Holiday Sales: Less Cheer in '07

While the headlines look encouraging, Action Economics says that inflation-adjusted sales could show their slowest growth in five years

The U.S. holiday shopping season got off to a great start over the Thanksgiving weekend, though we'll likely see a lull over the long stretch to Christmas. Steady income growth suggests that broad year-over-year sales gains in nominal terms—unadjusted for inflation—in the 2007 holiday season will nearly match the growth posted in 2006. Yet big food and energy price gains will drain resources for discretionary spending, leaving the weakest gain in "real" terms—adjusted for inflation—for sales in five years.

Industry research outfit ShopperTrak RCT reported that sales increased 8.3% year-over-year for the day after Thanksgiving as longer hours, high-profile discounts, and aggressive marketing all did their part to get consumers into the stores. The National Retail Federation also said that consumer traffic was up 4.8% year-over-year, to 147 million shoppers—or half of all Americans—though consumers spent 3.5% less per person. Both groups left their forecasts for the holiday season unchanged, though the strong start certainly helped to diminish downside risk to the figures.

Based on combined monthly figures for November and December, Action Economics' expects gains of 4.9% for overall retail sales (vs. 5.1% for the same period in 2006), and 5.3% for retail sales excluding autos (5.2%). For another key measure of consumer spending, personal consumption expenditures, we expect growth of 5.3% (5.5%) for the two months in nominal terms, but only 2.3% (3.3%) in real terms—the lowest since 2002. The real personal consumption expenditure figure this year reflects the strength in key inflation measures over the 12 months ending this Christmas, vs. the weakness last time around.

Consumer Fundamentals

While consumer fundamentals remain generally healthy, conditions have deteriorated from the robust environment in place during previous years. Job growth from the payroll survey in the government's monthly employment report has slowed this holiday period to a 1.2% year-over-year rate, vs. 1.7% in 2006, 1.9% in 2005, and 1.6% in 2004. Job growth from the household survey has slowed more abruptly, with 2007 growth of 0.5% vs. 2.1% in 2006, 1.8% in 2005, and 1.3% in 2004. The unemployment rate data still look encouraging this year, as the current rate has risen only modestly to 4.7%, compared with the cyclical low of 4.5% in place at this time last year, but improved from rates of 5.0% in 2005 and 5.4% in 2004.

Compensation growth is continuing to post its usual cyclical acceleration, with a notable increase in the hourly compensation measure late this year that is fueling solid growth in income. This should provide support for spending through the holiday season.

Gasoline prices are continuing their steady upward climb to a succession of all-time highs. But this year we have seen a hefty increase just as the holiday season is unfolding, whereas last year at this time gasoline prices were posting a notable, though temporary, lull. The different patterns are likely behind diverging paths for consumer attitudes between the two holiday shopping seasons, adding downside risk to discretionary spending this time around.

U.S. equity markets have trended steadily higher through much of the current expansion. However, the most recent downswing in equity prices has darkened the mood of holiday shoppers compared with this time last year, when stocks posted solid gains. Although share prices are still on track to post gains in 2007, the spin for consumer confidence from equity markets in recent weeks has been negative.

Consumer confidence measures have taken a turn for the worse relative to last year, which will add downside risk to the holiday season figures. Last year, high stock prices and falling gasoline prices proved more important influences on consumer confidence than fears of a weakening economy. This year the same is likely true, though sagging stocks and high prices at the pump are likely to erode confidence.

Economists continue to look for "wealth effects" on consumer spending as declining values of assets like stocks and real estate make people feel poorer and prompt them to spend less. Indeed, aggregate U.S. housing prices are poised to show their first declines this year since the Great Depression, though declines follow sizable overshoots over the prior six years that leave substantial room for a correction without impacting the longer-term uptrend in home valuations.

As we frequently note, it is unclear that net worth measures for households have any predictive power for short-term swings in consumer spending. Nevertheless, ongoing reports of real estate price declines and continued high inventory levels indicate that consumer spending could suffer as reports of real estate market weakness add to household perceptions that conditions are worsening.

Key Storylines for the 2007 Holiday Season

The growing influence of gift cards: Gift cards have been a rapidly growing segment of holiday sales. Sales of these cards are not recorded by retailers until they are redeemed, which has had a pronounced effect of shifting sales into post-Christmas December and January, away from November and pre-Christmas December. The International Council of Shopping Centers estimates that gift cards have accounted for 10% to 15% of holiday expenditures in recent years, with as much as 30% to 40% of gift cards ($15 to $20 billion) being redeemed after Christmas.

Continued growth of online shopping: Industry researcher Retail Forward expects online retail sales to approach $42 billion in the fourth quarter of 2007, compared with $35 billion in the same period in 2006 and $27 billion in 2005. That would mark a 19% year-over-year increase.

Competitive pricing: Each year the financial media and retail analysts focus on discounting as evidence of sales shortfalls, though the promotion of larger-than-expected discounts by retailers is critical to successful marketing campaigns, making such reports difficult to use for forecasting purposes. This year has plenty of examples already, but it is unclear what we learn from reports of newly introduced "really low prices."

A long holiday season, due to the early timing of Thanksgiving this year, should allow for a stretching out of sales this year vs. most prior years. We would expect a big surge in sales over the post-Thanksgiving weekend, followed by a lull as we approach the last-minute shopping of the Dec. 22-23 weekend. Strong gift-card sales should keep the post-Christmas sales solid relative to the overall season as well.

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