NEW YORK — The long-awaited economic recovery keeps being postponed.
This story first appeared in the October 7, 2002 issue of WWD. Subscribe Today.
Originally expected to kick in in time for the second half of 2001, many economists and sources in financial and credit circles now fear that the combination of fundamental economic weakness and a growing pool of uncertainty makes a rebound before the second half of next year unlikely.
Projections run the gamut from sluggish to doomsday-ish, but there is general agreement that it will take until the midpoint of 2003 at the earliest before the economy can start to reverse the damage done by falling equity markets, damaged corporate credibility, eroding consumer confidence, a shaky credit picture and geopolitical anxiety.
With the possibility of war the wild card, the expectation in a worst-case scenario is that it will take at least a few months to determine any military campaign’s success, deal with other war-related timelines and absorb the potential for repercussions, such as more terrorist attacks on U.S. shores.
However, there will be opportunities for well-positioned firms. While retailers aren’t expected to acquire their competitors, there is an expectation that strong apparel firms will gain market share and attain greater leverage in their respective distribution channels.
Elizabeth Eveillard, an investment banking consultant who also serves as an outside director on three retail boards, doesn’t think anyone knows yet the full impact of stock market losses on the consumer’s psyche and pocketbook.
“The losses could have a lot of people stopping and thinking that maybe their retirement and pension plans aren’t so secure. If it causes them to start saving to make up the losses, we’ll see a corresponding drop in consumer spending levels, which means it will get worse before it gets better,” she explained.
According to Eveillard, the possibility of war has only added to uncertainty generated by a frail economy, numerous corporate scandals and lackluster retail sales.
“I’m not convinced that a war will take us out of the doldrums like World War II took us out of the Depression. This will be a different kind of war, with the costs of bearing this burden tremendous because we’ll be involved in nation building as well. There are not a lot of positives out there, and I think we’ll have to get through the middle of next year before we get any clarity,” she predicted.
Gilbert Harrison, chairman of New York-based Financo Inc., which has a long history advising clients in the retail and apparel sectors, said, “I think we’re in troubled waters. The consumer is scared to death because of what’s going on in the economy. There’s also nothing really exciting out there, just the same me-too merchandise. When the two factors are combined, it is a recipe for disaster. I haven’t seen the economy this bad since the stock market crash of 1987. This is even worse than when we had the [automobile] gas lines.”
Harrison found Wal-Mart’s announcement last week that it was cutting its comparable-store sales forecast for September the scariest warning so far.
“Wal-Mart still has a steamroller effect. In recessionary times, one expects business to drop off at certain retail channels because consumers are trading down. However, they can’t trade down any further than Wal-Mart. How much worse can it get? God knows. I heard that the market could go down another 500 points. If it goes much lower, we should all pack up.”
David Lamer, equity analyst at Ferris, Baker Watts, said that the lack of resolution on numerous economic, political and military issues has caused consumers to stall in their spending patterns. “Consumers don’t like uncertainty and that’s what’s out there right now. Last year we had Sept. 11 and this year we have what is starting to look like a double-dip recession. We’re in a tropical storm right now. If we go to war with Iraq, it will be a hurricane. The good news is that the hurricane will pass. Let’s just hope that there’s no triple hurricane,” he said.
Lamer noted that the retail and apparel industries scaled back on production because they expected fall and holiday sales to be tough. Because of continued economic challenges, they also are keeping inventory tight for spring and summer. Consequently, top-line growth for the sectors won’t be apparent until the second half of next year, he predicted.
However, Lamer does expect that market sentiment will get worse before it gets better. He explained: “A lot of people think the Dow will drop down to the 5,200 to 6,000 point range. If there are high redemptions in the mutual funds, that will force a big sell-off from the large institutional investors. So it won’t be a surprise to see Wall Street push the bottom further.”
How much worse can it get?
Sounding a dramatically pessimistic note, Harry G. Van der Eb, portfolio manager for The Gabelli Mathers Fund, wrote in his semiannual report to shareholders in July, “Secular deflationary pressures plus systemic and specific risks are increasing and rapidly approaching a deflationary inflection point, potentially posing the greatest economic threat to U.S. capitalism and democracy since 1929-32.…Deflation erodes the ability to service and pay down debt, since the dollar amount of debt remains the same while incomes and asset prices fall. A downward price spiral occurs during a credit collapse because sellers are forced to liquidate assets at progressively lower prices in order to raise cash.”
