose 2.2 percent in the second quarter, and economic growth cooled to 1.7 percent from 5 percent in the final quarter of 2009. The Commerce Department will release third quarter data on Oct. 29.

Wal-Mart Stores Inc., the world’s biggest retailer, is optimistic about customers, with Chief Executive Officer Mike Duke predicting “positive” fourth-quarter sales at U.S. stores open at least a year after five consecutive quarters of declines.

“I feel good about our U.S. plans,” Duke said during an Oct. 13 investor conference in Rogers, Arkansas.

‘Cash for Clunkers’

Retail sales rose 0.6 percent in September, helped by broad-based gains that showed households are learning to cope without government stimulus, according to data released Oct. 15. Cars and light-duty trucks sold at an 11.6 million seasonally adjusted annual pace in the third quarter, industry data show, the fastest since the same period last year, when a “cash-for- clunkers” program propelled demand.

Russell Geller, owner of Beck Chevrolet in Yonkers, New York, said he has begun planning his first major renovation since at least 2000 as part of a voluntary program for General Motors Co. dealers.

“It’s encouraging that you can say to yourself ‘I will reinvest in my facility because things will be coming forward,’” Geller said. “A year ago, you didn’t know where exactly your business was going to be.”

Bernanke, in the Oct. 15 speech, said the “handoff is currently under way” for a recovery driven by consumer spending, net exports and business and residential investment rather than one fueled by government support.

Ease Monetary Policy

About 70 percent of President Barack Obama’s estimated $787 billion stimulus has been spent, according to a September White House report. The Fed’s steps to ease monetary policy included cutting the benchmark interest rate in December 2008 to a range of zero to 0.25 percent and buying $1.7 trillion of securities. Bernanke, who will meet with the policy-making Federal Open Market Committee Nov. 3, has said additional purchases may be warranted because inflation is too low and unemployment, at or above 9.5 percent since August 2009, is too high.

The Fed’s preferred inflation gauge, which excludes food and energy, was up 1.4 percent in August from a year earlier, below the central bank’s longer-run goal of 1.7 percent to 2 percent price growth.

While inflation is a concern for the Fed, it is helping workers’ buying power. After-tax income, adjusted for inflation, climbed 1.7 percent in the 12 months through August, the biggest year-over-year gain since April 2009, two months before the 18- month recession ended.

Improving Conditions

Three in five respondents in a Bloomberg National Poll taken Oct. 7-10 say their economic condition has improved recently or they are confident it will get better. One in three say things have gotten worse or aren’t likely to get better anytime soon.

The improving outlook, along with low inflation and the rising stock market, are “positive” for Democrats, who will win 49.3 percent of the national vote in next month’s balloting, said Ray Fair, a Yale University economist who developed a formula using economic data that would have correctly predicted all but three presidential elections since 1916.

“If the economy is better now than people had thought, that’s got to be a slight help for Democrats,” Fair said. While they may lose control of the U.S. House of Representatives, “it looks like the election will be relatively close.”

Discretionary Purchases

The National Retail Federation projects that sales during November and December will rise 2.3 percent from a year ago, the most in four years. Americans plan to spend an average of $688.87, 1 percent more than 2009, and may step up discretionary purchases, according to a survey for the Washington-based group by BIGresearch.

“We feel good about the momentum thus far,” Brian Goldner, chief executive officer of Pawtucket, Rhode Island- based Hasbro Inc., said during an Oct. 18 conference call. New toys are selling well at retailers, and “we expect a very robust holiday season,” he said.

The strength will carry consumer stocks higher into next year, according to Richard Hastings, a Charlotte, North Carolina-based consumer strategist for Global Hunter Securities LLC.

“The underlying economy continues to improve, very slowly for sure,” Hastings said. “We expect retailers and consumer names to offer some surprises regarding 2011 guidance that could help boost the sector.”

Disposable Income

Consumer credit has fallen nearly every month since mid- 2008 as Americans paid off loans and borrowed less, according to the Fed, and debt payments as a share of disposable income dropped to 12.1 percent in the second quarter, the lowest in a decade.

Households are better positioned to support the recovery next year and beyond than widely perceived, said Joseph Carson, director of global economic research at AllianceBernstein LP in New York.

Their reduced debt burden “could well provide the firepower for a stronger consumer-spending cycle in 2011,” he said.

To contact the reporters on this story: Shobhana Chandra in Washington at schandra1@bloomberg.net Cotten Timberlake in Washington at ctimberlake@bloomberg.net

To contact the editors responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net Robin Ajello at rajello@bloomberg.net

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