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Look for a gradual easing in overall U.S. economic activity. Inflation, and its impact on consumer spending, continues to raise major concerns. Rising interest rates, a slowing housing market and increased energy costs are the primary considerations.

The Federal Reserve recently suggested it expects an average rate of growth of significantly less than 3 percent (annualized) in the last three quarters of 2006.

Some other indicators of economic activity are generally more favorable, and will provide a reasonable support level. Corporate earnings are good, employment gains are reasonable, manufacturing activity is sound and business investment remains healthy.

First quarter Gross Domestic Product grew at an annual rate of 5.6 percent. The advance estimate of second quarter growth was 2.5 percent. Lehman Brothers estimates full-year economic growth at 3.5 percent. And its outlook for the year is 3.5 percent. Recall that for 2005, GDP grew by 3.5 percent, following a strong 4.2 percent gain in 2004.

But the Consumer Price Index for the first six months of 2006 increased by 4.7 percent, versus 3.4 percent for all of 2005. Energy prices alone grew at an annualized rate of 22.8 percent during the first six months of the year.

June retail sales fell by 0.1 percent. However, this weak headline number, while indicative of an overall economic slowdown, is not as dire as it may first appear. In fact, when you exclude the volatile auto, gas and building materials sectors, retail sales rose by 0.3 percent in June. But while sales were up 9.5 percent for the first quarter, they’re trending down – up 5.2 percent during the second quarter. By way of comparison, overall 2005 retail sales grew by 6.1 percent, following a strong 7 percent gain in 2004.

The National Retail Federation looks for retail sales growth to slow during 2006 to 4.7 percent. And, due to trends in consumer spending, we think the NRF is probably pretty close.

Consumer spending has slowed markedly in the second quarter. It’s estimated to grow at around a 2.5 percent annualized rate, after rising a strong 5.1 percent during the first quarter. In the short term, energy prices are impacting spending (gasoline prices surged roughly 30 percent from early March through May). Longer term, increased levels of consumer debt (hitting a high of 13.93 percent in the first quarter), a reduction of cash-out mortgages (on the rise since 2000) and falling equity prices will impact spending.

We believe that retailers are already adjusting to this expected slowdown. For example, year-over-year retail employment for the first six months of 2006 fell by 0.2 percent, versus an increase of 1.3 percent during 2005 (versus overall U.S. employment growth of 1.4 percent). In addition, McGraw-Hill Construction estimates that store construction starts will ease to 2 percent in 2006 versus 3 percent in 2005, the first decline since 2002.

Steven Keith Platt is managing director of S.K. Platt Co. (Hinsdale, Ill.). The firm specializes in representing buyers and sellers of companies, strategic financial planning, and market economic analysis and marketing consulting. He is also director and research fellow at the Platt Retail Institute, which brings together retail executives with leading academic researchers (www.plattretailinstitute.org). He can be contacted at skplattco@yahoo.com.

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