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By Amey Stone What makes us go out and spend money? Or more to the point these days, what makes us stay at home, afraid to spend money? With signs that consumer spending, which makes up two-thirds of the economy, is on the wane, these are important questions for investors. If people buy less, companies can't sell as much as planned, their earnings suffer, and they start laying off workers. Then folks really clamp down on spending.
Fortunately, most economists believe, we're not yet in that kind of downward spiral. Consumer spending is sensitive, all right -- which partly explains the disastrous fourth-quarter earnings some companies are posting even while the economy seems relatively sound. But the good news is that consumer confidence also still appears to be fairly resilient. By spring, barring a real calamity, people could be opening up their wallets again. That bodes well for the economy and the stock market in the second half of the year.
SMALL THINGS. Each individual purchase is made up of many smaller decisions, points out Christie Nordhielm, a marketing professor at Northwestern's Kellogg Graduate School of Management. Whether you actually need or want an item is just the first decision. Can you afford it? Actually, that may not even enter into the equation. What matters are small things like whether it's snowing on the Saturday you planned to go to the mall, whether the store has what you want, or even whether a salesperson provides the service you're looking for.
Consumers may buy -- or bolt -- at any point along the way. But the psychology of buying becomes even more tricky when they receive a whittled-down 401(k) statement in the mail, hear a news report that contributes to an unsettled feeling about future job security, or simply balk at spending $25 to fill up the gas tank. All these factors and more have probably stopped consumers in their tracks in the past few months, Nordhielm says.
Economists generally agree that what has had the greatest impact on consumer spending of late are higher energy prices, which have eaten into discretionary-purchase dollars, and lower stock prices, which fuel unease about the ability to fund large expenses. Americans have been outspending their income for years now, but higher debt levels in a slowing economy may finally be having an effect on the profligate (for more on consumer behavior, see "The Insatiable American").
NOT SO CONFIDENT. Signs are that consumers are really just starting to worry -- and that's worrisome in itself, especially for corporate earnings, which track consumer confidence. The consumer-confidence index, compiled by the research firm Conference Board, fell for the third straight month in December. The most negative indicator out so far is retail spending, which seriously slumped over the holidays.
Retailers report a 5.3% holiday gain, but that number is deceptive since it doesn't take into account the massive pre-Christmas discounting that occurred, says Thomas Friedman, publisher of Retail Systems Alert Research Report. Earnings warnings at Ann Taylor, Home Depot, and TJX Cos., parent of T.J. Maxx and Marshall's, are just the beginning (most retail fourth-quarter earnings come in early February). "Retailers are going into a cost-containment mode," Friedman says.
Weak PC sales and a downturn in auto sales also have led to poor earnings announcements or warnings from major companies such as Apple, Dell, General Motors, and Ford. These industries were gearing up for demand that failed to materialize. And because the economic slowdown happened so suddenly, they had less time to throttle back on fourth-quarter spending. Companies are likely to continue to blame poor fourth-quarter results on slower consumer spending. Result: The psychology of spending just feeds on itself.
REVERSIBLE NEGATIVISM. But investors may be right to shake off the bad news, as the recent uptick in the Nasdaq shows most clearly. Because consumer sentiment is somewhat ephemeral, the current negativism is reversible. "It is important to realize that the strain is most intense on the consumer right now," says Milton Ezrati, senior economist and strategist for Lord, Abbett & Co. Why? Higher winter heating bills and last year's stock market decline are hitting people hardest at this very moment, especially after they've bought all those holiday presents. Auto manufacturers are already bracing for drops in car sales, and that could affect related industries.
But after consumers mentally adjust to the weaker stock market and higher energy bills, they'll be ready in a few months to go ahead with spending plans, such as buying a new car or doing spring home-improvement projects, some consumer behavior experts believe. Internet-strategy consultant Peter Cohan likens this psychological adjustment to experiencing stages of grief. "My sense is that people are feeling almost as if something they really loved has died, which was this fantastic economy and the tremendous enthusiasm about the future," he says. Once they let go and see past the current downturn, they'll adapt, he argues.
Indeed, economists point to several positives for consumer-spending trends that are just around the corner. Notably, lower interest rates will reduce borrowing costs. Many homeowners should be able to refinance, putting more dollars in their pockets each month. Consumers should also be comforted going forward by stable energy prices and a steadier stock market, Ezrati believes. Having a new Administration in place in Washington should ease uncertainty as well. After all, the election-that-wouldn't-end is finally over. And consumers could soon be getting tax relief in the form of a massive cut, which would have an impact on spending, says economist Henry Kaufman.
"SHORT AND SHALLOW"? But to paraphrase Mama Cass, the darkest hour is just before the dawn. Make no mistake. The first and second quarter will bring more economic bad tidings. Morgan Stanley Dean Witter, among the most negative Wall Street firms, predicts the U.S. will slip into a "short and shallow" recession in the first half of this year.
That will result in more layoff announcements at companies, further eroding consumer confidence. But Lynn Franco, director of consumer research at The Conference Board, notes that consumers are much less troubled now by layoffs, which they've gotten used to even in a strong economy, than they were in the early 1990s. Likewise, she thinks they're less bothered by stock market declines than they were in the late 1980s. Most Americans now recognize that markets go up, and markets go down. "Consumers tend to adapt rather quickly nowadays," she says.
Far savvier about their finances, consumers may be better about avoiding financial collapse than their debt levels would indicate. The Consumer Credit Counseling Service, which offers counseling on money management, has already noted an influx of clients this year -- not the usual crop looking for ways to manage holiday purchases, but people trying to reign in debt levels.
BACK TO BASICS. Businesses should also be able to react more quickly to slowing consumer spending. Friedman says retailers are already stocking their shelves with more basics and fewer discretionary items. He thinks new technology will allow them to make smarter decisions about merchandising and managing inventory. Consumer spending is expected to be tight for six more months, which will be hard on retailers, but once shoppers pay down some debt and see some stock market value return, they'll be in the stores again, he predicts.
To be sure, there are still risks to consumer-spending health. Any kind of outside shock, such as war in the Middle East, could lead to a clampdown on spending. The electricity crisis in California also poses a risk, says Robert Smith, president of Smith Affiliated Capital (See BW Online, 02/22/01, "California's Power Crisis: Beware of Widening Shocks"). Then there's the "negative wealth effect": sharp losses in stock portfolios that some economists fear could be more lasting than expected. More than half of all U.S. households own equities. "The magnitude of the influence of the stock market on consumers is very difficult to quantify," Kaufman warns.
But in the end what really matters to consumer spending is whether people feel secure in their jobs, says Kellogg's Nordhielm. And right now they remain confident -- if slightly more worried than they were before the downturn. Corporate earnings will continue to take hits for the next quarter or two. But investors can take heart: Consumers will have more reasons to head back to the malls as the year progresses. Stone is an associate editor of Business Week Online and covers the markets in our daily Street Wise column.
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