The 2009 Economy

So here we are, eight days in to the new year, and I am ready to call it already: the economy is getting worse in January.

I base this on a number of data points, all of which are anecdotal but which I have high confidence in nonetheless. I have marveled throughout most of the latter part of 2008 how resilient the economy seemed to be, in particular in New York City, at least in the little things. Every time I went out for lunch, the places were still mobbed. People were still out in the stores, out walking Fifth Avenue, making the typical big line at Sephora and Saks and Crate and Barrel. I've seen it with my own two eyes over the past couple of months, and I have taken some quiet comfort in it, knowing that the people in the hardest-hit city in America by the financial crisis of the past 18 months are still out and about, doing their thing little by little to keep the economy chugging along.

Since 2008 turned to 2009, however, I have seen a very noticeable change. The noodle house where I eat lunch at with some regularity -- where I just waited for a table for 4 for a good 20 minutes at 1pm not even ten days ago -- was pretty much empty all through the lunch rush on Tuesday of this week. Ted's Montana Grill, a bison and beef burger place in the basement of my old building, never got more than one-third full at any time during the lunch rush on Wednesday, despite normally completely capping out by 12:30 or 12:40 every day in the recent past. And last night I went out to DSW, my favorite shoe store in the world, and noticed two disturbing things. First, there was almost nobody in the entire store. Now that's one thing when you go into one of these little boutiques that line the streets of Manhattan, as only one or two shoppers in an 18x12 shop does not necessarily portend bad business per se, but when you're in one of these giant one-room warehouse type of places and can only see one other shopper in the entire store, you take notice. That was me yesterday at the DSW.

But more than that -- and frankly, this I think was the most disturbing thing I noticed of all -- the inventory on hand at DSW pretty much sucked. I mean, here we are two full weeks after Christmas now, and DSW clearly has not restocked their shoe inventory to anywhere near their previously normal levels. And it's not like this store doesn't have a store manager, of course they do. And I imagine DSQ headquarters also likes to keep at least some tabs on how much each store has available to be sold. These guys are very clearly and deliberately not restocking at the clip they always used to (I've been there about a million times over the past ten years), not even close. And that is when things get really scary.

This is how recessions tend to feed on themselves, to derive fuel from the very existence of the recession to make itself get stronger and more broadly felt. So much of a recession -- not unlike a bubble, for that matter -- is mental and emotional. So, the DSW brass hears all about the recession we're in all through the final few months of 2008. They keep inventory on hand for the final couple months of the year, because the holidays are coming up and they know that, like most retailers, they make a third of their total profits heading up to and through the holiday shopping season, and they want to make sure they have the product to sell to the droves out looking for the perfect pair of dress shoes for their dad, the perfect little slippers for their young niece, or the perfect high tops for their teenaged son. The end of the year is retail's bread n butter, and they're not going to miss out on all that.

But all the while, they know this recession is out there. They manage to sell enough shoes during the holiday shopping season, by aggressively cutting prices and keeping a lot of inventory in all the different sizes on hand. It's not a great holiday season by any means, but they manage to get by ok. And now it's January. The big rush to buy shoes is over, and DSW knows it. They're fully expecting demand for shoes to drop dramatically as consumers rein in their spending in the new year, and the DSW brass comes up with a great idea to help stem the losses as 2009 begins -- buy fewer shoes from their manufacturers, keep less inventory on hand and thus lower their cost of goods sold. In a nutshell, this works. It's not going to stimulate demand at all, but DSW figures (correctly, I'm sure) that there is nothing they can do on the demand side, but at least they can exert some control over the supply side, by limiting the shoes they buy for resale in their stores.

So what happens next? I find a hole in his favorite pair of black shoes, and I hit up the DSW to buy a couple of replacements. But they literally have no shoes in the styles I prefer in my size. Sure they have size 8 and size 14, but nothing in my size in any one of four or five styles of shoe I would have bought if given the chance. Mind you, this has never happened to me before with DSW, which always has the best selection anywhere other than the Internets themselves. But amazingly, I leave the store with only one pair of shoes, not the ones I intended to buy, and surely less than I had planned to spend at DSW when I got in there a half hour earlier.

See what just happened there? DSW, in its attempt combat falling demand for its product, just lost a sale they would otherwise have gotten (and theoretically should desperately want to get, given the demand dropoff for shoes in the new year). And this is a sale they will never get back, as I will now probably try to make do with this one pair of shoes I bought for a while, and maybe I'll buy another pair of black shoes, and maybe I won't. And even if I do, it's doubtful I will drive all the way out to DSW again when suddenly the very selection that makes DSW such an attractive option may no longer be available to me. And thus, DSW's revenues and profits decline double -- first, because demand has fallen so much due to the existence of the recession, and then second because that lack of availability of shoes (due to DSW's reaction to the recession) causes them to miss even more sales among the little demand that does exist.

And this doesn't even touch the extent of the problem. When DSW makes the decision to purchase fewer shoes, this has a ripple effect that reaches far beyond just Hoyazo not being able to buy the shoes he wants on a Wednesday night in the New York City suburbs. All of DSW's suppliers of shoes, either the resellers like zappos.com, or the original manufacturers like Nike, 9 West, Cole Hahn, Florsheim, etc. see their revneues drop, because DSW, one of their largest customers nationally, is suddenly buying fewer shoes. This is in addition to the demand drop they are all seeing from their direct sales to consumers as well. What's more, those suppliers now go to the makers of the raw materials they use to manufacture their shoes, and cut their orders for those raw materials. So the leather companies, the lace factories, the rubber companies, all see their orders and revenues drop as well when DSW makes a decision like this. Farmers who grow rubber trees and who raise cows used for leather feel the pinch. The effects of the recession itself on demand are one thing, and are very measurable at that, but the effects on the truly broader economy once companies start to react to the recession by cutting production, this second stage of recessions are where the whole slowdown starts to fuel itself, and I fear we are entering this sort of environment right here right now as 2009 begins in the U.S.

And don't get me wrong -- I don't mean to suggest that one DSW store not having my shoe size available is going to take down the entire economy. But, when you take that one DSW experience I had this week as a microcosm of what I believe is happening among companies in the U.S. (and probably the world) across the board, you can imagine how this "second stage" of the recession can have a profound impact on things. Just like in boom times when demand soars, and then demand for raw materials soars as well (stage 2) because producers rush to make as many widgets as they can to meet rising demand, in a recession like this, it is often the second wave, the one focusing on the raw materials, that can really kick start a fresh decline in overall demand at a time when the country and the world can least stand it. My experience so far in eight days of 2009 has been purely anecdotal, but I fear that the lack of traffic I am seeing in retail establishments all around New York City and the surrounding area is far from isolated, and is probably a harbinger of more bad news to come over the next month or two on the economic front in the U.S.

Once again, I will be looking to short technology stocks (in particular chip companies, which are getting absolutely crushed right now due to lack of demand and falling prices for their chips) and retail stocks as profit possibilities in what I expect to be a dismal earnings season, even in the face of already lessened expectations.