Consumer Optimism to Lift Christmas Sales

If you’re one of those people who defines the start of the holiday season as the day Christmas decorations start showing up on store shelves, then you’re already aware that Christmas begins sometime in October. For many retailers, however, Christmas is an all-year consideration, something that is analyzed and planned for as the year’s single make-or-break event. And this year you can add in a presidential election, another worrisome variable, which statistically tends to be preceded by loose money as politicians seek to win favor, followed by a more sluggish year after the election is over. The ultimate effect of Super Storm Sandy is also uncertain. Cleanup should boost car and repair sales in the Northeast, though that is money that will not be spent on traditional Christmas items.

So what are CEO’s and consumers saying about Christmas this year? Recent numbers for housing prices, retail sales, and the jobs market have clearly helped buoy consumer confidence, with some reports suggesting the highest confidence level since the beginning of the recession. Housing prices are up for the fifth month in a row, with new homes sales hitting a 2-year high, giving at least homeowners a reason to feel better off. Retail sales have also increased over the past few months, and now many retailers are indicating that they will hire more seasonal workers than they did last year, roughly 600,000 new hires according to the National Retail Federation. More holiday hires means more consumer income and almost certainly more consumer spending.

It’s not just the U.S. that is seeing higher levels of consumer confidence. The UK has experienced modest gains in manufacturing, services, and retail, which has bumped employment, leading to increased optimism on the part of both consumers and businesses, even though employment gains have been largely in part time or temporary positions. One telling statistic about anticipated consumer spending is the number of expected deliveries to be made before Christmas. UPS, for example, is expecting to handle 10% more deliveries than last year, over half a billion packages. Along with that goes the need for more seasonal workers, with UPS planning to hire approximately 55,000.

Timing, however, is another thing. When will retailers get their earliest clear sign that consumer confidence is translating into consumer dollars? As indicated above, the holidays have already begun, and every retailer wants to be first in line. With Amazon and other online threats, brick and mortar stores have to be especially aggressive. Amid understandable controversy, Walmart has already announced that they are moving their Black Friday sales to 8 pm on Thanksgiving Day. But consumers are getting savvy, and don’t always view Black Friday as the be-all end-all sales day that it once was. There’s an increased recognition that at least some of the electronics and other goods sold at discount on Black Friday can be of questionable quality, and may not be such a good deal in the long run. In addition, studies have shown that many items, including major purchase items, are priced lower at other times than Black Friday, such as the two week period right before Christmas. With the holidays stretching from October right up until Christmas Day, it may be hard for retailers to get an accurate measure until it’s all over.

Are executives as optimistic as consumers? Companies traditionally have a longer view than consumers, and are less impressed by trailing indicators. As a result, businesses, though hopeful, are considerably more conservative in their outlook. The numbers they look at suggest a more subdued picture, with capital investment by companies continuing to drop and earnings sluggish. They’ve got a lot more to worry about than Christmas 2012.

That being said, indications are that retailers are generally upbeat about holiday sales, as suggested by the anticipated holiday hiring. A quote in a recent NY Times article by Peter Reiner, Sr. VP for Marketing at Toys “R” Us, reflects the stated views of many retailers: “We’re very optimistic about the holiday.” If nothing else, it’s a clear recognition that consumer optimism always drives the Christmas train.

Global Correlations Continue to Increase

International stock exposure appeals to many investors because they believe that foreign stocks have been reasonably uncorrelated from the U.S. market. The theory is that stock markets in different countries will tend to move in different directions at different times. So if the U.S. market has a period of bad performance, perhaps German, Japanese, or Chinese stocks will be doing better. Over time, this diversification could help smooth out returns and provide better long-term returns with less risk.

But is this view really accurate? Are investors really gaining diversification when they look abroad?

