By Amy Tsao
Consumers this summer have hardly been on a buying spree. Spending levels in both June and July came in weaker than expected -- likely due to exceptionally low job growth in July and oil prices' alarming surge. The lackluster numbers unsettled investors, who wondered what would happen to the economy if consumers showed signs of pulling back, since Corporate America is still sitting on the sidelines. The result: The Standard & Poor's 500-stock index has fallen more than 6% in the last two months.
Yet some good news for investors may be on the way. While consumer spending has weakened, there's good reason to believe that the recent slowdown has run its course. The latest update on retail sales showed that June, while still soft, "wasn't as bad as first believed," says Michael Gregory, a senior economist at Nesbitt Burns, the Bank of Montreal's equity division.
June and July data put together show that the summer has had pockets of strength. July retail sales gains of 0.7% were lower than the 1.2% increase economists had predicted. June, however, was revised substantially higher, to a decline of only 0.5%, vs. a fall of 1.1% previously. "Together, these changes put core retail spending, excluding autos and building materials, on a 5.4% annualized growth pace into the third quarter vs. 2.6% previously," write Goldman Sachs' economists.
Not bad. And digging into the sales numbers, spending on big-ticket items like automobiles and furniture grew nicely in July. That, Gregory says, suggests that "consumers are prepared to spend" on expensive items, but they're giving more discretionary merchandise like apparel a harder look before buying. Caution could linger, as consumers continue to feel the pinch of higher oil and gas prices, Gregory says. "As we go through this cautionary phase, we'll get some more lull."
What's needed to reenergize consumer spending is strong job creation. Companies have been careful about investing money in new projects, so hiring has been lackluster. But some experts say that's about to change, in part because "we've probably seen profit growth peak," Gregory says. Corporate America, needing to find new ways to increase profits, will need to begin to focus more on expansion and hiring.
If August payrolls, reported in early September, aren't stronger than in June and July, investors will be in a mood to sell. "We're in a transition where job growth has to make up for other sources of consumer spending," such as tax cuts and the rock-bottom borrowing rates seen in the last two years, says Gregory. His early projection on August payrolls is for an increase of 200,000. He expects consumer spending to bounce back in autumn. "We should have a firm holiday season," he says. Plus, if Federal Reserve Chairman Alan Greenspan is right and recent economic weakness is a speed bump in a long-term recovery, then job growth should improve the rest of the year. Meantime, the latest earnings guidance from retailing giants Wal-Mart (WMT ) and Target (TGT ) adds evidence to the notion that consumer spending is on the mend. On Aug. 12, Wal-Mart projected that same-store sales for the third quarter ending Oct. 31 would be in a healthy range of 3% to 5%. Target affirmed same-store sales growth of 2% to 4% in the same period, even though it forecast August same-store sales would rise up to just 2%.
Second-quarter earnings reports from across the retailing sector are up for scrutiny next week. Their results will help make clearer the direction of consumer spending. Kmart (KMRT ) and Lowe's (LOW ) report results Monday, while Staples (SPLS ), Home Depot (HD ), Gymboree (GYMB ) and J.C. Penney (JCP ) are slated for Tuesday. Ross Stores (ROST ) and Talbots (TLB ) report Wednesday, and Barnes & Noble (BKS ), Gap (GPS ) and Limited Brands (LTD ) give their earnings updates Thursday.
LOOKING TO JOBS.
Not everyone thinks the stronger earnings guidance from Wal-Mart and Target is because consumers are opening their wallets. Eric Jemetz, senior equity analyst at asset-management firm Rockefeller & Co., cautions that the better outlook could be due to these outfits' leadership positions in the sector and their ability to improve profit margins. "We're seeing strong execution on the parts of both retailers," Jemetz says.
In the end, a rosy picture on consumer spending could develop, though it will require substantial job creation.
Tsao is a writer for BusinessWeek Online in New York
Edited by Beth Belton