Global Economic Outlook

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The economic situation for retailers

The past year began with such promise and ended with such uncertainty. At the start of 2010, the world was relieved to have avoided a more grim economic result. The downturn of 2009 was the worst in decades, but it was not as bad as what might have happened. Government intervention to recapitalize banks, stimulate demand and flood the market with liquidity helped to avoid pandemonium. However, all of this was not sufficient to start a robust recovery -- at least not in the developed economies of North America, Europe and Japan. There, growth has been modest, and thankfully, inflation has been low. On the other hand, strong growth came to the emerging world and with it the risk of rising inflation. Hence, as 2011 begins, retailers worry about inadequate demand in rich countries and overheating in emerging countries. In addition, they now face concerns about exchange rate volatility, changing fiscal policy and the sustainability of recovery in some markets.

One problem is that imbalances continue to haunt the global economy. Interest rates in developed countries are unusually low, reflecting aggressive monetary policy and weak demand for credit. Thus, money is flowing out of these countries and into emerging markets with higher interest rates. Yet in those countries where growth is strong, the inflow of capital is putting upward pressure on currency values, thereby hurting export competitiveness. At the same time, rapid growth in emerging markets is creating new inflationary pressures, which have led some central banks to tighten monetary policy, thereby putting additional upward pressure on currencies. Now, many emerging governments are intervening in currency markets to hold down their currencies in order to improve export competitiveness – but this risks exacerbating inflation. Moreover, if every country tries to devalue its currency, no currency will decline in value, but all countries will increase their money supplies, thus generating inflation.

And so the global economy remains imbalanced. Countries that have traditionally relied on exports (such as China, Japan and Germany) and need to move toward domestic-led growth continue to depend heavily on exports. Countries that relied too heavily on their consumers (such as the United States and the U.K.) and need to export more now face competitive devaluations in their target export markets, thereby hurting their own export competitiveness. Failure to adjust to new realities will only delay the day of reckoning, yet making the necessary adjustments involves short-term pain.

Affluent countries that nearly experienced economic meltdown now face tattered financial markets. Credit fails to grow as consumers and businesses hoard cash and continue to deleverage. Debate rages over whether central banks and governments should respond by becoming more aggressive, but an aggressive stance risks continuation of global imbalances.

Overall, the outlook for 2011 is for strong global economic improvement, with the preponderance of growth taking place in emerging markets. In the developed world, however, growth is not expected to be exceptional. Let us examine the outlook in each major market and consider the potential impact on retailers and their suppliers.

United States
The U.S. economy did not perform especially well in 2010, but 2011 looks to be more promising due to several factors. First, there is considerable pent-up consumer demand. In addition, consumer cash flow has markedly improved, so there ought to be a pickup in consumer spending. Second, the aggressive expansionary policy of the Federal Reserve, known as quantitative easing, is likely to push down real interest rates and, therefore, boost demand for credit. It could also lead to increased values for various financial assets. The result, it is hoped, will be a stimulus for consumer and business spending. Finally, although a high degree of structural unemployment remains, there are indications that job growth will pick up speed in 2011. This would boost consumer spending and help to reduce worrisome budget deficits at the federal and state levels.

Still, there are some negative factors that could restrain economic recovery. Slowing growth overseas could hamper export growth, which was strong throughout 2010. In addition, a tighter fiscal policy could have a negative impact on overall economic activity. Finally, continued private sector deleveraging in the wake of the financial crisis could hamper growth.

As for U.S. consumers, they appear to be operating within the realm of a “new normal.” After a near orgy of debt-financed spending over the past decade, greater sobriety is now in evidence. While good for individual households, this new frugality is not necessarily good for retailers. It is manifested in greater value orientation, more price sensitivity, less discretionary spending generally and less spending on big-ticket items in particular. In the past decade, much spending was fueled by the housing market; in the coming years, housing is likely to be constrained if not dormant. While low prices of homes boost affordability, for many households it means having mortgage debt in excess of the value of the home. This fact, applicable to about one-quarter of all U.S. mortgage holders, has a negative impact on spending and mobility.

For U.S. retailers, the reality of the new normal has meant substantial cost cutting, lean inventories and modest expansion. As a result, despite slow growth, many U.S. retailers have become well positioned for the coming year. Those with strong value propositions or clear differentiation are likely to do well. Still, there is probably more retail capacity than the country needs, and further consolidation is not out of the question.

We are also likely to see spending restraint in the realm of discretionary merchandise. Thus, retailers focused on home-related and other big-ticket items may face challenges. The bifurcation of U.S. retailing, so evident the past decade, is likely to accelerate. This means strength for highly price-oriented retailers and those focused on superior customer experience -- and trouble for those in between. Clearly the challenges in the U.S. market will stimulate some retailers to invest outside the United States.

Western Europe
Although Europe as a whole bounced back in 2010, a confluence of factors is likely to cause a slowdown in growth in 2011. More importantly from a retail perspective, most of Europe’s growth is coming from exports rather than consumer spending. In Germany, for example, which had strong export-driven economic growth in 2010, consumer spending remained relatively stagnant. On the other hand, the modest and declining unemployment rate in Germany bodes well for a modest pickup in consumer demand.

Notably, economic policy within Europe has been aimed at reducing budget deficits rather than stimulating growth. Most governments are currently engaged in fiscal contraction, which entails tax increases and spending reductions. The European Central Bank (ECB), unlike the United States and Japan, has not engaged in quantitative easing and remains focused on minimizing inflation. Finally, European credit markets remain troubled by continuing sovereign debt problems and bad bank assets. The result is that the only factors stimulating economic activity in Europe are the weak euro and strong growth in emerging markets, which have boosted exports. Meanwhile, consumer spending is going nowhere, and fiscal contraction is likely to have a negative impact in the year ahead.

The other interesting thing about Europe’s outlook is that the continent faces a two-track economic outlook. Germany, Sweden, The Netherlands and other northern countries are performing well, largely based on export strength. In contrast, the peripheral nations of the EU face the prospect of recession or slow growth, largely due to massive government austerity combined with troubled credit markets. In some cases, like Ireland and Spain, the outlook is hurt by the need for banks to repair their balance sheets following the collapse of a housing price bubble. In other cases (such as Greece), the problem is a history of government largesse combined with failure to boost productivity. In any event, the recent recession shocked Europe into confronting long-simmering problems.