Consumers Are Running Out of Gas

06/19/2008 12:00 am EST

Focus: MARKETS

Gary Shilling

Columnist, Forbes

Gary Shilling, editor of Gary Shilling’s Insight, says a recession is unfolding as tapped-out consumers finally pull in their horns.

Phase three of the four-phase recession, the biggest drop in consumer spending of any post-World War II recession, is commencing and will extend the downturn at least through the first half of 2009.

Consumers know they're in trouble, and 81% of Americans believe the economy is in recession. Still, most forecasters don’t believe so: Gross domestic product continues to rise, although at a snail’s pace. Employment losses—so far—have been small even compared with the mild 2001 recession.

None of these imply a deep [recession] unless consumer spending nosedives. In the 1980s and 1990s, consumers relied on stock appreciation to fund oversized spending, and more recently on house appreciation.

Many have already turned elsewhere for funds, maxing out credit card and auto loans and even invading their meager 401(k) accounts. But they’ve run out of borrowing options and they have no choice but to cut spending. And the leap in energy costs and now food prices only adds pressure for consumer retrenchment.

The evidence that consumers are finally, finally, finally cutting back is mounting. In supermarkets, generics and house brands are gaining at the expense of more expensive national brands. Starbucks’ same-store sales are dropping as cash-strapped customers shun $5 cups of coffee. Consumer retrenchment is [also] speeding retailer bankruptcies and store closings.

A recent Conference Board poll found that the number of Americans planning a vacation in the next six months is at a 30-year low. Another survey found only 19% plan to spend on consumer electronics in the next 90 days vs. 39% last November.

Rising food and fuel costs are shifting price-conscious consumers to eating at home, so restaurants are featuring lower-cost offerings. Among Standard & Poor’s 500 companies, earnings for consumer discretionary firms [should] fall 15% in the first quarter, while those of consumer staples producers rise 11%.

Even the wealthy are retrenching. A recent survey found 80% of the richest 10% of Americans, with average discretionary income of $342,000, believe the economy is in recession, and their optimism is at a record low. Consequently, they are cutting debt, increasing saving, and buying cautiously.

Less affluent consumers are really searching for ways to cut outlays. More are falling behind on utility bills, and the number of families receiving federal energy assistance funds is the largest in 16 years. Pressed consumers are selling DVDs, VCRs, tea kettles, anything to raise cash.

The disappearance of home equity and widespread squeeze on consumer spending is causing many older people to postpone retirement. A recent poll found that a quarter of the respondents plan to work longer because of the rough economy in the past year.

On balance, we look for inflation-adjusted consumer spending to drop by 2.5% in this recession. That would be a larger decline than in any post-World War II recession.

So far, the nosedive in consumer spending has taken longer than we expected, but maybe we’re finally correct. If so, many will soon join us in at least admitting a recession is in progress.

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