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Retail Sales Are Warning Shot Across Economy's Bow


Sustainable rebound in consumer spending may not be forthcoming.

In Solving The Consumer Demand Dilemma, I predicted imminent disappointments in consumer spending data.

Today, the Commerce Department reported that total retail sales declined -0.1% in July, a very significant disappointment, considering that economists had been predicting an increase of 0.8%. Readers should also note that the decline in July comes on the heels of a revised gain in June of 0.8%.

Sales excluding autos and auto parts also registered an unexpected decline of -0.6%, compared to a revised 0.5% increase in the measure in June. Economists had forecast a gain of 0.1% in July sales, excluding auto purchases.

Core retails sales (excludes autos, gas and food), fell -0.4%. Excluding a +2.4% uptick in automobile sales (also a disappointment) related to the "cash for clunkers program" and a 0.6% gain in clothing purchases, most other retail categories suffered sales declines. Building materials sales fell -2.1%, electronics purchases fell -1.4%, department store sales slumped -1.6% and sales at general merchandise stores declined -0.8%. Furniture sales fell -0.9% and sales at food and beverage sellers declined -0.3%.

These worrisome numbers were very much reinforced by data released by Wal-Mart (WMT), which reported a sharp 1.2% decline in second-quarter same-store sales. Analysts had been expecting a +1.0% increase.

Perhaps even more foreboding were comments by CEO Mike Duke in the company's pre-recorded call: "Even though our comparable sales were lower than we had expected, we believe our comparable sales outperformed the retail sector almost in every place that we do business."

Indeed, during all of 2008 and 2009 since the recession started, Wall-Mart has been consistently outperforming its peers by a very large margin. This raises serious questions about what's going on with other retailers such as JC Penney (JCP), Best Buy (BBY), Bed, Bath & Beyond (BBBY), Dillard's (DDS), and in the economy at large.

As readers know, since March of 2009, I've been predicting a reversal in consumer spending trends beginning in July or August. In Solving The Consumer Demand Dilemma, I explained the reasons that I am expecting consumer spending trends to disappoint the economic consensus in coming months.

It's my view that these disappointments in retail sales are extremely significant. For reasons that I lay out in the aforementioned article, an economic recovery unaccompanied by growth in consumer spending simply isn't sustainable.

Furthermore, it is my view that the widely predicted inventory correction is unlikely to materialize to the degree anticipated in an environment of contracting consumer spending. This view gains some support from today's release of June inventory data, which shows that inventories contracted by 1.1%. The inventory /sales ratio in June registers at 1.38, which is near all-time highs. It compares to a level of 1.26 12 months ago.

How anxious are business owners going to be to deploy precious capital to restock inventories in circumstances in which consumer spending continues to decline and inventory levels -- although they have plunged -- are still high relative to the level of sales?

This has major implications for the overall economy.

1. Consumer spending accounts for about 70% of GDP, and almost 90% of private sector GDP. If consumer spending continues to contract, or even if it simply stays flat, it is virtually impossible for GDP to grow in a sustainable fashion.

2. Growth in private investment cannot be expected to lead the economy out of growth in an environment of overcapacity and sluggish final demand.

3. The explosive growth in government spending is pretty much a one-off event. It would be a stretch to expect government spending to continue to grow 12 months from now. At the very least, it certainly cannot be expected that government spending can grow significantly after mid 2010.

4. Finally, net export-led growth for the US is highly unlikely.

Thus, a sustainable recovery in GDP growth in the US depends almost entirely upon a re-ignition of growth in private consumption. I have serious doubts as to whether such a sustainable rebound is forthcoming. Indeed, I believe today's retail sales report and Wal-Mart's earnings may prove, in retrospect, to be a significant warning of serious disappointments ahead.
No positions in stocks mentioned.
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