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Retailers Gain Momentum

This week, the Commerce Department reported that retail sales declined in October, due to weakness in auto sales. Since weak auto sales were already a foregone conclusion, the focus was on the 0.9% increase in retail sales excluding autos. This was significantly better than the 0.3% economists were expecting. On a year-over-year basis, retail sales excluding autos increased 9.5%. Motor vehicles and parts sales dropped 8.7% compared to last October and was the worst performing sector for the second consecutive month. Retail sales of building materials increased 2.1% from September and were 14.1% higher than last year, helped by the rebuilding efforts following the hurricanes. Clothing sales rebounded from a weak September, up 3.1% month-over-month, and were up 7.3% from last October.

Weather has played a large factor in retail sales during the fall season. Most of the country has had above normal temperatures, which have hindered sales of seasonal merchandise. Michael Niemira, economists for the International Council of Shopping Centers, commented that "even with retailers' Veteran's Day sales, retail sales seemed to sway with the warm breezes and overall demand for seasonal goods suffered this past week." This week, it finally appears fall weather has come to most of the nation. This should be welcomed by retailers heading into one of the most important weekends of the year.

Last week, Wal-Mart reported that its third-quarter earnings increased 3.8%, which was the slowest pace in four years. Sales did much better, rising 10%. Same store sales increased 3.8% and management sees November sales increasing by 3% to 5%. Wal-Mart said that its freight costs increased 15% from the previous quarter. Last month during its analysts meeting, Wal-Mart said to combat lackluster holiday sales last year, it would launch "the earliest and most aggressive campaign in our history." The "Home for the Holidays" promotion was kicked off on November 1.

The increase in promotional activity from Wal-Mart is mostly due to Target taking market share. During the third quarter, Target maintained it dominance over Wal-Mart. Target reported that earnings per share increased 36% compared to last year and exceeded Wall Street's forecasts as well. Total sales increased 11.9% driven by a 5.9% increase in same store sales. Gross margins increased by 121 basis points to 32.3%, driven mostly by higher initial markups. Considering Wal-Mart announced it was going to be aggressive starting November 1, several analysts asked Target's management if the retail environment was getting more competitive. Target maintained that it saw nothing different this year compared to last year. Then just four days later, Target said that sales will be lower than its 4%-6% plan based on the first two weeks of November.

Not only has residential construction been strong, the remodeling industry has also been very strong. Harvard's Joint Center for Housing Studies reported that spending on remodeling increased 4.4% during the third quarter. This has obviously benefited the home improvement centers. Lowe's reported that third-quarter earnings jumped 26%, with revenues that increased 17%. Lowe's forecasts that fourth-quarter sales will increase by 22% with same store sales contributing 4% to 6%. Same store sales in the third quarter increased 6.2%. Average ticket rose 8.0%. Home Depot reported third-quarter earnings increased 17%, driven by strong sales of appliances and kitchen installations. Same store sales increased 3.6%, and were driven entirely by higher average ticket, up 6.1%, as traffic declined. Much of the decline in traffic has been due to the cannibalization of existing stores as Home Depot continues to expand its store base.

Last month, GM vowed that it would change to a value pricing model and start to wean consumers off high rebates. After suffering back-to-back months of declines greater than 20%, rebates are back. The discounts will result in a sales price similar to what the employee pricing incentives offered. Ford followed suit on Wednesday announcing its incentive plan until January 3 and Chrysler is "working on the details" and should announce its promotion on Thursday. There has been much more discussions regarding GM filing bankruptcy. The price to insure against GM defaulting on its bonds over the next five years has increased by 50% over the past month. Credit defaults spreads have also widened for Ford. Equity investors have also lost confidence in General Motors. On, Thursday, GM's stock price sunk to the lowest level since November 1987.

Inflation pressures continue to build in the economy. On Tuesday, the Bureau of Labor Statistics reported that producer prices rose 0.7% from September and increased 5.9% from last year. While this was slightly less than the increase in September, it was still a larger increase than any month since November 1990. Producer prices of consumer goods increased 1.0% in the month and have jumped 7.4% over the past year.

Similar to producer prices, the increase in consumer prices eased a bit in September, but rose faster than any other month since July 1991. Prices for consumer goods rose 4.3% from last year. Energy prices were the primary driver, but other areas are starting to see increased prices. Rents increased by 0.4% from September, which was the largest month-over-month increase since August 2001. Inflation pressures will continue to build and will trickle into consumer inflation. During its conference call, Target was asked about its ability to pass along price increases manufacturers have instituted. Its response indicates that consumers are accepting higher prices.

"It really varies but on average they have been passed through and the consumer has been responsive to them. In some cases, it's taken a little while because the magnitude of the price increases is bigger than we what we would have hoped to have seen, so if it's a big price increase in the range of 10 or 12%, it might take the consumer a little longer to respond to it vs. something that is in the 3 to 5% range but over time the market does settle up and the guest does get comfortable with those new prices."

There will not be a commentary next week. We wish everyone a safe and happy Thanksgiving.

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