Morgan Stanley on Friday sharply cut its forecast for retail sales growth next year, saying US consumer spending will be restricted by declining home values, tighter credit standards and more modest job growth.
Analyst Gregory Melich now expects retail sales to grow 3 percent next year, down from a previous forecast of 4.5 percent. That would mark the slowest annual growth in retail sales since 2003.
His forecast assumes average home prices will fall about 6 percent from where they are now, leading to about US$100 billion less in total consumer spending, half of which he predicts would come from traditional retail categories.
Declining home sales and rising mortgage defaults have sparked fears of a slowdown in spending and forced lending institutions to tighten credit standards. Overall, however, consumers have proven resilient even as prices for gas and food remain high and housing prices decline.
Melich's revised forecast is based on a predicted deceleration in household wealth, credit availability and jobs growth, which he calls "key lead components" of retail sales. Consumer electronics and home improvement sectors are particularly at risk, the analyst said.
Consumer spending is closely watched by economists because it accounts for two-thirds of the total US economy.
Jeoff Hall, chief US economist for financial-information provider Thomson Financial, said Melich's assumptions are valid but it might be a darker take than necessary.
"That's a pretty big haircut he's given the total outlook for 2008," Hall said. "This far in advance, it's difficult to say what is going to happen."
Melich encouraged investors to focus on companies that have the ability to increase earnings in a "decelerating market." He named Wal-Mart Stores Inc, Target Corp, CVS/Caremark Corp, J.C. Penney Co, Coach Inc, Staples Inc, O'Reilly Automotive Inc and Safeway Inc as good bets.
Drug retail could be a safe harbor in a consumer slowdown, particularly CVS/Caremark, Melich said, since it recently acquired Caremark, a "recession-resistant" prescription-driven business.
In the apparel sector, J.C. Penney and Coach have the ability to "drive margins higher, even amid decelerating retail sales," and they proved it in the first and second quarters this year, Melich said.
Staples has a booming international business and room for growth in many markets, Melich said.