By and  on June 11, 2007

The second half of the year is going to be a bumpy ride as higher gasoline costs, soft home sales, inflation and uncertainty over interest rates affect spending.

But analysts and economists said the picture could brighten in time for the holiday shopping season.

"The downturn of home sales and high cost of gasoline are affecting consumers' discretionary spending. I believe that those two factors will have a longer-term effect on retailers because some may have involuntary inventory accumulation that will cause them to take markdowns. These promotions hurt regular business, and we may see a very strong promotional fall season," observed Walter Loeb, retail consultant with the firm that bears his name.

"Even though consumers will buy for special occasions, such as holiday gifts in the fourth quarter, for the most part, they are trained to make their purchases on a day-to-day basis. I see the fall season to be very difficult, more so than I had anticipated, with an upswing in the fourth quarter for Christmas."

Economist David Rosenberg at Merrill Lynch wrote in a research note in May that the "American consumer" was one part of the U.S. economy that "has yet to slow and [is] the wild card in the outlook."

He noted several obstacles, such as rising gasoline costs, that might slow consumer spending in the next few months.

"But it's not all just about gasoline — the food bill is also rising rapidly with the CPI [Consumer Price Index] food index up almost 4 percent year-on-year and a 6 percent annual rate over the past three months....The grim reality is that the recent acceleration in food and gasoline prices is unlikely to subside anytime soon," he wrote.

In a more recent report June 4, Rosenberg said, "Consumer spending is in the process of slowing," and concluded that heading into the third quarter with higher inventories and slower consumer demand may "put a bit of a cloud over the second half of the year."

Retail analyst Christine Augustine of Bear Stearns, in her May "State of the Consumer" report, said her firm's chief U.S. economist, John Ryding, expected core inflation to rise. Ryding predicted the Federal Reserve eventually would have to "modestly" increase rates. Ryding expects the federal funds rate to increase to 5.5 percent by yearend and to 5.75 percent by the middle of 2008.Augustine said energy-related costs represented 9 percent of consumer expenditures for the average American household, and was an even larger percentage for lower income households who have less disposable income.

So far, Seventh Avenue is optimistic, even though economic headwinds might suggest otherwise. Zachary Belil, vice president of sales and merchandising at Pine Needles Apparel, said he hadn't seen or felt any nervous cutbacks yet.

"You can't compare April or May selling to what August selling is going to be. Some retailers may look to see how May sales turned out and you might see some cancellations. However, those with the right merchandise should do well. So far the business is great for the fall. I think that the [presidential] election is starting to get people excited about a change. One clear, consistent message is that people want the war to be over and the closer we get to see signs of that, the better it will be for the economy. And people will be back in the stores. But we probably won't see it happen till the fall, in mid-September," Belil said.

Gary Wassner, president of Hilldun Factors, said his clients so far were optimistic. "Our focus has always been in the higher end of the apparel market. Retail sales are still strong there. Orders for the coming season are ahead of last year, in many cases in excess of 20 percent. That's an enormous increase," he said.

But Wassner is also cautious in his outlook. His concerns center on possible federal interest rate hikes and expansive growth in the specialty market.

"If rates continue to go up and the housing market stalls even further, then we could see a more cautious consumer in the fall....[Also,] I've been concerned for a while that there's been too much growth, too fast, in the specialty designer store market. The patrons of those stores are younger and have less to fall back on in a period of slower growth. A larger and larger percentage of a younger person's income is devoted to rent/interest/housing than ever before. If rates go up and the job market gets tighter, and if we start to see layoffs and larger companies trimming staff, this market will suffer quickly. The younger, fashionable consumer fuels the sales in this category, and that consumer isn't accustomed to harder times. With an alarming lack of savings due to fewer years in the job market and greater spending habits, the retail category that's supported by this group will suffer," Wassner said.Stanley Officina, president of factoring firm Ultimate Financial Solutions LLC, also noted that his clients so far seemed fairly optimistic about back-to-school and the fall selling season. And while he expects holiday promotions to drive retail this year much as they did in 2006, he also said higher gasoline prices and home heating oil were potential problems that had yet to fully affect consumer spending.

"Much of the increases in these necessities have occurred in the past few months, when heating bills and driving vacations have not been significant. The third and fourth quarter of 2007 could be greatly impacted if we have an early and cold fall. Typically, that climate change is viewed as positive for retail, but not if it erodes disposable dollars at the consumer level," Officina said.

Michael Stanley, executive vice president at factoring firm Rosenthal & Rosenthal, believes that the rest of the year could be "challenging. I think what's happening is the retail community may be gearing their purchases for this somewhat softer season. I don't think it's the end of the world, but I do see some signs of some softness."

Wassner added that the economy "is so much more global than ever before. High oil prices and political instability in critical areas affect prices and perceptions."

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