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Friday, August 14, 2009 2:33 AM

Peas In The Deflationary Pod

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In the face of mounting job losses with the only real demand coming from cash for clunkers and other silly stimulus programs doomed to fail, it should not be surprising to anyone for retail sales to drop. Nonetheless, Bloomberg notes the following surprise: Sales Unexpectedly Decrease as Job Losses Mount.

Sales at U.S. retailers unexpectedly fell in July, raising the risk that consumers will keep cutting back as job losses mount and temper a recovery from the worst recession since the 1930s.

Purchases decreased 0.1 percent, the first drop in three months, as shrinking demand at department stores such as Macy’s Inc. and Wal-Mart Stores Inc. overshadowed a boost from the cash-for-clunkers automobile incentive program, Commerce Department figures showed today in Washington.

Retail sales were projected to rise 0.8 percent, according to the median estimate of 76 economists in a Bloomberg News survey.

Macy’s, the second-biggest U.S. department store chain, said yesterday it cut inventories 7.5 percent in the second quarter from a year ago as sales dropped.

Other reports today showed companies trimmed inventories in June for a 10th consecutive month, and prices of imported goods dropped in July for the first time in six months as the cost of commodities such as petroleum and chemicals decreased.

Figures from the retail sales report showed the government’s cash-for-clunkers plan did boost auto purchases, confirming industry data released earlier this month. Sales at dealerships and parts stores climbed 2.4 percent last month, the biggest gain since January.
You Can't Spend What You Don't Have

With ever tightening credit standards, and credit card companies like Chase (JPM), American Express (AXP) and Citigroup (C) slashing card limits, buyers are very mindful of costs as Pay Raises Are the Worst in 33 Years.
Feel like your company has been particularly stingy on the raises this year? You're not imagining it. For 2009, the typical non-hourly worker will see a 1.8% bump in salary, according to a survey by the human-resources consultancy Hewitt Associates. That increase, the smallest in at least 33 years, doesn't even keep up with inflation.

Going back to the early 1990s, base salaries never increased by less than 3.4% a year, according to Hewitt, which polled 1,156 large companies to get its latest data. Companies desperate to slash costs are turning to worker salaries more deliberately than they have in the past. Some 48% of companies have frozen salaries this year, compared to just 2% last year.
Actually 1.8% more than keeps up for inflation. I have the CPI at -6.2% while the official CPI is -1.3% as discussed in What's the Real CPI?

However, you can't spend what do don't have, especially if you have no job and no credit. Note that an unprecedented 4.4 million workers have been unemployed and looking for work for 26 weeks or longer. Indeed, various Social Safety Nets Mask A Deflationary Depression.

Diving Into Retail Sales

Dave Rosenberg dove into retail sales in Thursday's Lunch With Dave.
If there was ever going to be a month where retail sales were going to rise, this was it — due to the “successful” Cash-for-Clunkers program. The program may be a “success” but all the government is really doing is taking away from future spending. The 2010 outlook for auto sales is going to be even further muddled as a result, but the hope is that by then, the economy will be kicking into higher gear. (J.D. Power published a new forecast for U.S. vehicle sales for 2010 and while it sees 15% annual gain from the depressed 2009 level, at 11.5 million units, that would merely be stagnant from the stimulus-induced tally in July). If not for that gimmick, sales would have actually declined around 0.7%, by our reckoning.

Furniture sales slid 0.9% and are flat or down in each of the past five months. Ditto for building materials, which collapsed 2.1% in July. So, if “stabilization” is really emerging in the residential real estate market, it certainly is not showing through in the derivative housing-related segments of the sales data. Electronics sales tumbled 1.4% and now down sequentially in every month since March. General merchandise sales (mostly department stores) dropped 0.8% in July and have also lost ground in every month since the brief spurt we saw in February. Sporting goods stores sported a 1.9% plunge in July, the second outsized declines in the past three months. Web-based sales basically stagnated last month. What is called “retail control”, which is the headline excluding gasoline, building materials and autos, and goes into the consumer spending segment in the GDP data, fell 0.2% MoM and is flat or down in each of the past five months, and this was in the face of some pretty massive fiscal stimulus. So far in 3Q, retail control has declined at a 1.3% annual rate. So for the current quarter, GDP gets a boost from inventory building but 4Q could be flat or negative in the absence of a consumer pickup.
Walmart Cuts Prices

Inquiring minds are digging into details of the Walmart's (WMT) beat the street numbers. Please consider Walmart Profit Tops Estimates on Inventory Management.
Wal-Mart Stores Inc., the world’s largest retailer, reported second-quarter profit that exceeded some analysts’ estimates after managing inventory to reduce costs. Comparable-store sales trailed the company’s forecast.

