Friday, November 28, 2008

What Color Friday?

Retailers have dubbed the Friday after Thanksgiving as Black Friday since it, as the beginning of the Christmas shopping season, is often the most profitable business day of the year. No red ink is expected on this day as shoppers wearing outsized Santa hats and felt reindeer antlers rush out to find the most popular toys and electronics.

This year promises to be a different hue altogether. Which color has yet to be determined. One headline earlier this week suggested Blue - for the color of depression.

The Deloitte Research Leading Index of Consumer Spending fell in October 2008 to negative 0.10 percent. This is the first time the Index has produced a negative reading in the last twenty years and the sharpest deceleration in ten years. It appears the U.S. consumer is tapped out or is unwilling to let go of the last dollar.

The Consumer Spending Index is composed of four factors: 1) tax burden, 2) initial unemployment claims, 3) real wages, and 4) real home prices. The underpinning of much of the consumer spending in the U.S., real home prices, fell 13.4% in October 2008.

Several retailers have already been hurt by the newly penurious consumer. Sharper Image (SHRPQ: PK) declared bankruptcy in February 2008. Home furnishings etailer, Linens n Things, was bought out by private equity fund Apollo Management in early 2006, but neither a change in management or Apollo’s deep pockets could save Linens n Things from liquidation. Even being one of the largest of the “big box” retailers does not provide a cushion against hard times. Circuit City Stores, Inc. (CCTYQ: PK) declared bankruptcy in October 2008 and is closing stores. Unlike Linens N Things, Circuit City expects to re-emerge from bankruptcy in early 2009.

During the Great Depression in the 1930s, consumer spending declined by over 10%. There is no clear consensus on where spending will stabilize this time. The shrinkage in home values - the collateral for so many mortgages - should provide a clue as consumers join the investment banks and hedge funds in the rush to “de-leverage.”

What is the take-home message for investors besides the obvious “steer clear of the retail sector?” There is also a question mark beside the names of all manufacturers that rely heavily on retailers as a distribution channel.

Neither the author of the Small Cap Copy web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein.

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