Ill Winds for Consumer Spending?


By Amey Stone Hale and hearty U.S. consumers were already showing signs of fatigue last summer -- Wal-Mart's (WMT) sales growth was slowing, real estate was cooling in some of the hottest markets, and measures of consumer confidence were plunging.

All this was happening well before Hurricane Katrina smashed into Gulf shores, wreaking death and destruction, displacing a million U.S. citizens, and sending the price of gasoline above $3 a gallon at local gas stations.

Now, as data provides fresh insight into the ferocious storm's staggering economic costs, many investors are starting to worry that Hurricane Katrina and the spike in gas prices it triggered could send consumers into hibernation this fall. The impact could be troubling for the economic outlook.

"ON THEIR DEATHBED." "If things were turning down before Katrina, what's it going to be like now?" asks Nick Colas, director of research at Rochdale Securities in New York City. "I think we have to be careful about the U.S. consumer and what we expect for Christmas."

Marc Heilweil, manager of the Marathon Value Portfolio, believes consumers are "on their deathbed." According to him, "Even apart from the price of gas, Katrina may have a psychological impact on the confidence of the American public and its willingness to spend in as free a way as it has."

However, it's probably too early to turn pessimistic yet. For one thing, the latest data on consumer spending, some of which derives from activity before the storm, is quite mixed. Retail sales fell 2.1% in August, but that resulted mostly from a drop in auto sales, the Commerce Dept. reported on Sept. 15. Take out autos, and sales were up 1% last month.

ANXIETY-PRODUCING. Even more encouraging, points out Ian Shepherdson, chief U.S. economist at High Frequency Economics, in a Sept. 14 report, weekly chain-store sales measured by Redbook rebounded in the most recent week after slumping immediately following the hurricane. "There's just no way to know how this will play out through the whole month, but so far at least things seem better than we initially expected," Shepherdson wrote to clients.

Still, Sept. 15 brought news of a huge jump in first-time jobless claims -- an estimated 68,000 out of 398,000 came from Katrina victims -- as well as a continued rise in the consumer price index by 0.5% in August, mostly due to rising energy prices.

A surprising plunge in the so-called Philly Fed Index, a report on economic activity in the mid-Atlantic states conducted by the Philadelphia Federal Reserve, was particularly anxiety-producing to investors, many of whom sold their shares after the report came out.

TYPICAL PATTERN? Economists and investors will pay close attention to the release of the University of Michigan's consumer-sentiment survey on Sept. 16 to see how much Katrina is hurting spenders' psyches. Economists expect the report to show a moderate retreat, according to surveys by research firm Action Economics. Michael Englund, Action's chief economist, believes Katrina's wrath may affect sentiment but won't necessarily deter consumers' spending.

Temporary weakness would fit into a typical economic pattern whereby when a recovery gets a little long in the tooth, consumption slows temporarily before picking up again, says Dan Boone, portfolio manager of the Calvert Social Investment Equity Fund.

With unemployment running at just 4.9%, Boone says he's comfortable with his portfolio including such high-quality retailers as Costco (COST), Kohls (KSS), Bed Bath & Beyond (BBBY), and Walgreens (WAG). Stock prices tend to overreact to natural disasters, he says. But he's nonetheless keeping close track of efforts to restore refinery capacity in the Gulf.

TROUBLING SIGN. If energy prices don't fall further, Boone admits he'll feel a bit more apprehensive. Although the price of crude oil retreated from a high of $70 a barrel immediately after the storm, it jumped by $2 on Sept. 14, to $65, sending the benchmark Dow Jones industrial average down more than 50 points that day.

For the most part, stocks have rallied after the storm since many investors are hopeful the Federal Reserve, which meets on Sept. 20, will stop raising interest rates a bit earlier than anticipated to make sure economic growth stays on track (see BW Online, 9/12/05, "Death on the Gulf, Delight in the Street").

Colas, however, worries investors may feel too optimistic about Fed policy, gas prices, and the consumer's health. He views a Sept. 14 Best Buy (BBY) report, which showed decreased customer traffic in its retail stores, as a troubling sign and warns investors to cut back on their exposure to retailers.

MORE ECHOES. "It defies common sense to think the consumer can eat that much of a bounce in gasoline prices and not cut spending in other areas," Colas says. "You have to sit down and be realistic."

Of course, it's still a bit early to assess the storm's full impact on consumers. Sales data may have looked stable mainly because affected families had to replace lost clothing and furniture -- not because the typical U.S. consumer is eager to keep spending in the months to come. But if consumers pull back sharply, the Katrina effect will reverberate throughout the economy.

Stone is a senior writer for BusinessWeek Online in New York


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