Target: The Canary in the Economy?

Many fear the slowdown in the retailer's sales is a harbinger for reduced consumer spendingand that business can't pick up the slack

Cheap-chic retailer Target suffered a one-two punch from higher gas prices and the cooling housing market as shoppers pared down visits to the store.

Target (TGT), one of the country's most high-profile retailers with 1,418 stores nationwide, has often been able to shrug off weak consumer sentiment, thanks to its unique offerings and low prices. But when it gave its mid-month update for July, Target dropped its sales projection for stores open at least one year or more to between 3% and 4%, compared with a previous growth range of 4% to 6%.

Economists and Wall Street have been watching closely for any sign of slowdown in consumer spending, which accounts for about two-thirds of U.S. economic activity. Many took the news from Target as an indication that there could be worse things to come for other retailers. "While Target is not immune, we do believe it should weather any slowdown better than most," says Goldman Sachs (GS) analyst Adrianne Shapira.


  Investors pounded not just Target's shares on July 18 but also those of all retail companies. Target's stock dropped $2.05, or 4.25%, to close the day at $45.50. The Standard & Poor's retail index dropped 2% as stocks like Macy's operator Federated Department Stores (FD) fell 3.42%, to $33.33, J.C. Penney (JCP) fell 3.49%, to $63.37, and Best Buy (BBY) lost 3.77%, to $44.10.

"We believe the weakening housing market and prospects of high oil and gasoline prices, along with other negatives, will during the next few quarters pressure same-store sales for Target and other retailers," A.G. Edwards analyst Robert Buchanan wrote in a research report as he downgraded Target and several other retail stocks to hold from buy (see BW Online, 5/17/06, "Could Consumers Call it Quits").

Everywhere there are signs that consumers are reining in their spending. Also on July 18, a survey of 1,000 households conducted by Opinion Research Corp. on behalf of International Council of Shopping Centers and UBS Securities said that due to rising gasoline prices, 53% of U.S. households now are reducing their discretionary spending on clothing, shoes, jewelry, consumer electronics, restaurant meals, spa and beauty services, and other nonessential purchases. Little surprise that the weekly report released by the International Council of Shopping Centers showed chain store sales posted a sales decline of 0.6% for the week ended July 15.

It's a difficult backdrop for Federal Reserve Chairman Ben Bernanke, who begins his testimony before Congress on July 19. He's certain to field tough questions from lawmakers about consumer spending, inflation, and the economy. Some are concerned that the Fed's repeated interest rate hikes—17 consecutive ones and counting—will do too much to hurt the economy, especially the housing sector.

At the same time, others are worried that Bernanke needs to do more to tame inflation, which is being fueled by higher prices for oil and other commodities. The Producer Price Index released on July 18 was somewhat higher than expected, and the Consumer Price Index is due out on July 19. "Things are unraveling faster than the Fed would like," says Brian Bethune, economist at Global Insight, a firm that specializes in global and financial analysis.


  Some economists argue that the Federal Reserve believes that consumers are already stretched too thin and should be putting the brakes on their spending. However, the Fed doesn't want them to run to the hills either. Shoppers are worried about higher gas prices, and as Wal-Mart (WMT) has already noted, consumers are consolidating shopping trips to save on fuel. According to the U.S. Energy Information Administration, the average U.S. price of a gallon of gasoline stood at $2.99 for the week ended July 17, up 29% from the same period last year.

No wonder consumers aren't feeling positive. The University of Michigan's Index of Consumer Sentiment hit 84.9 in its June, 2006, survey, up from 79.1 in May but well below the 96 recorded in June, 2005. The report noted that consumers will likely curtail their spending in the year ahead to accommodate higher gas prices and smaller cash-outs from home refinancing. In addition, consumers were quite pessimistic about prospects for their incomes.

"Just one-third of all consumers expect their financial situation to improve, with a rising number that expect inflation to offset any wage gains they receive during the year ahead," says Richard Curtin, the Director of the University of Michigan's Survey of Consumers. Overall, nearly half of all consumers anticipated that their inflation-adjusted incomes would decline during the year ahead, the worst outlook since the early 1990s.

If consumers pull back on spending, the Federal Reserve also hopes that business will pick up the slack, especially since many of them have cleared up their balance sheets and refinanced their debt with the low interest rates of the last few years. But these same companies are likely constrained by higher costs resulting from soaring energy prices, which means increased costs for transportation and to run their machinery.

If increased competition makes it tough for to pass along those costs to the consumer, it won't be easy for them to boost spending substantially. Retailers, for instance, have started to pull back on hiring after spotting how their shoppers were behaving. "Retailers have cut their service staff to the bone," says Global Insight economist Bethune (see, 7/12/06, "The Real Problem with Job Growth").

Indeed, much like the Fed, Target will be trying to strike a delicate balance. The difference is that it will have to balance its own rising costs due to high energy costs with the investments it needs to lure people into stores with its sharp designs and low prices.

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