As Wall Street unravels and the economy confronts its crucial holiday spending season, consumers cannot be expected to prop up retailers as they have in past downturns. Even luxury stores, whose customers have been immune in recent years to retail price sticker shock, are expected to take a hit this time, according to Wharton faculty and consumer analysts.

Most consumers were already struggling with high food and energy prices, shrinking home equity and concerns about their jobs even before the financial crisis hit with a vengeance in September. Now, those with big exposure to real estate and stock market investments are suffering as well, says Wharton marketing professor Stephen Hoch. “It’s been a rotten year for the consumer already and this latest round of ugly developments has probably not fundamentally changed the situation. The people affected now are the upper [end] who have — or had — accumulated wealth and have lost a third of it. This is the nail in the coffin of the luxury sector.”

Deloitte Research forecasts a 2.5% increase in spending for the period between October and January, but — after accounting for inflation of more than 4.5% — that is actually a decline, and puts this holiday season on a par with downturns in 2002, 1991 and 1981. The end-of-the year sales period is critical for retailers because spending during the holiday season can account for 40% of retail sales and more than half the industry’s profit. Moreover, consumer spending accounts for 70% of GDP.

Meanwhile, the latest news from The Conference Board is hardly upbeat. Its Consumer Confidence Index fell to an all-time low in October. (The cutoff date for October’s preliminary results was October 21.) “Consumers are extremely pessimistic,” the Board said in a statement on October 28. “This news does not bode well for retailers who are already bracing for what is shaping up to be a very challenging holiday season.”

Or, as Erin Armendinger, managing director of the Jay H. Baker Retailing Initiative at Wharton, puts it: “There will be a Christmas and there will be gifts, but it will be a lean Christmas. Who wants to run up all these credit card bills when no one is sure what the future holds?” Gift-givers will be looking for value-driven products or will splurge for something that is new and special, she adds. “If they are going to part with their money, there better be a compelling reason.”

Build-a-Bear’s $10 Products

The good news for retailers, according to Hoch, is that they were already expecting a weak season. Warning signs of trouble were brewing before the holidays a year ago as credit tightened, home sales declined and gasoline prices were on the rise. Now, with a severe stock market collapse and a growing list of corporate layoffs, retailers are braced for hard times.

Amazon told analysts it is already seeing weakness in purchases over $1,000 in particular. Build-a-Bear workshop, the St. Louis-based specialty stuffed animal chain, is emphasizing its $10 products. On “The Today Show,” Neiman Marcus unveiled its traditional holiday gift catalog for the ultra-rich, including the Dallas Cowboys’ end zone of the soon-to-be-replaced Texas Stadium for $500,000. But later in the program, Neiman Marcus also presented some lower-priced gift ideas, including slippers, pajamas, popcorn and a selection of teas in the $100 price range.

Wharton adjunct associate professor of finance Christopher Geczy says that while all consumers are suffering, affluent individuals have been more heavily exposed to highly leveraged positions in real estate and equity markets. Those consumers are now feeling the effects of the financial crisis as housing, equity and emerging markets all pull back at once. Further, he says, financial advisors failed to rebalance portfolios and poured investments into high-performing categories just as the bubble peaked, setting their high-net worth clients up for today’s shocks.

People whose net worth has dropped from $5 million to $3 million, for example, “are feeling anxiety that they have never felt in their lives,” notes Geczy. In many cases, people in this income bracket were business owners who worked a lifetime, or across more than one generation, to accumulate wealth that has now evaporated. “The volatility you see in the market is something you rarely see day-to-day in a business, and it’s a new experience. They felt very comfortable at $5 million; at $3 million, their retirement and lifestyle are in jeopardy,” says Geczy, who in December will lead an executive education program at Wharton titled, “Wealth Preservation in an Age of Uncertainty.”

At higher levels of affluence, the falloff in short-term portfolio assets is less meaningful, according to Geczy, who says that as families reach $10 million to $15 million in net worth they begin to build long-term portfolios. Even in that range, however, medical expenses and inflation could bring diminished expectations of retirement. “I don’t think a person with $20 million is going to sweat medical expenses as much as a person with $1 million or much less. But even at what seems to be tremendous levels of wealth, there is still anxiety.”

As a result, luxury retailers are no longer immune to the jitters that have plagued other retailers in past spending troughs. Carl Steidtmann, chief economist at Deloitte Research, says that in recent years, luxury retailers had been able to sustain strong growth by developing new entry-level brands and products to draw in “aspirational” shoppers with lower incomes than traditional customers. Now those aspirational spenders who helped support high-end retailers in recent years are more susceptible to the economic downdraft than long-time clientele. Luxury retailers are no longer “bulletproof,” he says.

The most vulnerable retailers, according to Steidtmann, are department and specialty stores in the middle market. These retailers offer a product mix that is highly discretionary and affected sharply by the loss of income or layoffs.

