The U.S. economy has historically been able to mitigate the impact of downturns in domestic consumer spending through robust trade with foreign nations. However, given the multiple challenges currently facing the U.S. economy and the U.S. consumer, coupled with the fact that consumer spending currently represents approximately 70% of the $14 trillion domestic economy; it now seems apparent that foreign economic growth will not be enough to prevent a recession in the U.S. None of this is particularly surprising, but what is surprising is the far-reaching impact that a prolonged recession in the consumer and service sectors can have on seemingly unrelated industries.
By now most everyone is aware of the global impact the downturn in the U.S. housing market, exacerbated by the fallout in subprime lending, is having on financial institutions. But perhaps of greater concern is the impact this is having on consumer spending.
At the height of the recent real estate market, U.S. consumers were using their homes to finance nearly $800 billion per year via home equity lines of credit, refinancing, and related activity. According to a study by an economist at the Bank of Tokyo-Mitsubishi, in the fall of 2006, total unused credit arising from home equity lines of credit, credit cards, and bank loans was growing at a 15% annual rate. Now this unused credit is currently declining at an 8% annual rate due mainly to:
According to the Federal Reserve, growth in the use of credit cards, between the first quarter of 2006 and the fourth quarter of 2007, increased from 2.6% to 7.4%, annualized. This is further supported by Wal-Mart's recent report that January gift card redemptions were lower than expected and that consumers were not only holding onto these cards for longer, but they demonstrated an increasing trend towards redeeming them for necessity versus discretionary items.
But with China and India leading economic growth amongst industrialized nations, Latin America and Australia right behind them, and the Middle East and Russia selling energy at record prices, one would think that American companies would be able to capitalize on this growth. Indeed, a recent report from the Commerce Department indicated that, in December 2007, factory orders for "big-ticket" items jumped an impressive 5.2%.
But, as we just considered, American consumers are tightening their belts just as lenders are tightening their credit standards. Consumers have exhausted much of their available credit and are finding access to additional credit restricted. Between the end of 2005 and the end of 2007, delinquent credit card debt jumped from 3.5% to 4.3%. The result? Retailers appealing to all socio-economic demographics are experiencing significant sales declines. Many retailers recently reported comparable store declines of 5-10% for the month of January 2008 versus 2007.
The retail ripple effect occurs when we look outside of our economy to see the impact that a significant decline in the retail sector has on all sectors of the global economy. If U.S. consumers decrease purchasing, this lowers the demand for foreign goods on a global scale, which can, in turn, lessen demand for American goods in multiple industries.
With regard to many business sectors, ranging from aerospace to heavy industrial equipment, American goods are still viewed as superior to comparable goods from foreign countries. However, just as with U.S. capital expenditures, capital equipment is typically purchased in conjunction with business growth.
The result of the retail ripple effect? As U.S. consumers decrease purchasing, less goods are imported, which means less foreign goods have to be produced. As foreign manufacturers lower their sales forecasts, they will likely cancel or scale-back any planned capital projects or new equipment and technology purchases in an effort to cut costs and drive profitability through efficiencies.
Watch for collateral asset values to decrease in many business sectors this year. The most obvious areas of concern would be any company dealing with the consumer housing industry. From construction equipment to retail home furnishings, 2008 will likely be a challenging year from the demand-side.
Textiles and apparel, including clothing, linens, and upholstery, will also likely encounter difficulties in driving consumer sales for most of 2008, thus potentially impacting collateral asset values for inventory or manufacturing equipment for these industries.
Additional industries to monitor closely in 2008 include discretionary and luxury consumer goods. As previously mentioned, revised lending standards and declining home values in many regions of the country are creating woes for a broader swath of the American socio-economic scale as compared with other recent economic recessions. This will have the likely effect of negatively impacting previously "recession-resistant" businesses such as high-end jewelry and consumer electronics.
Any way you look at it, 2008 is shaping up to be a challenging year economically, and increased monitoring and diligence is warranted when dealing with any business. Because as the retail ripple effect demonstrates, the potential impact of economic events is often far reaching and less than obvious.