During the last 15 years, correlation coefficients, especially in the emerging markets, have been reasonably low. A correlation coefficient of 1 would imply that the S&P 500 and the foreign index would move in lock step while 0 means that there is no relationship between the two. Looking at historical data, China has been the least correlated with a coefficient of 0.47, the Nikkei 225 coming in next at 0.60, and the BRIC index coming in third at 0.68. Europe tended to hew closer to the U.S. market, and the All World ex-U.S. index comes in at 0.87.

When we compress the time period to only the last five years the changes become readily apparent. The coefficient for China jumps up to 0.73, and the all-world ex-U.S. index climbs to 0.93.

When evaluating only the most recent year, we find that emerging markets have paralleled U.S. markets more closely than they have during the last 15 years, though there was generally less correlation for many markets than there had been during the last five years.

Large corporations have become increasingly more globalized during the last 15 years. Newly open economies and a quest for growth has given U.S.-based firms the incentive to do more business abroad and for companies in developing markets to make inroads in the U.S. The cross-pollination of revenue sources makes firms in all countries more dependent on the global economy and not just the economy in their home countries. So a downturn almost anywhere in the world is going to have an impact on the earnings of almost all big firms, regardless of their home base.

Most major indexes tend to be loaded with large-cap names to the exclusion of smaller stocks. It is these smaller companies that are likely to be pure plays on the local economy leaving the indexes heavily weighted to larger more globalized firms. This can have a profound impact on the correlation coefficient. Take Brazil for example. The correlation coefficient of iShares MSCI Brazil Index (EWZ), a broad-market exchange-traded fund, to the S&P 500 was 0.86 during the last three years while the Market Vectors Brazil-Small Cap (BRF) ETF had a coefficient of only 0.72.

Another key factor to the high levels of correlation has been the financial crisis. The credit crunch and subsequent economic slowdown was a truly global event; there were few corners of the economy in any country that didn't feel the impact. This means that markets everywhere sold off in huge numbers at the beginning of the crisis, and when the smoke cleared, they all came back in a big way.

So is this higher level of correlation permanent? There is no way to give a definitive answer, but it seems likely that correlations will remain higher than historical averages even if they fall from today's levels.

First off, interconnectedness is here to stay. Without question China will see more impressive growth than the U.S. during the next 10 years, but U.S. firms are frantically trying to develop bulkheads in China to participate in that growth. This will help further link the prospects of shares in both regions.

An additional factor that should reduce correlations somewhat going forward is that as the recovery progresses, there will be more separation between markets. Despite globalization, many stocks' fortunes are still tied closely to their local markets. As the fog of credit crisis clears and the gulf between the high-performing markets and laggards expands, we would expect performance to eventually follow. That said, correlations should still remain higher than past levels.

The data shows that even though different local economies around the world are growing at vastly different rates, the large multinationals that most investors buy are becoming increasingly interconnected. This has and will continue to make it more difficult to construct an international portfolio that provides true diversification.

U.S. Wholesale Costs Decline in October

Wholesale prices in the U.S. posted the biggest decline in October in more than a year and a half, mostly because of lower costs of gasoline and motor vehicles.

The producer price index fell a seasonally adjusted 0.2% last month, the Labor Department said Wednesday. Economists surveyed by MarketWatch had predicted a 0.2% increase.

The cost of gasoline dropped 2.2% on a wholesale basis and the price of natural gas and home-heating oil also fell. As a result, the energy index declined by 0.5% in October after surging by 4.7% one month earlier.

Yet wholesale-food costs rose for the fifth straight month, up 0.4%. Pork prices jumped 8.1%, the fastest increase since summer 2008, while poultry and dairy prices climbed around 3% apiece.

Excluding the volatile categories of energy and food, wholesale costs decreased by 0.2%, the biggest drop in one year. Economists surveyed by MarketWatch had expected a 0.1% increase.

Car prices fell by a seasonally adjusted 1.6%, the largest drop since July 2009, and the cost of light trucks fell by 1.5%.

The decline in the price of motor vehicles was linked to a periodic change in how the government measures the value of quality improvements in motor vehicles. Wholesale prices for both categories of vehicles rose last month excluding the adjustments.