The Consumer and the Stock Market Storm

Will consumers stand fast or batten down the hatches? The health of the U.S. economy hangs in the balance

Only two months ago, the idea of crude oil falling below $100 a barrel and sharp drop in agricultural commodity prices would have seemed like a godsend to cash-strapped consumers. Gasoline and food prices have been slow to adjust to falling commodity prices, but that's probably not what is uppermost in consumers' minds right now. They may be more worried about their access to credit—and the health of the bank they stash their savings in—as the U.S. financial crisis has escalated in recent weeks.

With the defeat of the $700 billion financial rescue plan in the House of Representatives on Sept. 29, the fear now is that the longer the credit markets are forced to fester without a solution, the longer and deeper the economic recession the U.S. is likely soon to face. Congress is working on a revised version of the rescue bill, which is expected to pass within a week. But in a market environment where legendary institutions like Lehman Brothers disappear overnight, any financial-system rescue plan risks the patient expiring while waiting to be admitted to the emergency room.

Given the chill that has coursed through the credit system (, 9/29/08), with banks denying requests for mortgage, home improvement, small business, and car loans left and right, it's not inconceivable that credit cards could be next. That would leave consumers with no source of cash except for their weekly paychecks, which in many cases are already pre-spent. Still unknown is to what extent the stability of credit cards may be affected by a handful of big commercial banks going under, but certainly banks are becoming less willing to let consumers run up bigger balances on their cards, says David Lockwood, consumer insights director at London-based Mintel International Groupin Chicago.

High and Dry

"That could be the next little thing that impacts individual consumers," says Lockwood. "I don't have a sense of how quickly that could happen. It seems it could happen fairly soon." That, plus the more remote possibility of payroll checks stopping if companies that rely on short-term credit from banks to meet payroll requirements start getting turned down, would leave consumers high and dry.

Lockwood doesn't believe most consumers are even aware of the broader implications of the credit freeze or the reasons behind the legislative battle over a rescue plan, however. "They'll respond [to the failure of the rescue bill] like they do to all major financial and policy initiatives, which is with long glazed stares," he says. Consumers have no connection to what's going on except for how it might affect the security of their bank accounts, he adds.

That's not what Richard Curtin, director of Consumer Confidence Surveys at the University of Michigan's Survey Research Center, is seeing in recent respondent data, which interviewers collect throughout the month. According to Curtin, 150, or 10%, of the survey's 1,500 respondents over the past three months, have reported having trouble getting a loan.

Slump in Confidence

"In the last week, we found confidence in the economy and how [consumers] expected the economy to behave have declined significantly," he says. "There's some evidence consumers have paid attention to this and are concerned about this." Just how worried consumers are will be reflected in the October numbers that the University of Michigan releases next week.

T.J. Marta, economic and fixed income strategist for RBC Capital Markets (RY) in New York, worries that a negative feedback loop might be forming, where short-term funding problems at Wall Street firms start to spread to companies and municipalities, prompting them to cut their workforce, which would then compound the pressure on consumers whose stores of personal wealth and access to credit have already eroded. "Consumers begin to retrench. That feeds back into corporations investing less and even cutting back on employees, and then you've got yourself in the loop," he says. "It's like a forest fire, It has to burn itself out. It's very hard to short-circuit these things. My fear with this bailout is it could psychologically unhinge the credit markets that are already very fragile."

While some sentiment indicators show signs of consumer confidence bottoming, that doesn't necessarily promise a rebound to healthy levels anytime soon, says Marta. "We could stay at the bottom for quite a while depending on what goes on with the financial situation," he says.

Unlike the Michigan survey, the RBC Consumer Attitudes and Spending by Household (CASH) Index is based on surveys done over a three-day period once a month. The latest surveys were conducted during the weekend the Treasury stepped in to nationalize mortgage giants Fannie Mae (FNM) and Freddie Mac (FRE), before Lehman Brothers filed for bankruptcy and American International Group (AIG) was saved by an $85 billion federal bailout — the events that triggered new alarms in the financial crisis. That suggests the October confidence reading could revert back to the all-time low hit in July or even worse.

Dropping the Shopping

Battered confidence may already be evident in one of the more important consumer-facing sectors: retailing. This year's back-to-school season was especially weak, with August sales at stores open at least one year up 1.7% from last year but unchanged from a year ago when Wal-Mart Stores' (WMT) strong results were excluded, the International Council of Shopping Centers said in a Sept. 4 release. The National Retail Federation reported a 1.1% increase in August sales but a 0.4% decline when including non-general merchandise categories such as autos, gas stations, and restaurants.

Sales have fallen off sharply over the past couple of weeks, as consumers have had to grapple with a torrent of financial developments, says Lizabeth Dunn, a retail analyst at Thomas Weisel Partners (TWPG) in New York. "They figured out their money market funds aren't as safe as they thought, and now they have to be worry about which banks they have their money in," she says. "It's very unsettling." Continuing evaporation of home equity and further weakening on the jobs front are also causing turmoil for the average household, she adds.

The latest pullback in spending is "squarely tied to what's going on in the financial market," she says. Still, she doesn't think the recent drop-off in spending will turn into a new trend. Men's and children's segments have held up better than the women's segment, which has been harder hit because women's purchases tend to be more discretionary, while buying for kids and men is based more on necessity, she says. "You're seeing people on a broad scale delaying purchases. You delay home improvements and car purchases," she says. "If your normal replenishment cycle is every year, now maybe its every two years."

Stressed-Out Consumers

While Lockwood at Mintel doubts that consumer purchasing habits have changed with the escalation of events in the financial arena, he does believe that consumers are already as stressed as they can be. Still, the focus for most people is changes in prices and what happens in the financial markets "has no meaning for people until it gets down to the wallet level, and that's not likely to happen anytime soon," he says.

Even where people may still be shopping, they are falling increasingly behind in paying their bills. High-end department store chain Nordstrom's (JWN) latest data on its securitized credit-card receivables for August showed total delinquencies climbed 0.71% from a year ago, to 2.83% of total receivables, and were up 0.28% from July, according to a Sept. 15 research note by Credit Suisse (CS). Those were the largest upticks, on both a monthly and year-on-year basis since the data became publicly available in May 2007. Nordstrom is one of the few retailers that still owns the receivables of its credit-card business, which contributed 2% to the company's total earnings before taxes last year, analyst Michael Exstein said in the note.

Retailers' earnings in August implied a decline in the two-year trend for comparable sales, says Dunn at Thomas Weisel, who also says she's hearing that business has worsened in the last two weeks. So far, only one of the companies she covers — Cache (CACH)— has actually cut its profit outlook, but she cautions that not much should be read into that since Cache is a relatively small company.

Smaller retailers, such as Lululemon Athletica (LULU) and Urban Outfitters (URBN) continue to attract new customers and perform well. But as for bigger, more established retail names, "there aren't really any I see that are bucking the trend," she says.

You can bet that if consumers lose sleep in the next few weeks amid new developments in the bailout drama and financial crisis, the outfits that depend on their business will not be getting much rest either.

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