Small, independent retailers will also struggle, Armendinger says. On the one hand, they know their customers extremely well and can merchandise effectively in a downturn. But with the higher costs of borrowing and with consumers looking for the best price possible, independents will be squeezed. Locally owned shops usually can’t offer the lowest price because they are too small to buy directly from manufacturers and must cover the costs of their wholesale supply network. “They are going to get hit like everybody else,” she notes.

Not surprisingly, discounters fare better than other retailers in recessions because they pick up more middle market customers, according to Steidtmann, who notes that this trend was strongly evident in the 1991 downturn.

The Family Dollar chain, which sells most of its inventory for less than $10, has been taking steps for nearly a year to prepare for the current economic slump. The company’s target customer earns up to $30,000 a year, but the company is now expecting to see an increase in sales to people earning up to $40,000, according to spokesman Joshua Braverman. The company has shifted its inventory mix to more consumables — such as cleaning supplies, food and paper products — and away from more discretionary items, such as home goods. “When we look at our customers, they would rather have a $1 lower price than 1,000 more points on the Dow,” he says. “The trade down is a benefit for us, but our focus is on the core customer.”

Because the industry had so much time to see the problems coming, it has been exceptionally proactive in managing for the coming slump, Steidtmann adds. Inventory-to-sales ratios are at historic lows and retailers have been extremely cautious month-to-month about hiring. “Retailers are not going to get the panicky promotions that we have seen in some recessions. They have planned more conservatively going into this holiday season than in the past, which means they will make money on what they do sell. Nonetheless, costs are still going up, and if you don’t have revenue increases, it becomes challenging to grow profitability.”

Indeed, according to a BBDO survey released Monday and reported in the Wall Street Journal, chief marketing officers at 100 retail companies with sales of more than $100 million predict that same-store sales in the next two months will fall an average of 2.7% over last year’s figures, while 88% of those surveyed expect to offer more discounts and promotions than in 2007. In addition, while 20% of the executives forecast an increase in sales this season, 41% predicted flat sales, according to the Journal.

‘Hunker Down’ and Survive

Retailers’ top strategy, Hoch suggests, should be to survive. Past holiday spending downturns prompted a rash of post-holiday bankruptcies and mergers. He predicts there will be some consolidations and store closings in the mid-market — West Coast retailer Mervyn’s, for example, recently closed its doors — but perhaps not as many as in the past because most of the merger deals have already been accomplished. “In other times of weakness,” he notes, “a strong player with deeper pockets would get more aggressive and try to steal share and business. I don’t see that happening this time. I think everybody is going to hunker down and be very circumspect.”

The nation has excess retail capacity, Hoch states, adding that retailers will reduce locations or eliminate store openings. They should become aggressive on promotions and pricing, he suggests, “not with the intent of grabbing business, but just hanging in there.”

And while lower gasoline prices are a relief to consumers, the price decline will not be enough to override all the other challenges retailers face this holiday season, says Armendinger, noting that Wal-Mart has already taken a strong stand on toy pricing in an attempt to maintain its position. Overall, retail advertising through the holidays will have a strong emphasis on value, she predicts, adding that retailers should take a hard look at every aspect of their operations. If a concept or location is not working, the current climate does not offer enough of a cushion to keep addressing the problem until it can be turned around for a payoff. “You have to cut your losses and focus on the core business and make sure that is performing well.”

Scott Hoyt, senior director of consumer economics at Moody’s, says consumer spending this holiday season will be shaped by two forces. Faced with declining home prices, job worries and credit card debt, consumers simply are in no position to raise spending levels. In addition, they have lost confidence in the economic future, making them especially wary of spending. “Confidence is down in the doldrums,” states Hoyt. “So not only will consumers struggle to find the wherewithal to spend, it’s not at all clear that they want to.”

While consumer spending and debt levels had reached unsustainable levels and were bound to come down, Hoyt says, the abrupt and painful collapse in housing prices and dramatic stock market losses have brutalized consumer psyches. As a result, the slowdown may be harsher than it would have been had the bubble deflated more gradually. “Consumer spending had been growing faster than GDP for decades, and we were to the point where it couldn’t continue. The hope was that you could make a gradual transition to increased saving. If we hadn’t had the housing bubble and the financial panic, presumably we could have done the transition more smoothly.”

Despite the severity of the current downturn, Hoyt is forecasting a turnaround beginning in the middle of 2009 with a peak in unemployment in early 2010. Home prices are expected to bottom in the summer of 2009, but not begin to increase until the second half of 2010.

A full-out economic crash is not in Hoyt’s base forecast. “If the government were to prove unable to stabilize financial markets, that risk can’t be ruled out,” he says, “but if you look back historically, when governments recognize a major problem and actively combat it, they usually succeed.”

Steidtmann expects consumers to face several years of retrenchment, but other elements of the economy, including business investment, trade, and energy productivity and investment will step forward to replace consumers in driving future growth. “We will have a recovery next year, probably late next year, but we’re going to have a very different economy,” he says. “We have had a consumer-driven economy for 25 years. Now we will have an export and business-led economy.”