Walmart will accelerate efforts to cut costs after U.S. stores reduced inventory by almost 6 percent, Chief Executive Officer Mike Duke said today on a recorded call. The chain also attracted more customers, helped by price reductions on its Sam’s Choice Black Angus beef patties, baked beans and flat-panel televisions to lure consumers grappling with shrinking paychecks and the worst unemployment since the Great Depression.

“They are providing great value to the consumer, but the consumer is very stressed these days,” Craig Johnson, president of retail-consulting firm Customer Growth Partners LLC in New Canaan, Connecticut, told Bloomberg Television today.
From baked beans to Black Angus beef to flat panel TVs, Walmart is lowering prices. Sales were lower but profits were up on "inventory management". Others are cutting prices too.

Safeway Lowers Staples Up To 25%

The Washington Post reports Safeway Lowers Prices To Lure Frugal Shoppers.
Safeway has lowered prices on thousands of items at its stores in the Washington region as the supermarket chain adjusts to shoppers' increasingly frugal mind-sets.

The grocer, the second largest in the region, is slated to announce the initiative Wednesday with banners and signs throughout its stores. The price cuts primarily are targeted at staples sold in the center of each store, such as paper products, laundry supplies and coffee, and the reductions run as high as 25 percent.

Giant Food undertook a similar initiative in 2006. Even Whole Foods has cut prices on key items. Use of its coupons has grown to nearly 4 percent, the company said.
Huge Attitude Adjustments For Store owners And Consumers Alike

The article also point outs that 82 percent of consumers reported making shopping lists in June, up from 70 percent in January. Those comparing store ads rose to 64 percent from 52 percent. And in a number bound to increase, 46 percent said they shop at several stores based on price, compared with 37 percent in January.

Ironically, consumer changes have forced Safeway's hand immediately after it spent several years upgrading the perimeter of its stores to help the chain compete with upscale grocers such as Whole Foods.

Price Wars In Canada

The Globe and Mail is reporting Price wars grip Canada's grocery stores
Inflation is unwinding and, according to the country's largest grocer, sales volumes in the sector are starting to decline. Now Loblaw Cos. Ltd. has signalled it's ready to drop prices on thousands of products to keep customers coming to its stores. Its rivals vow to remain competitive, which could spark a price war.

Last week, Loblaw slashed prices by between 10 and 25 per cent on about 3,000 products in its stores in Atlantic Canada. This week, Loblaw followed suit at its Zehrs stores in the hard-hit region of southwestern Ontario, while also providing a 10-per-cent break to unemployed people shopping at those outlets.
Peas In The Deflationary Pod

Deflation, a net contraction of money and credit, is the pod.

Falling retail sales, frugal shoppers, and price slashing efforts at Walmart, Safeway, Whole Foods and Giant are all peas in that pod. So too are consumer attitudes and tightening credit standards by banks.

Consumer attitudes towards spending have changed for good. So have banks' attitudes towards lending. It's tough to raise prices in this kind of environment. Expect lower prices ahead in the CPI.

None of the above matters today as the S&P is rolling right along.

Corporate Bonds Still Acting Well

Here is a chart from Corporate Bond Spreads Key To Continued S&P Rally that tells the story.

The investment grade bond rally lasted 23 consecutive days, ending two days ago. The widening today is a statistically irrelevant 1 basis point.

As long as corporate bonds fetch a good bid, which in turn allows companies to raise cash at decreasing costs, the stock market is likely to be reasonably firm.

I am skeptical the rally in bonds can last much longer, but until the corporate bond market starts showing increased signs of stress, equity bears expecting huge pullbacks are likely to be disappointed.

Either way, it will pay to keep one eye on the credit markets to help ascertain long-term equity direction. In August of 2007 the corporate bond market cracked wide open. Although the S&P 500 made a new high in November, the corporate bond market didn't. It was the mother of all warning calls that most missed.

History is setting the stage for another repeat.

Mike "Mish" Shedlock
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