Forecast 2008

Slowing sales. Higher costs. Tighter margins.

Ouch! Those unhappy trends were a three-legged stool of misery for many retailers in the past 12 months. Indeed, 2007 was a period of transition for an entire economy that began to slow down after a half decade of vigorous growth.

And what lies ahead for 2008? Most observers see a challenging environment where healthy profits will require nimble management.

Economy Slows

"We have a considerably weaker nearterm outlook than we did a year ago," warns Sophia Koropeckyj, managing director of industry economics at Moody's Economy.com, a research firm based in West Chester, Pa. "The economy will be performing below its potential until at least the end of 2008."

Just how far below potential might that be? The answer is reflected in forecasts for the gross domestic product, the most widely used measure of economic health. Scott Hoyt, director of consumer economics at Economy.com, expects GDP growth to come in around 2.0 percent when 2007 numbers are finally tallied. That performance is well below the 2.9 percent recorded for 2006.

Not much improvement, if any, is expected in the year ahead, when GDP is forecast to grow around 2.3 percent. That's not good news because economists say 3.0 percent is the average rate of long-term growth in a normal economy.

The message is even worse for core retail sales, an important measure that excludes the distorting effects of auto and gas station revenues. Hoyt sees core retail sales increasing by some 3.4 percent in 2008. That represents a deceleration from the 4.7 percent growth expected when final numbers are tallied for 2007, a year which itself racked up a less-robust increase in this area than the healthy 7.1 percent growth of 2006.

Taken together, these numbers reflect the more challenging environment for retailers. "Retailers are bracing themselves for a slow start in 2008," says Jen Millard, director of McMillan|Doolittle, a Chicago consulting firm.

Housing Woes

So what's the problem here? Several villains are play leading roles: the erosion of the housing market, high fuel and commodity prices and the continuing struggle by business owners to put a lid on labor and medical costs. Housing woes, of course, have hit the headlines big time. "The major weights on the economy have been the implosion of subprime mortgages, the downturn in the housing market and the resulting decline in building activity," says Koropeckyj. Look for more ahead. "Problems with the housing market are not going to disappear overnight. They will affect the economy through the end of 2008."

The decline in the turnover of existing homes is expected to bottom out by early 2008, but the related home construction activity that is so important to the economy is not expected to turn around until well into the year. As for the troubling housing price slide, that's not expected to hit bottom until the end of 2008.

Perhaps the most serious elements of the housing market crisis are the interest rate resets on adjustable-rate mortgages, which are now putting financial pressure on homeowners.

These haven't peaked, says Koropeckyj: "There will be more foreclosures, and that could have a serious impact on the economy."

Financially strapped homeowners, of course, shop less. But there's another reason the mortgage meltdown affects business owners: Financial trauma can erode an employee's workplace performance. "All of these repossessions are impacting workers," reports veteran business consultant Don Schackne, president of Personnel Management and Administration Associates, Delaware, Ohio. "Many of my clients are struggling with how to respond. How much should they try to salvage an employee's problems with corporate money which was not meant for that purpose?"

Energy Prices

High prices for gasoline and heating oil have continued to plague consumers and retailers over the past 12 months. "Pressure on margin will continue to be a challenge," says Millard. Retailers feel pressed on two sides. First, higher transportation costs are increasing the cost of goods sold. Second, consumers are resistant to higher prices. "Consumers have handled energy costs rather well themselves and are not willing to accept price increases. People are price conscious."

Labor Costs

One major positive factor is propping up the economy: healthy wages. Economy.com expects a wage-growth figure of some 3.5 percent when 2007 figures are in, up from 3.0 percent in 2006. The figure for 2008 is expected to be 3.2 percent.

These wage increases are a result of pressures on employers from the low unemployment rate, which has been hovering around 4.5 percent. It takes more money to retain and keep good people.

And that, of course, is a doubleedged sword. On the one hand, robust wage growth is good because more money in consumer pockets stimulates shopping. On the other, business owners feel squeezed between escalating payrolls and customer resistance to price increases in a decelerating economy.

"Wage growth is rising at a rate faster than inflation, which is rising some 2 or 2.5 percent," notes Ken Goldstein, an economist at The Conference Board. "That's been the case for a couple of years and is not likely to change in 2008. As a result, business owners foresee a negative impact on profits."

Given the predictions of low unemployment through 2008, upward pressure on labor costs should continue. "The help-wanted signs are out," says Schackne. "We are not hurting for jobs but we're hurting for qualified employees to fill them. In many respects we are right on the edge of the unemployables. Employers are refusing to hire the applicants they are seeing."

Finally, no element of labor cost has received more attention recently than the perpetually aggravating increase in healthcare coverage.

"Healthcare costs are going up in astronomical figures and my clients are asking, 'How much of this premium can I subsidize?'" notes Schackne. "Employer contributions have gone from 100 percent down to 60 percent in many cases, and employers are saying, 'I cannot absorb this anymore.'"

Recession Risk

Business owners begin a new year in a risky economic environment. Will the nation fall into recession? Economy.com estimates the risk of such a downturn in 2008 as one-inthree. That's a reduction from the 40 percent level that the organization maintained between the housing industry debacle of last summer and the Federal Reserve's interest rate cut in September.

While the Fed may cut rates further, economists caution against expecting too much from monetary policy. "The chances for a recession are still fairly high although it is not in our baseline forecast," notes Hoyt. "We expect that the economy is undergoing a 'soft landing' but we have to make sure it runs up next year and not down before we can definitely say that."

And just what final entry into our litany of woes might trigger a recession? There's little doubt that the most likely culprit would be a downturn in consumer confidence and shopping patterns, says Koropeckyj. "The big wild card is this: Will consumers continue to support the economy?"