Markets : Will Consumers Sink the Market?
New York: July 06, 2004
By John R. Stephenson

There's been a lot to cheer about lately as companies have seemingly dodged a bullet and have started to get earnings back on track. Last year, the stock market took notice and surged in an appropriate fashion. But the true unsung heroes that have been really carrying the economic ball are the consumers. Let's just hope they hang in there until we fully round the economic corner.

But can they? With gasoline prices surging, interest rates on the rise and their tax refunds all but spent, are consumers finally running out of ammunition to prop up the economy and the stock market in turn? Perhaps. One of the strongest sectors over the last year has been the retailing sector. Over the past year, the Standard & Poor's (S&P) retailing index soared an impressive 70 percent — driven by strong home sales. The fortunes of retailers are closely tied to that of housing — another strong sector. The reason that retailers tend to benefit from strong home demand is that typically new home purchases and mortgage refinancings lead to an upswing in spending for big ticket items. But, over the last week, the retail index is starting to slide — down some 4 percent.

The alarm bells of slower retail sales are starting to sound. WalMart, the world's largest retailer, announced last week that its June sales were worse than expected because of slower Father's Day sales and cool weather. The bad news wasn't limited to WalMart as Target Stores also warned of a slowdown in sales which sent its stock spiraling down 11 percent since the warning. Not only are things slowing down in the discount aisle, but bigger ticket items such as cars are starting to get pinched a little as well. According to auto industry reports, car sales slid to the lowest level in six years and the stock of General Motors was the single biggest loser in the Dow this past week.

But the news isn't all bad as employment numbers seem to be trending up. For consumers to keep spending, they need to be employed and feel confident about the prospects for the future. With the jobs picture improving, people have a reason to feel more confident but that isn't the whole story. Consumers are also counting the dollars that they have in their pockets and discovering that with interest rates starting to creep back up, gasoline prices sharply higher and the refunds spent, they have less money to spend. Even though the effect of interest rates is modest at the present time, there is no doubt that it is starting to take a little froth out of the market.

With it being a little unclear as to whether consumers will continue to hang in and continue to spend at the pace that they have for the last few years, it might be wise to start to lighten up on your equity holdings. Particularly those stocks that have the most exposure to higher interest rates. Retailers, homebuilders and utilities should be under performers if interest rates continue to rise and consumers decide to take a break.