Higher Taxes Mute Wealth Effect for Wealthy: EcoPulseAnna-Louise Jackson and Anthony Feld
High-income Americans are demonstrating some frugality as the positive wealth effect from a rallying stock market is being offset by tax increases.
The Standard & Poor’s 500 Index is up about 19 percent since Nov. 15, as the benchmark group rose for seven consecutive months through May, the longest streak since 2009. In the past, stock-market gains have led to accelerated sales at retailers, including Saks Inc. and Nordstrom Inc., catering to shoppers earning more than $100,000, said Liz Dunn, an analyst for Macquarie Group in New York.
That relationship is less evident now, with these companies describing a weakening sales environment as customers grapple with higher taxes, according to Dunn.
“For the most part, we’ve been in static tax environment for a few years and now that’s changing,” she said. “That’s the factor that has really changed for luxury retailers.”
Seattle-based Nordstrom reported earnings and revenue on May 16 that missed analysts’ consensus estimates for the period ended May 4 and lowered its full-year sales forecast.
Tiffany & Co. experienced “somewhat softer” than anticipated sales in the Americas during the three months ended April 30, Mark Aaron, vice president of investor relations, said on a May 28 conference call. While profit of 70 cents a share -- excluding expenses related to cost-saving initiatives -- beat the 53-cent average of analyst estimates compiled by Bloomberg, the New York-based jeweler didn’t raise its outlook for full-year results.
Investors have taken note. Shares of Nordstrom, Tiffany, Coach Inc., Ralph Lauren Corp. and Michael Kors Holdings Ltd. have lagged behind the S&P 500 by an average of 1.2 percentage points as of 11:02 a.m. in New York today since a market rally began Nov. 15, data compiled by Bloomberg show. That’s a departure from early in the recovery from the recession that ended June 2009, when several of these companies were leading the market, said Dunn, who maintains a neutral recommendation on Nordstrom, Saks and Tiffany.
Some categories of consumer spending now are holding up better than luxury retail, said Dan Popowics, a portfolio manager in Cincinnati for Fifth Third Asset Management, which oversees $6.6 billion. Comparable-store sales for TJX Cos.’s HomeGoods business rose 7 percent in the fiscal quarter ended May 4, reflecting consumption that’s “more of a need than a want,” he said. Sales at Saks stores open at least a year climbed 5.9 percent, the New York-based company said in a May 21 statement.
Wealthy Americans face obligations on top of the payroll-tax increase that hit all wage earners this year after Congress and President Barack Obama let the tax that funds Social Security benefits revert to 6.2 percent from 4.2 percent.
Also starting this year are a new 0.9 percent surtax on wages and 3.8 percent added tax on investment income for individuals making more than $200,000 and couples making more than $250,000. Additionally, Congress set the top income-tax rate at 39.6 percent for taxable income above $400,000 for individuals and $450,000 for couples, compared with 35 percent last year.
Tax rates about eight to 10 points higher are affecting the behavior of core Saks’ consumers, Chief Executive Officer Steve Sadove said on a May 21 conference call. Even with the Dow Jones Industrial Average trading above 15,200 last month -- “a remarkable improvement” from several years ago -- the industry isn’t “as robust as you might expect to see at that kind of a Dow.”
While some customers’ concerns may have “alleviated a little bit” during the fiscal quarter ended May 4, Saks helped drive sales by increasing the discount for a friends and family promotional event, Sadove said. Revenue rose about 5 percent in the period to $793.2 million, exceeding analysts’ estimates that averaged $778.1 million, the company reported May 21.
Demand for luxury goods was “pulled ahead” earlier in the economic expansion, helping to lift earnings for these retailers before many of their peers, said John Canally, investment strategist at Boston-based LPL Financial Corp., which has $373 billion in advisory and brokerage assets. Luxury spending recovered faster and stronger than other categories coming out of the 18-month slump, though these customers have become more cautious, he said.
“These folks sated their appetite post-recession, and now it’s hitting a wall” as taxes take a bite out of discretionary income, Canally said.
In addition to this year’s tax changes, Obama’s 2014 budget plan would cap deductions for top earners, increase the estate tax and require those earning more than $1 million a year to pay a minimum tax rate.
Such prospects serve as a “big deterrent” to many wealthy Americans, particularly for spending on luxury goods, said Walter “Bucky” Hellwig, who helps manage $17 billion at BB&T Asset Management in Birmingham, Alabama. “Everything is on the table” because these consumers “remain at the forefront for policy decisions about raising taxes.” There’s “obviously something on the mind of high-end spenders that’s holding them back.”
This hesitation is reflected by the Bloomberg Consumer Comfort Index, which was at 8 in the week ended June 2 for people earning more than $100,000, down from 19.7 in the week ended April 28. Sentiment for this high-income group averaged 7.4 during the past 29 weeks, after reaching a post-recession peak of 21 in September 2010.
These consumers are adopting a “much more frugal and conservative approach” as some of their trust in the government and markets is weakening, said Lance Roberts, who oversees $500 million as chief executive officer of Streettalk Advisors LLC in Houston.
Even amid a bull-market rally, his individual investor clients have been “really bugged” by higher taxes, potential costs related to the Affordable Care Act and the Federal Reserve’s intervention, he said.
There’s a lingering question about the efficacy of the Fed’s quantitative-easing programs on the economy and consumption in particular, Hellwig said. Amid debate about when and how the central bank should reduce the pace of stimulus, “talk of tapering is creating some caution on the part of investors and those who have benefited from this stock rally.” The Fed currently is buying $85 billion of assets a month.
There are some encouraging signs from luxury retailers. Nordstrom saw improvement in April after its fiscal first quarter started with “softer sales trends,” Chief Financial Officer Michael Koppel said on a May 16 conference call. Michael Kors reported that comparable-store sales increased 35 percent in North America for the three months ended March 30, the 28th consecutive quarter of growth, Chief Executive Officer John Idol said on a May 29 conference call.
The Hong Kong-based company sees “continued momentum” and nothing “that’s indicating any differentiation with how the customer’s responding to the business,” Idol said.
Even so, the lack of significant improvement in confidence for wealthy consumers since November has been “pretty stark,” Hellwig said.
“Whenever there’s uncertainty, whether it’s related to spending or investing, the typical response by consumers is to postpone the decision.”