Consumers: Tightening the Purse Strings?

More retailers are struggling as housing market woes seep through the economy. Investors are fretting that consumers will cut back on spending

Back in March, the stock market wobbled as a handful of retailers, including Wal-Mart Stores (WMT) and J.C. Penney (JCP), complained about anemic sales (see, 3/15/07, "Consumers Feel a Chill"). Investors fretted about a slowdown in consumer spending, but the concerns quickly passed.

Now, however, the group of griping companies is growing. On July 10, Sears Holdings (SHLD) said its second-quarter earnings will fall well below Wall Street expectations due to more disappointing sales of home appliances and other products. The company's Kmart stores reported a 3.9% decline in nine-week comparable store sales, while sales at Sears stores fell by 4%. The warning came the same day that Home Depot (HD) cut its annual profit forecast. The nation's largest home-improvement retailer also said that sales may fall 2% for its fiscal year, the first annual decrease in the company's history.

Dwindling Gains

It's a sign that troubles in the housing market are rippling through the economy. "This is a direct effect of softness in housing demand," says Michael Niemira, chief economist at the International Council of Shopping Centers. "When people buy a new house, they buy new furniture or appliances, and those retailers are suffering the most."

But they're not the only ones. Even some of the stronger retailers have been struggling of late. Bed Bath & Beyond (BBBY) issued its first profit warning since becoming a public company last month. Kohl's (KSS), which had a 10.5% increase in sales in May, is expecting a decrease in June sales.

Clearly, consumers are continuing to spend, and there isn't a collapse in spending yet. However, shoppers are not opening their wallets as freely as they have in recent years. Niemira's Council of Shopping Centers group, along with UBS Securities (UBS), said in a report that sales in June will likely rise from 1.5% to 2%. That would be the smallest gain for the month since a 1.2% gain in 1991.

Staggering Losses

The prime concerns for consumers are the housing slump and gasoline prices. The national price for regular unleaded gasoline jumped 2.2¢ over the past week, to $2.98 a gallon, according to the U.S. Energy Information Administration. Prices are expected to continue to rise. The retail price of gasoline is expected to average $3 a gallon this month and climb to $3.07 in August, the government said.

At the same time, housing market troubles are continuing. Home mortgage financier Freddie Mac (FRE) said that sales of new and previously owned homes will likely total 6.28 million in 2007, down 7.1% from last year. The 2007 figure would be the lowest number since 6.2 million homes were sold in 2001, at the start of the five-year housing boom. The company also said that residential lending will drop to $2.75 trillion, the lowest level since 2002. "Home equity debt used to be super cheap, and when the Fed raised the overnight variable rate, it cut many people out of that market," says Richard Hastings, retail sector analyst at the research firm Bernard Sands. "Today, unless you are in the top 5% of the nation in terms of credit score quality, you will pay 9% or more for home equity loans, and many people are just shut out."

While the housing market has been troubled for months, the degree of the problems continues to surprise investors and others. On July 10, the country's second-largest homebuilder, D.R. Horton (DHI), said it will report a third-quarter loss after orders plunged a staggering 40%. "We expect the housing environment to remain challenging," Chairman Donald Horton said in a statement.

Worries and Warnings

Investors are clearly fretting the fallout. The Dow Jones industrial average was off 148 points, or 1.09%, to 13,501, with the warnings from retailers and fears of more troubles with subprime mortgages (see, 7/10/07, "Stocks: Another Subprime Stumble"). Sears' stock fell 10%, to 154.21, while Home Depot's shares added 2¢, to 40.25, as the company tempered its bad news with a buyback of a whopping 250 million shares.

Many more retailers are slated to release their financial results on July 12. Discounter Target (TGT) has already warned that its June same-store sales will be at the lower end of its forecast of 3% to 5%. Forecasting declines for the month are high-end retailer Saks (SKS), J.C. Penney, and Macy's (M). "Given continued softness in the home sector, we would expect similar pressures at retailers with home exposure such as Macy's, J.C. Penney, Kohl's, Bed Bath & Beyond, Williams-Sonoma (WSM), and Ethan Allen (ETH)," warned Goldman Sachs (GS) retail analyst Adrianne Shapira.

Niemira of the Council of Shopping Centers points out that the job market is healthy, inflation is under control, and wage growth is quite decent. "While consumers are pinched, I don't expect consumer spending to get worse," he says. Clearly, this is a thought that nervous investors are hoping will hold true.

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