Employment Slump Pressures Consumer Companies

S&P Ratings surveys the outlook for retailers, restaurants, and makers of apparel and personal-care products as unemployment rises and housing struggles

From Standard & Poor's RatingsDirect

(This is the first of two parts.)

With the U.S. unemployment rate at its highest in more than a quarter-century and likely to rise further, industries that depend on discretionary consumer spending may not rebound soon.

In October, the jobless rate jumped to 10.2%, a 26-year high. Standard & Poor's Chief Economist David Wyss predicts that unemployment will continue to climb, reaching 10.6% in mid-2010. Even with Congress' extension of jobless benefits and the pace of job losses having slowed since the recession's trough, Americans will probably value frugality until there's a verifiable and significant reduction in unemployment, which could take years to happen.

In addition, a still-unstable housing market and concerns that the economy could again falter continue to outweigh any so-called wealth effect that the recent rebound in stock markets may have created. It's no surprise, then, that Americans prefer to save than to spend: The U.S. personal savings rate reached 3.3% in September, almost double the low of 1.7% we saw in 2007, but still below its historical average.

Retailers—particularly luxury chains—have suffered most in this environment. Gaming and lodging companies have also taken a hit because they depend on discretionary spending (and, in the case of hotel operators, on business travel). Manufacturers have suffered as well. Apparel companies are generally struggling, and automakers are looking at annual sales that are more than one-third below their peak.

After a temporary boost from the government's cash-for-clunkers car rebate program, consumer spending fell 0.5% in September. Subsequently, consumer confidence dropped to 47.7 in October, from 53.4 a month earlier, suggesting that Americans are tightening purse strings as they head into the end-of-year holiday season. And while October retail sales rose 1.4%, this came as the Commerce Dept. revised September sales data to show a 2.3% decline.

Retailers And Restaurants: Quiet Cash Registers

While even some upscale retailers have enjoyed a bump as sales at U.S. chains increased for the second consecutive month in October, Standard & Poor's Ratings Services believes this is only an early sign of stabilization, rather than the start of a sustainable surge.

The main problem facing retailers is high unemployment.

"Consumers can come to terms with many things: rising gasoline prices, stock market volatility, etc.," says Standard & Poor's Senior Director Gerald A. Hirschberg. "But you can never get accustomed to being out of a job."

Adding to the overall pain in the retail sector is the fact that even wealthy consumers have curtailed spending. Luxury retailers such as Neiman Marcus (S&P credit rating: B) and Saks (SKS) (B-/Negative/—) have taken a somewhat surprising beating, given that their core customer base still has plenty of buying power. Simply put, psychological forces that counterbalance the wealth effect seem to have changed even affluent consumers' spending mentality.

Fortunately, many retailers have prepared for a prolonged slump. Heading into the holiday season, they have slashed inventories, which may help them bolster prices. It seems unlikely that shoppers will enjoy the 70% and 80% discounts they saw last year. That isn't to say that promotions, with attractive discounts, are a thing of the past, but merely that stores are prepared for what will surely be yet another very competitive season. All told, while sales may be down for the holidays, merchandise margins stand a good chance to be up from last year.

At any rate, Standard & Poor's believes that retailers can expect more traffic this holiday season than in 2008, even if consumers remain wary because they have less discretionary income.

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