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The Wealth Effect



November 29, 2007 – Comments (11) | RELATED TICKERS: SHLD

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. 

11 Comments – Post Your Own

#1) On November 29, 2007 at 9:58 AM, dwot (29.69) wrote:

Different topic here, read Mish.

Moral Hazards and Federal Actions 

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#2) On November 29, 2007 at 10:25 AM, floridabuilder2 (98.77) wrote:

sears is sears + kmart... if you ever walked into their stores you would see why they are not making any money....  wal-mart is the benchmark for the poor... and target is the benchmark for the middle class and rich who like bargains.... i don't think the market is healthy, but every time i went into cash this year the market shot up... so now i stay invested and if i think the market is going down i recently discovered you can buy ultrashorts to protect your downside...  i love a market where you no longer have to short stocks you can just buy a stock that shorts stocks....

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#3) On November 29, 2007 at 10:26 AM, floridabuilder2 (98.77) wrote:

dwot should i view your significant increase in blog posts in november as a contrarian indicator?  lol

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#4) On November 29, 2007 at 10:46 AM, kristm (99.76) wrote:

SHLD isn't anything we should use to judge the retail segment, much less the economy as a whole. Sears was a damaged but fixable business, until they were bought by K-Mart. Now K-Mart serves as an albatross dragging the whole thing down. K-Mart stores are disgusting and nasty, with surly ignorant employees -closer to Big Lots than to Wal-Mart. Sears itself isn't what it used to be either, they're certainly not a Macy's or Target.

The real judge of this economy and your theories will be earnings from WMT and TGT.

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#5) On November 29, 2007 at 10:50 AM, kristm (99.76) wrote:

Oh hi florida - you apparently posted your comments while I was reading the original blog and typing my comment. Glad to see somebody agrees with me (or, I guess, technically it looks like I'm agreeing with you).

Go look at the SHLD page on Caps - My score leader gains are giving me the big head today!

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#6) On November 29, 2007 at 11:15 AM, floridabuilder2 (98.77) wrote:

hey kristm.... i'm still mad about the demon doug pool... cause i initially picked lev, then switched to toa cause i thought we had to comply with caps rules... and just told doug to keep it there... congrats on your victory... and your shld points leader stat

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#7) On November 29, 2007 at 12:17 PM, dwot (29.69) wrote:

Seems to me that KMart is equally a mature company in terms of the business cycle...

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#8) On November 29, 2007 at 12:21 PM, dwot (29.69) wrote:

Floridabuilder, I was preparing for a move and doing all kinds of thinks that kept me from writing or doing much in the way of research.

Which reminds me...

-40 is freaking bloody cold!!!!!

I am living in the North West Territories these days... 

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#9) On November 29, 2007 at 4:45 PM, GS751 (26.92) wrote:

yeahh been up there.  I was born and grew up in Texas for most of my life and have lived in new hampshire for the past year.  I feel your pain.

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#10) On November 30, 2007 at 5:04 AM, mgiv (38.19) wrote:

Interesting theory but I believe it's not the wealth effect but instead the home ATM ran out.  We are not perceiving ourselves as less wealthy, we are less wealthy as a whole. If you bought a new house and are making the payments, there really isn't too much disposible cash left over.  This is why I say the credit crisses is solved by default.  Default free's up cash flow thus boosts consumer spending.

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#11) On November 30, 2007 at 8:31 AM, dwot (29.69) wrote:

mgiv, I think we've got three different things reducing spending here.  I know when I got my second home I did not like the appliances and even thought I also didn't like the debt loan we were taking on, we borrowed more to replace the appliances.  That would be the ATM effect. 

I also know from living in the most expensive city in Canada that if feels like all I do is pay back debt for housing.  Paying mortgage, strata fees, and taxes (property and income) have eaten up as much as 85% of our household income.  That's a disposible income issue.

What I said about the wealth effect is "that the perceived loss of wealth regardless of ability to spend money reduces spending," so people who have a highly manageable mortgage, or even no mortgage, will reduce spending due to the wealth effect.

It makes sense to me that if my assets go down in value I'd tighten things up a bit. 

But I'd agree that the biggest effect that will kill the economy for years is the lack of disposible income because of debt on housing.  In Vancouver we've had fairly flat wages so wage increases have done little to help out with paying back debt. 

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