While it’s too soon to tally full-year results for 2002, Van der Eb’s 2001 yearend letter to shareholders noted that last year total U.S. credit market debt as a percent of U.S. gross domestic product had more than doubled since 1980 and stood at a record 282 percent. Meanwhile, U.S. household credit market debt rose to a risky 105 percent of disposable personal income as consumers spent more of their incomes, financing the difference with borrowings and driving down their savings rate to historic lows.
As for stock markets, he wrote: “Historically, after bubbles burst, prices eventually decline below the point of the initial advance, implying that, over the next several years, the Nasdaq may fall to about 700, the S&P 500 to 425 and the Dow to 3,500. These levels, last seen just seven years ago, seem distant, but would likely put stocks at only modest historical undervaluation.”
Richard Hastings, credit economist at CyberBusiness Credit, said he won’t be surprised if the Dow hits as low as 3,500 points because the market is still “overvalued. What I see is that stocks will continue to test the lows of July 23 for a while. There are confusing signals from growth in consumer credit, such as mortgages and credit card usage, while confidence levels about the future are weakening. Since sales at chain stores such as Rite Aid and CVS are significantly below levels of a year ago, that suggests that lower-income shoppers are getting affected first.”
According to Hastings, the recession of 1991 was far worse than the current economic picture. What is different — and why it feels worse — is that back then, there were far more safe havens for investment because the stock market wasn’t as overvalued.
“However, I do think it will get worse. The Middle East problems are the wild cards on top of the increase in debt levels on the consumer front. Corporate debt isn’t so bad, but you’ll see more problems on the municipal government side,” he said.
Experts across the pond in Europe aren’t that hopeful about a quick recovery either. According to a report by professors at the London Business School, there is a 50 percent probability that the S&P 500 will have to wait until 2010 to recapture its all-time high, and a 50 percent chance that the breakthrough will come later.
David Millberg, president of Millberg Factors, observed that current conditions feel worse than the 500-point drop in 1987. “The financial markets detest uncertainty and right now both the individual and the institutional investors don’t know whether to trust the numbers that companies are reporting. While I hope for a good Christmas, it is hard for me to see how it will be good for my clients. The layoffs are not over yet and capital spending by businesses has not improved. It’s hard to see how any turnaround will kick in before mid-2003.”
Millberg has already seen some marginal firms experiencing a credit crunch. “Our impression is that banks have become much more conservative. We see that finance companies aren’t overextending themselves and contraction in credit has already begun in the marketplace. I don’t know if that will get too much worse. Many apparel firms are in a much more liquid position now than they’ve ever been. They realized that now is not the time to take excess risk and they hunkered down by shrinking their workforces and keeping inventory levels very lean,” he said.
For Harvey Gross, who is on the board of trustees at New York Credit Institute, the current downturn is the “worst ever” for textile and apparel firms. He explained: “In the past the feeling was always that one could control the business and work within the cycles during up and down years. If attention was paid to the basics, there was always the possibility of having a successful business. Business today is more global and many domestic operations have not been able to adapt to the global arena. I don’t know if we’re at rock bottom, but we are very low. The fabric and trade shows have not been well attended. That’s bad news since a lot of business is done at the shows.”
Arnold Aronson, managing director of retail strategies at Kurt Salmon Associates, also had negative views about the current state of economic affairs: “It is about as bad as it has ever been, at least certainly in the last 20 years. We have been hit by multiple things at the same time. It is one thing to be in a recession, but it is another to be in a recession and have to suffer from Sept. 11 and the specter of a major war ahead of us. There is a whole set of imponderables complicating business decisions. The Catch 22 is that we have all the negatives and the yellow lights blinking at the same time.”
The good news is that there should be at least modest growth for holiday sales. Walter Kaye, president of Merchant Factors Corp., expects that Christmas sales will grow at a 2 percent rate over last year, with discounters and mass chains gaining some market share from the department store channel. He does expect an overall slowdown in business because of the fear factor among consumers, stemming from the roller coaster rides of the stock market and the potential for war and more terrorist attacks.
Paul Schuldiner, national business development director at Transcap, a purchase order and trade finance firm, observed, “I think for our particular type of financing, you’ll see retailers place increased scrutiny on evaluating a product’s sell-through history. This is definitely the worst that we’ve seen so far. The last two MAGIC shows have not been well attended. We also expect some consolidation at retail and apparel. My impression is that you’ll see a shakeout post-holiday.”
While we are certainly in challenging circumstances, not all financial professionals think that we are in the worst of times.
