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With the passing of Labor Day and the long days of summer behind us, the attention of all retailers now turns to the all-important Christmas selling season. After last year's blowout holiday season, what inquiring retailers and their suppliers want to know is -- How will we do this year?
Last holiday season had some powerful tailwinds driving consumer spending. Tax cuts added to consumer cash flow, as did strong home mortgage refinancing. Most retailers also had the benefit of easy previous-year comparisons.
While the sources of consumer cash flow are changing, they still remain in good shape. This holiday season will not be as strong as last year. It will, however, still be a solid season with above-average sales growth for most lines of trade.
The big positive change in the consumer outlook is in the area of jobs. A year ago, the job market was still contracting. In the first six months of 2004, the economy has added 1.27 million jobs compared to a loss of 237,000 jobs in the first six months of 2003. Job gains have been particularly strong in health services, business services, and construction. But government, manufacturing, and telecommunications sectors continue to shed workers. Retail employment is up a little more than a modest one percent.
While employment is up, wages are not. Real wage growth has been hurt by the sharp rise in gasoline prices and the continued rise in the cost of benefits. Real wages are down slightly from a year ago. Even with gasoline price relief, real wages are likely to remain flat to down for the remainder of the year as a considerable amount of slack remains in the labor market.
The housing market remains robust despite fears of rising interest rates and soaring home prices. Since peaking in early June, home mortgage rates have actually fallen slightly. Home prices continue to rise at a healthy pace, giving households more home equity to tap into when they refinance.
The biggest headwind to stronger consumer spending growth is the rise in gasoline prices. Rising oil prices act much like a tax increase on consumers by reducing purchasing power for non-oil-related items. Oil prices continue to hit record or near record prices above $42 a barrel. Prices are being driven higher by a combination of strong global demand and fears of a terrorist-induced disruption in supply. With oil inventories at record levels, any relief in the fear of terrorist attacks will exert downward pressure on oil prices.
While the sales outlook may not be as robust as it was a year ago, the profit outlook continues to look strong. For the first time in many years, retailers are finding that they actually have a modest amount of pricing power. Food prices at retail are up nearly four percent from a year ago, the fastest pace of price increase in more than seven years.

One of the reasons for the return of pricing power is the continued improvement in inventory control. Inventory-to-sales ratios are at record low levels nearly across the board. Retailers are no longer forced to resort to price promotional activity to move unwanted inventory. The combination of improved pricing power and inventory coupled with disciplined cost control as seen in the modest increase in retail employment levels points to a very good profit environment for retailers.

Food and Drug Retailers
Unlike much of the rest of the retail sector, food and drug retailers did not have a blowout holiday season in 2003. Sales since the first of the year have been steadily accelerating off of their mid-2003 lows. Rising prices for both food and pharmaceuticals will continue to boost sales growth and profitability.


For the rest of 2004, sales growth should continue to move sidewise to slightly higher. For the holiday season, sales growth should come in around 6.5 percent, up from 4.6 percent in 2003.

Convenience Stores
Convenience stores turned in a solid holiday sales season in 2003. After strong sales in the first half of the year, holiday season spending rose 6.8 percent from the previous year. Since the first of the year, rising gasoline prices have sent sales growth soaring.
The outlook for the holiday season depends largely upon the future direction of gasoline prices. Stable prices will leave sales growth in the high teens. Falling prices will push sales growth down to the high single digits. A further rise in gas prices will send sales growth above its current growth rate in the low 20s. Given the high level of oil and gasoline inventories, prices should head lower, barring some disruption in supply.

Mass Merchants
More than many lines of retail trade, mass merchants depend heavily on a good holiday season to make their sales and profit numbers for the year. Last year, mass merchandisers posted a solid sales gain of 6.5 percent. Since the first of the year, sales have continued to accelerate as mass merchandisers benefited directly from last year's tax cuts and larger-than-expected tax refunds.

With stronger comparables, mass merchants will see the pace of their sales growth begin to slow as the holiday season approaches. Despite this slowdown, sales growth for the holiday season should come in around 6 percent, down just slightly from a year ago.