Gross domestic product growth is robust, hovering above 3 percent. Unemployment is low at about 5 percent. Shoppers are more than willing to drop $200 on a pair of jeans or $500 on a handbag. But rising energy prices and a lack of real wage growth has some consumer demographic segments pinching every penny.
This dichotomy between an economy humming along and contrary consumer sentiment was a key theme raised during a panel discussion of financial experts who explored potential economic red flags for 2006, which might resemble a recession.
Participants on the panel held during the WWD/DNR CEO Summit included: Lakshman Acuthan, managing director of Economic Cycle Research Institute; Carla Casella, credit analyst for high-yield research at J.P. Morgan Chase & Co., and Ken Goldstein, economist at the Conference Board. Phil Bleser, senior vice president and group executive for Mid-Corporate Banking at J.P. Morgan Chase & Co., moderated the panel.
“The current situation we’re seeing, compared with the last several years, is that the capital markets are getting a little bit choppier,” Bleser said.
For 2006, the banker expects credit terms to tighten up while the retail and apparel sectors will have “continued consolidation, spin-offs and buyouts.” Bleser said so far this year, the merger and acquisition pace resulted in about 395 deals, a number that’s more than the total transactions done for the full year in either 2001, 2002 or 2003.
“The financial markets are looking pretty good. Again, they’ll be a little cautious going forward, but the financial markets are really strong,” Bleser said.
Acuthan said the expectation earlier this year was for the economy to slow. Rising interest rates and higher fuel costs over the summer were expected to pull down on economic growth. “We’ve recently seen some GDP numbers putting growth at 3.8 percent in the third quarter, higher than expected. That’s the 10th quarter of above 3 percent growth. In light of the shocks [such as higher oil prices], we’re still growing fairly well,” he said.
Still, for 2006, Acuthan expects to see a change in the business cycle due to higher interest rates as well as higher energy prices. But he does not expect a recession, mostly because business profits and productivity are generally positive. However, he noted that the economic backdrop is a mixed bag for consumers.
“The housing wealth effect has really held up the consumer if you own a home,” Acuthan said. “Five-sixths of consumer spending is made by homeowners. I think that the feeling of savings or wealth from the rise of home prices is helping them continue to consume. The one-sixth that don’t own homes are getting heavily squeezed.”
Goldstein was more bearish and cautionary, describing 2005 both as a transition time period when the economy shifted from above average to average growth and as a time when “cheap energy is over.”
Regarding the impact of higher energy prices on spending, “consumers will be spending more money and not perceiving that they’re getting more for the value. That’s going to sour their mood even more,” Goldstein said, adding that a decrease in job security and a lack of bonuses could also make them nervous. “I agree there’s no recession in the outlook, but its going to feel like a recession.”
For Casella, caution was the watchword. “The markets are definitely becoming concerned about the holiday, but so far we’ve only seen the concern coming from the low-end consumer and hearing it from the low-end retailers like Wal-Mart, [whose customers] are already pinched by the higher gas prices. What we’re really concerned about is when those gas prices turn into heating bills, particularly in the Northeast and Upper Midwest.”
She said consumer sentiment is almost as bad now as it was in 2002, which was the worst holiday season at retail since 2000. As for the financial markets, “J. Crew postponed its initial public offering, and the markets are definitely nervous. People don’t want to test the market now, thinking that it’s best to wait until after the holiday season. That’s what the markets are thinking at this point,” Casella said.