According to Jerry Sandak, executive vice president at Rosenthal & Rosenthal, the worst economic time period for retail and apparel was in the early 1950s. “There were many problems then with the textile industry. This malaise will turn itself around, but it’s hard to stop a freight train. What we’ll have is a slow and gradual process. I think we’ll enter 2003 still in a weak economic [cycle] and it will be quite a while before we see any signs of a recovery.”
Jim Rice, vice president for Sands Credit Services, also thinks the recessionary years between 1987 to 1991 were far worse. “Back then we had all those leveraged buyouts. From a retail perspective, it lasted for quite a long time and we saw a lot of bankrupt firms because of credit issues arising from LBOs laden with debt. Those concerns aren’t big credit issues right now and asset-based lenders have been very aggressive in scrutinizing balance sheets. While you will see some firms shutting their doors, it certainly won’t be a rash of bankruptcies among the bigger players as most weaker ones have been weeded out.”
Stuart Glasser, head of softlines merchandising operations at Value City Department Stores and former president and chief operating officer of Casual Male Corp., observed, “I don’t remember it as challenging as this. A down cycle usually comes every 10 years, but this one is a doozy. Every month I think we’re at the bottom and then it gets worse. While business hasn’t been wonderful, I don’t think anybody is ready to write off 2003.”
To be sure, the economy is still growing. Steven R. Ricchiuto, economist at ABN-AMRO, is forecasting 2.5 percent real gross domestic product (GDP) growth in the second half of 2002, with the downside risks depending on the drag on consumer spending from a full-scale military confrontation with Iraq and possible negative consequences from either a spike in oil prices or a further drop in stock prices.
Maury Harris, chief economist at UBS Warburg, wrote last month in an economics note that he sees real GDP growth in 2003 of about 3 percent. He cautioned that it will be “back-loaded” because of heightened new-term geopolitical uncertainties.
“At this point, it’s hard to know just how much war fears and related oil price concerns will restrict consumer and business spending, and the risks are that they could be weaker than expected,” he wrote.
According to the Oct. 4 issue of The Kiplinger Letter, confidence indexes will slip further over the next few months “in response to a soft job market and concerns about a war with Iraq.” Consumer spending growth, responsible for two-thirds of U.S. GDP, will be about 3 percent in the fourth quarter, down from 5 percent in the third, according to Kiplinger.
Philip Bleser, senior vice president at J.P. Morgan Chase, said the bank’s clients in mid-market apparel are doing decently because they’ve been anticipating retailers’ needs as well as how much consumers will buy. “Our clients have cut their overhead, kept inventory in line and are looking forward to an upturn. No one is seeing a home run, but they are staying the course,” he noted.
Perception, the banker pointed out, is what is making the economic recovery appear almost nonexistent. “The economy is growing at a 3 percent rate. But you have to remember that we were going really fast for a while and not slowing down. Right now, it is like the toll booth effect. We are slowing down and there are a lot of shocks out there, such as a dock strike on the West Coast that could affect the economy. The Fed still has room to move interest rates and if it still sees more shocks will do so,” the banker said.
Bleser also expects that we’ll see some mergers and acquisitions, not so much from liquidity constraints but as part of a general realization that there are some benefits, such as heightened efficiency, to being part of a larger organization.
Still, it could take at least a year before the economy is out from under the overhang of corporate governance issues, according to Beth Halligan, managing director Fleet Boston Financial. Because retailers and apparel firms are in a far stronger position today than in the Eighties, she expects most will survive the economic challenges they are facing.
“Department stores are doing some very interesting things to reinvigorate their sales, a process that is still in transition,” she said. “This is a good time for firms to gain market share. The strong firms will become stronger. You’ll also see more mergers and acquisitions among apparel firms, not necessarily being driven by synergies but more with an eye on creating leverage within the distribution channel they’re working with,” she observed.
Transactions are taking place, albeit at a slower pace. Kenneth Fisher, a partner in the corporate practice department at the Phillips Nizer law firm, described business as “a lot like doing a track and field event in the mud. It takes extra effort to get anywhere and it is very easy to fall on your face. I’m still seeing merger and acquisition activity, but it is not happening at break-neck speed. Integrity has assumed a larger role in these deals in light of corporate governance issues. Whether one is dealing with a private or a public firm, people aren’t willing these days to make great leaps of faith. Everything is being scrutinized and no one wants to pay 40-time multiples when 10-times or 12-times is more in line with normal evaluations.”