In the past few years, analysts have noted the phenomenon of Two Americas Shopping. Retailers that cater to the working class (Wal-Mart, Dollar General, Burger King) have seen sales grow below the pace of the economy at large while those that cater to yuppies, bobos, food snobs, extreme consumers, and dandies—in short, the better-off—have thrived.
But now, even as the ultrarich continue to shop as if money grows on trees, there’s mounting evidence that rising inflation, slow wage growth, and higher energy prices are pinching the upper-middle class. In recent weeks, several of the publicly held companies that cater to the mass affluent have reported disappointing results.
Last Thursday, Starbucks announced its results for the most recent quarter and for July. The results were generally fine, but they failed to meet caffeinated expectations. Same-store sales, the ultimate metric for any retailer, rose only 4 percent in July—a rate significantly below what investors were expecting. Starbucks came up with a strange excuse: Because of the heat, lots of people ordered Frappuccinos. And because it takes a long time to whip up the blended drinks, the demand created long lines, which in turn forced jonesing professionals to seek their fix elsewhere. (Blogger/analyst/investor Barry Ritholtz has a graphical representation of this phenomenon here.) Starbucks’ stock fell 8 percent on the day.
Intuitively, the excuse makes some sense. But Starbucks’ disappointment was hardly an isolated event. Whole Foods, which is to groceries what Starbucks is to coffee—an expensive, upper-middlebrow global do-gooder—also reported earnings last week. At first glance, the results were impressive. Same-store sales growth was 9.9 percent in the quarter. But that was below last year’s rate (15.2 percent) and below the average for the last five fiscal years (11.2 percent). And Wall Street was further disappointed that the company ratcheted down expectations for sales growth. Fretting that there may be some limit to the number of Americans willing to pay $7 for a head of organic broccoli, investors filleted, pounded, and sautéed the stock: It fell 11 percent last Monday.
Restaurants that cater to the type of people who take their coffee at Starbucks and shop at Whole Foods have also been feeling the pain. P.F. Chang’s, which serves up tasty, deracinated Chinese food in shopping centers around the country, reported a dismal quarter in late July. Worse, the company projected that same-store sales at both its “dining concepts“—P.F. Chang’s China Bistro and Pei Wei Asian Diner—would fall in the second half of 2006.
It could be, of course, that people are simply making more coffee and cooking more meals at home. But then they’d be buying lots more espresso machines and woks. Only they’re not. Last month, Williams-Sonoma, the leading purveyor of yuppie kitchen utensils and accessories, lowered its earnings guidance, saying same-store growth in the second quarter would be between 1.5 percent and 3 percent.
What gives? For years, betting on the ability and willingness of high-end consumers to spend was a winning formula for both retailers and investors. The ranks of the mass affluent were growing, their wallets filled thanks to tax cuts and rising home values. And thanks to the phenomenon of trading up, plenty of people on the lower rungs of the income ladder were splurging on things they were passionate about: golf clubs or shoes, for example. Now the powerful trend seems to be going in the opposite direction. Well-off consumers are reining in spending, and there is likely to be a growing phenomenon of consumers trading in steaks at Morton’s for Whoppers at Burger King. As the Wall Street Journal reported, “Burger King Chief Executive John Chidsey told investors during a conference call that the Miami-based chain is benefiting from a slowdown in spending at sit-down restaurants that is prompting some consumers to trade down to fast-food chains.” Investors are clearly worried that America is going downscale. Here’s a three-month chart of Starbucks, Williams-Sonoma, P.F. Chang’s, and Whole Foods against the S&P 500.
Clearly, the bite of inflation, rising interest rates, slow wage growth, low savings, and higher prices is starting to work its way up the income ladder. After all, people with higher incomes pretty much spend everything they make, too. In fact, there’s a degree to which upper-crust consumers could be feeling the pinch disproportionately. Depending on where they live, how they work, and what they spend, consumers experience inflation differently. Someone who takes a subway to work won’t feel the pain of rising gas prices, while someone who drives a pickup 70 miles to work each day certainly will. A person who takes a loan to buy a gas-guzzling power boat will find that the cost of buying and operating the boat has gone up dramatically; someone who buys a kayak made in China will find that the price of boating is falling.
Merrill Lynch economist David Rosenberg has examined the spending and consuming habits of his colleagues and clients on Wall Street and has created his own “Wall Street core inflation index,” which tracks the rise in prices of the necessities of yuppie life: “jewelry, spas, lawn care, health care, sporting goods, housekeeping services, tuition, airlines, hotels, salons, legal/financial services, and dry cleaning.” His conclusion: The price of spoiling yourself rotten is rising rapidly. “The Wall Street core CPI is running at 4%, nearly double what it is for Main Street,” he wrote in a report on July 28.
In other words, forget about the heat and the Frappuccinos. Sales at Starbucks and its sister high-end retailers may be faltering because the cost of living well is rising more rapidly than the overall cost of living.