Consumer Spending’s Nine Lives May Have Run Out

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“It wouldn’t surprise me if Ebenezer Scrooge, instead of Santa, comes down the chimney on Christmas Eve,” Los Angeles money manager Arnold Silver says. The head of A. Silver Associates adds: “Stores on Rodeo Drive tell us people are spending less, and if it’s happening there it’s happening everywhere. It could be the consumer is finally running out of steam or perhaps getting a lot more worried.”

A Morgan Stanley economist, Richard Berner, also expresses concern about consumer spending — the salvation of economic growth in recent years — warning clients that the ingredients are in place for a “perfect consumer storm.”

It should be noted, however, that for eight years running, one economist after another has buried the debt-ridden consumer, warning Wall Street that consumer spending is about to fall off. So far, that forecast has proved to be consistent hogwash, with the resilient consumer weathering one storm after another, including the 2001 recession, the dot-com and technology stock bubble, the terrorist attacks of September 11, 2001, a six-year surge in energy prices, and a lengthy housing recession.

Through each crisis, the consumer has responded with the kind of spending vigor that basically echoes a famous Mark Twain quote: “The reports of my death are greatly exaggerated.”

That vigor, Mr. Berner suggests in a recent commentary to clients, could soon be history. He raises the question of whether dark clouds finally and ominously herald the perfect consumer storm. Among the dark clouds: slowing job growth, surging energy and food prices that will likely drain more than $70 billion from purchasing power in the last three months of 2007, tightening lending standards, the resetting of adjustable rate mortgages at higher rates, and a cooling of wage growth. To Mr. Berner, it all suggests housing wealth will likely decline.

To our worried economist, the handwriting is already on the wall for what some pros believe could be the emergence of a potentially financially impotent consumer. He points to two anecdotes that suggest consumer woes are spreading to upper income shoppers: high-end retailers reporting sales declines in October, and a New York auction of a van Gogh painting failing to attract a single bid.

A struggling housing market also figures prominently in Mr. Berner’s scenario of a perfect consumer storm. Here, he points to the squeeze in adjustable rate mortgages, a sharp increase in foreclosed properties, the failure of home builders to cut production and eliminate the mismatch between housing supply and demand, and a tightening of mortgage credit availability that is already tighter than in the 1990 credit crunch period. As such, he says he thinks home prices will decline 10% nationwide over the next year.

Based on rules of thumb, Mr. Berner reckons such a hit to wealth — about $1.5 trillion, or 2.5% of overall household net worth — might promote a decline in consumer spending of between $75 billion and $100 billion. Clearly, he notes, a bigger hit to wealth could trigger a bigger consumer spending pullback.

What does it all mean? That consumers face their toughest challenge since the recession of 2001, Mr. Berner says. In fact, his forecast calls for a tepid 1.4 annualized rise in consumer spending over the next three quarters, ending June 1.

For a gauge of consumer health, he says one need look no further than the University of Michigan’s early November canvas of consumer sentiment. The index sank to 75%, matching the post-Katrina low in September 2005, which was the lowest reading since 1992.

For investors, he goes on, it’s important to note that some, but not all, of the risks are reflected in equity prices. Significant economic weakness, but not a recession, seems to be in the price of most asset classes. On the other hand, he points out, equity markets seem fully priced for consumer weakness, but not retrenchment.

Mr. Berner doesn’t say it in so many words, but his bottom line seems obvious: A collapsing consumer — and the signs surely herald one — could send the economy and the stock market into a further tailspin.

dandordan@aol.com


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