Prepared by First Chicago

The First National Bank of Chicago

Real GDP jumped 3.5% in the third quarter, close to the pace of the second quarter. Robust gains in consumer spending and business investment were only partially tempered by a drain in inventories and a sharp deterioration in trade. Imports of toys for the upcoming Christmas season were particularly strong.

Prospects for the fourth quarter are not quite as good. Consumer spending has moderated, but aggressive ordering for the Christmas season is expected to keep production and inventories at relatively high levels. Equipment spending is expected to remain relatively strong, and the stage is set for a substantial improvement in trade. On net, real GDP is expected to rise 3.0% in the fourth quarter. Growth for the year is expected to average 3.8%, its strongest performance since 1988.

This special report takes a closer look at the outlook for Christmas, and what it suggests about growth going forward. Robust gains earlier in the year have set the stage for relatively strong year-on-year gains during the Christmas season. Underlying momentum has slowed in recent months, however, and the result could leave retailers with more inventories–and more discounting–than they would like for the start of the new year.

Total retail sales in November and December are expected to rise 5.2% from a year ago. Sales at general merchandise and apparel (GMA) retailers, which capture the traditional Christmas market, are expected to rise a more robust 5.7%.

Uneven Gains

Strong gains in household furnishings and GMA store sales are expected to provide some offset for weakness in the light-vehicle market. Home buying has held up, while vehicle sales have softened. Summer incentives borrowed sales from vehicle demand this fall, and rail car shortages at Union Pacific are delaying deliveries for some producers.

			1995	1996	1997
Total Retail Sales	3.4%	4.6%	5.2%
Inflation-Adjusted	0.9	1.2	3.0
Gen. Mer. and Apparel	3.3	3.7	5.7
Inflation-Adjusted	3.5	4.0	4.6

Consumers are clearly doing better than they were a year ago. Unemployment has dipped below 5%, and consumer confidence has reached new highs. Recent spending gains will be tough to beat, however, and there are signs that underlying momentum is slowing:

–Employment growth has begun to moderate, suggesting that the number of new paychecks that this economy can generate is limited.

–The cushion on saving has eroded.

–The kick from credit is not what it once was. Credit card providers are attempting to target a more credit worthy household than they did in the past, and as a result, have contributed to a slowdown in debt accumulation.

Index of Consumer Confidence, Conference Board

There are also concerns that recent equity market volatility could contribute to weakness during the Christmas season. Financial markets were ripe for a correction heading into the fourth quarter, however, and the recent drop in saving suggested that consumers had already spent earlier gains. The additional drag created by recent market turmoil is expected to be marginal.

On net, retailers can expect substantial, but not spectacular, year-on-year gains in consumer spending during the Christmas season.

The problem is that retailers have ordered for a spectacular Christmas, and now they will have to use discounting to unload unwanted inventories. Some slowdown in ordering is also likely for the first quarter, as fears of a Christmas hangover mount. A late Thanksgiving, and the crush it creates in December, will only exacerbate the situation. Timing is everything during the Christmas season, and the later that consumers shop, the more discounting that is likely.

The Great Lakes Index rose 2.9% in the third quarter, slightly behind the pace of real GDP growth. Strong gains in consumer spending and investment were partially offset by a deterioration in trade and a drain in inventories. A summer surge in sales left light vehicle inventories particularly tight by the quarter's end.

Preliminary data suggest slightly better fourth quarter growth. Light vehicle production is scheduled to top the highs of the third quarter, equipment orders remain strong, and exports are expected to accelerate. Gains in Europe and Latin America continue to provide ample offset to problems in Southeast Asia. The only soft spot is household spending, which has slackened from the robust pace of the third quarter. On net, the GLI is expected to jump 3.2% in the fourth quarter, slightly above real GDP growth.

This report examines the Christmas outlook and how it translates for the industrial Midwest. Low unemployment and strong gains a year ago are limiting our ability to outperform the nation. Underlying demand remains extremely strong, however, and there are still some pockets of strength worth noting. Chicago is poised to do particularly well.

Total retail sales are expected to rise 5.1% from a year ago in Illinois during November and December, slightly behind the pace of gains for the nation. Chicago is expected to do somewhat better than the rest of the state, with gains topping 5.5% for the period. There are many reasons for this, not the least of which is that the area has become a shopping destination for Christmas shoppers.

Chicago has also benefited more from the run-up in wealth over the last several years than other parts of the region. A larger percentage of employment is directly dependent on the behavior of

financial markets in Chicago and home values in the city skyrocketed in 1997. Area homeowners have more to gain from the recent spurt in refinancing activity than homeowners elsewhere.

Last January, the Commerce department discontinued its regional retail sales survey. The table shows the only data available, which represents a translation of tax receipts for the state of Illinois. Timely data was not available for other states.

			1995	1996	1997
Total Illinois Sales	0.4%	5.0%	5.1%
Inflation-Adjusted	—2.1	1.6	2.9
Total Chicago		0.3	5.3	5.5
Inflation-Adjusted>	—2.2	1.9	3.3

*Based on retail sale tax receipts for the state of Illinois.

Source: Federal Reserve Bank of Chicago

More Broad-Based Gains

Sales gains are expected to remain more evenly distributed across categories in this region of the country. Auto dealers are located closer to the source of production, meaning trucks can more readily replace rail cars for shipment purposes.

Separately, the unseasonably warm weather experienced earlier this fall is likely to take a greater toll on area apparel sales. Discounting was especially heated in the last weeks of October, well ahead of the official start of the Christmas season.

Conditions in the region remain extremely favorable. Unemployment continues to drop, despite already low levels, and area confidence continues to improve. Area consumers remain among the most optimistic in the country. The improvement for higher income households has been particularly large, which is not surprising given the phenomenal rise in area home values over the last several years. Almost three-quarters of households still consider their home (rather than their stock market holdings) their largest asset.

*Estimates derived from Conference Board data.

Finally, lower debt burdens (and commensurately lower bankruptcies) suggest that the kick from credit might be greater here than elsewhere. Area consumers still have a considerable amount of credit to tap in their homes and elsewhere.

Great years are tough to beat, however, and there are signs that underlying momentum is waning. Most people looking for a job have already gotten one, and the number of new paychecks that we can generate is limited. Moreover, the additions to employment that we have seen have largely occurred at the entry level. That is great for workers looking to transition from welfare-to-work, but does very little for the vast majority of retailers hoping to attract middle and upper income shoppers.

On net, area spending is expected to remain relatively strong over the Christmas season. The premium in growth that this region once enjoyed over other parts of the country, however, is disappearing. The only exception might be Chicago, a retail hub for the region. Michigan Avenue is expected to do particularly well.

Strong gains will not be enough, however, to bail out retailers and liquidate overstocked inventories. Look for discounting to remain a prominent feature of the Christmas season, even in the more buoyant Midwest.

November 10, 1997 Diane C. Swonk

First Chicago

The First National Bank of Chicago

One First National Plaza, Chicago, Illinois

Consensus National Futures and Financial On Line Index

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