The Wealth Effect
I haven't looked closesly at the financial reports for Sears (SHLD) but looking at the 99% decline in earnings this morning I am question if we are seeing the wealth effect in action here.
What the wealth effect is that when people perceive they have more wealth they tend to spend more and when they feel less wealthy, they cut back on spending. Since the housing bull in 2001 we most likely have been seeing increased consumer spending just because people feel wealthier. The housing market topped about 2 years ago, but it is only the last year that people really see that their wealth is declining.
I believe the wealth effect suggests that consumers reduce spending by 5 to 9 cents for every $100 less of wealth. I don't have time to look it up, what's important is that the perceived loss of wealth regardless of ability to spend money reduces spending.
Sears is a long time establish business that is far more likely to follow a business cycle rather that a fad in its overall sales.
It looks like Sears is being hard hit by the wealth effect. Revenues were only down about 3%, yet earnings were down 99%. That means that Sears has had to cut prices and margins to the bone to get consumers into their stores.
And, if you compare the Q2 2007 to Q2 2006, well earnings were $1.17 last quarter and $1.88 the year earlier. The signs of reduced consumer spending are showing big time in Sears.
So, to all those promoting that the stock market is healthy, it is trading on a lower P/E now than when the bull run started in 2003 so there is no reason for the recent decline, well, if you want to think in a box the size of an atom, good luck with your investments.
We've just witnessed how earnings can implode 99% on a 3% decline in revenue. Reducing interest rates aren't going to change the wealth effect, nor will it improve consumer confidence that if they buy a home it is going to be worth as much as they pay for it today.
Plan your investment accordingly.