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Consumer Spending Slows, Corporate Earnings Fall

Last week, retailers reported October sales that were weaker than expected, and expectations were tepid. The ICSC reported that October sales increased 1.6%, the same increase as September and weakest October since 1995. Weakness was most apparent in woman's apparel, Chico's and Talbot's posted 10.6% and 7.9% declines, respectively. Gap reported that same store sales were off 8% in October, but somehow margins improved. Due to improved margins, Gap said it expects to earn between 28 cents to 30 cents per share. Analysts were only expecting 22 cents. There has not been much of a rebound so far in November. The ICSC reported that same store sales increased 2.4% and 2.7% during the first two weeks of November. Not only was this weaker than the 3% hurdle most retailers need to get SG&A leverage, but was on top of weak year ago comparables. Falling consumer confidence does not bode well for consumer spending. The University of Michigan survey of consumer confidence dropped 5.9 points to 75.0 in November. It was the second lowest level in the past fifteen years. Only the post-Hurricane Katrina reading was lower.

Investors breathed a sigh of relief after Wal-Mart exceeded earnings estimates early this week. While Wal-Mart's results were better than expected, it was not an indication that the consumer is healthy. Over the past few quarters, Wal-Mart experienced declining margins which they were able to reverse in the third quarter. But top-line results were quite weak. Same store sales increased only 1.5% company wide and up only 1% at the Wal-Mart division, which was due to higher average ticket. The retailer said that traffic decreased during the third quarter. Furthermore, general merchandise sales must have been weak. The company said that food same store sales were 5.3% at its Supercenters. Most of this was due to inflation. While Wal-Mart said it experienced food inflation that was 100 basis points lower than what the grocery industry is reporting, the CPI food index is up 4.5% over the past year. Wal-Mart also achieved its goal of growing inventory at half the pace of sales. This has been a trend in retailing lately. Inventory levels have been managed much better than in previous downturns. Retailers are hoping this means better margins during the holiday season. This also sheds light on why the trucking firms have reported weak volumes.

Third quarter earnings for the S&P 500 will post the first down quarter since the fourth quarter of 2001. Less than 10% of the companies are left to report. Earning are 2% lower than a year ago and using estimates for the remaining company are expected to finish the quarter down 3.3%. At the sector level, earnings growth is very bifurcated. Besides utilities, all groups were up or down by at least 12%. Further more expected earnings growth as been shocked back into reality. Fourth quarter earning are now expected to increase only 4.7%. Just a week ago that was 8.4%, and 10.9% a month ago. While estimates for the fourth quarter have receded, growth is expected to jump back to double-digits next year. Estimates for the first half of the year have dropped by about 200 basis points over the past month, but have increased by 200 basis points for the full year. Most of that is due to the "easy comps" for the second half of the year. Companies are hoping that the current economic and credit environment is temporary and will soon pass. That appears to be a very optimistic scenario.

Due to the Thanksgiving holiday next week, the next Mid-week Analysis will be November 29.


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