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August 09, 2007

More Signs of Slowing Growth
by Chad Hudson

Most retailers will report July same store sales on Thursday. The results along with their comments will shed light on the health of the consumer. Weekly same store sales have maintained better than 3% year-over-year growth over the past four weeks, according to the ICSC. This was the best four-week average since April. It shouldn't be too surprising that the ICSC forecasts that July same store sales increased 3.0%. However, the weekly same store sales do not always predict the monthly increase. In February, the weekly sales averaged about 3.5%, but the monthly increase was reported was only 2.6%. Momentum has clearly waned as same store sales have been below 3% for the past three months (April's results were negatively impacted by the Easter shift). Moreover, June's 2.4% gain was on top of a weak 2.4% gain last June. Same store sales in July 2006 were 3.6% making for a more difficult comparison. Retailers generally need about 3% same store sales growth to leverage the store's expenses. If sales grow less than 3%, margins usually come under pressure.

A few retailers reported July sales on Wednesday. Hot Topic reported that it's July same store sales were down 7.4%. American Eagle Outfitters reported its same store sales were off 6%, analysts expected sales to increase 2.6%. The company said that sales were impacted from a "later back-to-school starts across the country" along with Florida and Texas moving the tax-free events to August from July. While same store sales were lower for the last month of the quarter, total sales for the quarter exceeded analysts' forecasts.

Polo Ralph Lauren reported that it earned $0.83 per share during its fiscal first quarter. While this was 9% better than last year, it was two pennies lower than analysts anticipated. Additionally, the company reduced its guidance for the full year for the second time and the midpoint of guidance moved to $3.69 from $3.75. Sales rose 12% to $1.07, but missed the $1.1 billion that analysts expected. Woman's wear-to-work clothing were "softer" and home goods were "weakest." The company did say that sales for the current quarter have been "solid." This is one of the first indications that the higher-end consumer maybe starting to slow spending.

Toll Brothers, the largest luxury-home builder, announced that third quarter revenue dropped 21%. Net new orders dropped 31% and its backlog fell 34%. Cancellations rate increased to 24% from 19% last quarter. The average price of a house under contract dropped 4.7% to $657,700. While the company believes there is pent-up demand, it admitted that the recent "uncertainties rolling the mortgage market right now the pace of home sales could slow further until the credit market settle down and sort themselves out." There have been reports that the stress in the mortgage market has started to spread past subprime and into Alt-A. Toll Brothers said that only 1% of its buyers were considered subprime, but during the Q&A the company disclosed that 43.4% of the mortgages it originated were Alt-A.

Last Friday, the Labor Department reported that 92,000 non-farm jobs were added in July, which was lower than the 127,000 economists expected. Over the past several months, the revisions to the previous month offset the "surprise" on both the upside and downside. This was not the case this time as the Labor department revised down May's and June's gains by 8,000. Existing trends continued in July as there were declines in the number of goods-producing, construction and manufacturing jobs and gains in the service sector. The number of government jobs declined by 28,000, the first drop since January 2006. Retail employment fell by 1,000. This was the third drop in the past four months. Temporary employment, which is often viewed as a forward indicator dropped another 7,000. This was the sixth consecutive dropped in temporary employment. Looking back when employment fell starting in 2000, temporary employment first dropped in May 2000 and was weak throughout the rest of the year, averaging a loss of 11,000 jobs per month. At this time, the headline number averaged 102,000. Starting in March 2001, the economy lost jobs every month for the next fifteen months. Additionally, the median number of weeks workers were unemployed increased to 8.9 weeks. This is the longest since February 2006.

To nobody's surprise, the Federal Reserve kept its target rate at 5.25% at its meeting this week. The Fed did surprise most economists by not signaling that an ease is in the near future. The statement from the Fed acknowledged the turmoil in the markets by commenting that "financial markets have been volatile in recent weeks, credit conditions have become tighter for some households and businesses, and the housing correction is ongoing." By combining the tighter credit conditions with the housing market, it appears the Fed anticipates that the housing market will be impacted by the credit crunch. This also downplays the Fed growth assessment, which is "to expand at a moderate pace." Given that the Fed said there was some risk to its growth assessment, it included supporting evidence of "solid growth in unemployment and incomes and a robust global economy" on why economic growth should continue. The Fed also maintained its stance that inflation is the "predominant policy concern." And this was lessened a bit by preceding it with, "Although the downside risks to growth have increased somewhat." Bloomberg recently introduced a function that analyzes and the Fed Funds options and futures price to assign probabilities of different outcomes at future FOMC meetings. , The market is now pricing in about an 82% chance that the Fed maintains rates at the next meeting, up from about 72% the day prior to the meeting. Additionally, its now a 69% chance that there will be no change at the October meeting as well. It is not until the December meeting that the likelihood that the Fed changes rate is over 50%. It's only at 48% chance that rates remain at 5.25%, but there is a 6% chance that rates move up to 5.5%.

The job market will be the key focus for handicapping what the Fed will do over the rest of the year. While employment has held up, there are signs that the underpinnings are weakening. At the same time, inflation concerns have not receded much and wage inflation is starting to look worrisome. This week, productivity was weaker than expected and unit labor costs were up 2.1%, higher than the 1.8% expected. Additionally, first quarter unit labor costs were revised to 3.0% from 1.8%. We have said before that economic growth loses steam; it is likely to decelerate quickly. There is a good chance that the turmoil in the credit markets will be the event that causes consumers to reign in their spending. Not by their choice, but because the line of credit has been severed.

Chad Hudson
Mid-Week Analysis
PrudentBear.com

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