This bulletin provides an update of the state of the U.S. economy as well as the likely corresponding impact of developing economic trends on the consumer for SMS clients and commercial partners.

Executive Summary

1. The U.S. economy is showing clear signs of improvement, beginning in March 2009, after the longest recession since 1955 (six quarters).

2. Previously improving economic statistics have shown signs of deterioration in June and early July. These trend reversals were not unexpected given the absence of substantial recovery in the U.S. employment and housing markets; a broad and consistent economic improvement is not expected until late 2010 into 2011.

3. In the current recession, consumers have exhibited significant changes in attitudes, spending, consumption, and a range of shopping behaviors (deal shopping, price sensitivity and outlet switching).

4. There is broad consensus among the research, economic and CPG community that following the current recession, U.S. consumers are unlikely to return to previous shopping and spending behaviors, and that new brand and retailing strategies are required to effectively compete for the share of the new consumers’ wallet
   
   

Short Term Improvement in Economy, Consumer Confidence & Spending

The U.S. economy has shown significant signs of improvement starting in late Q1/2009. A number of economic indicators support this thesis:

• Improvement in consumer confidence (up to 59.2 in May from a record low of 25.0 in February)

• Increase in durable goods sales two of the past three months, the best showing in nearly 15 months

• Increase of 2.9% in existing home sales in April

• Incrementally positive revision to U.S. GDP decline rate in Q1 (-6.2% to -5.7%)

• 40% increase in the value of the S&P 500

• Increase of 6.7% in home sales (largest increase in 7 years)

More importantly, statistics measuring forward-looking consumer sentiment appear to be improving at a faster rate than statistics measuring current consumer sentiment. Despite a slowdown economic activity in early summer (as had been anticipated), overall consumer spending is expected to show positive trends for the remainder of 2009, barring a significant economic shock.

There are two primary drivers of improved economic performance:

• The unusual length of the current downturn. While the average U.S. recession has in the past 60 years lasted 2 to 3 quarters, the current downturn, which began following the housing market collapse in August 2007 recently completed its 6^th quarter (Q4/07-Q1/09). Positive GDP growth is expected in Q3 and Q4, 2009.

• The impact of the $1.8 trillion dollar government of stimulus program. It is important to note that a significant portion of the stimulus is being targeted towards populations segments that are likely to have experienced the most severe repercussions of the downturn. Extensions in unemployment benefits and other similar programs are likely to unfreeze spending by bottom-2 quartile consumers, which in turn should result in improving aggregate money flow.

Based on the two factors noted above, the current improvements in U.S. economic performance are not surprising. However, there is significant debate over the longevity of the current economic rebound primarily based on the fact that consumer spending drives 68% of U.S. GDP, and at this point the manufacturing sector does not appear to be recovering substantially. Until structural improvements in the labor markets occur, a sustained and full economic recovery is unlikely.

One key economic variable SMS is carefully monitoring is fuel prices, which have increased by 50% in less than six months. It is worth noting that the start of the 2007/2008 recession coincided with rapidly rising gasoline prices, which had a material negative impact on consumer discretionary income and spending. Additionally, high fuel prices led directly to significant shopping trip consolidation, which helped drive single-source mass merchandiser retail outlets. If fuel price continue the current upward trend, the consumer is likely exhibit similar shifting shopping dynamics as we observed in 2008 (fewer trips and reduction in non-essential spending).

Continuing data points suggest that consumer shopping and consumption behavior is changing in a number of fundamental ways:

• Sales of consumer discretionary products continue to lag, despite downward pricing resulting from input cost deflation.

• Price cross-elasticity remains elevated suggesting that consumers are continuing to price-shop at an elevated level compared to pre-recession period.

• Private Label growth continues to outperform branded (especially premium brands). Overall PL share for the average category was recently reported at over 17.5%, the highest ever observed in the U.S. market.

• Promotional response has increased sharply and remains exceptionally high

The current consumer research project is examining these and other consumer trends and establishing an on-going path for measuring changes in consumer behavior. The strategic objective of this research is be to determine which consumer segments will be likely to retain their post-recession attitudes and behaviors, and which segments may prove more likely to return to previous shopping behaviors.

Mid to Long Term Perspective on the Consumer Confidence & Spending

Related to the previously note consumer behavior trends, there are a number of factors that are likely to have a LONG TERM impact on consumer spending in the U.S:

1. A Reduction of access to debt. In 2008 consumer debt increased by only 0.4% vs. 6.6% in 2007. This translates into a reduction of 2% to 3% in consumer spending strictly as a result of reduced access to debt in 2008. It is worth noting that while 2009 statistics will not be available until Q1/10, consumers’ overall access to debt in 2009 is expected to further contract from 2008 levels.

2. A significant increase in savings rate. While an increase in the savings rate in the U.S. is a positive development, its impact on spending is net negative. Between 2005 and 2008, household savings rate shifted from -1.5% to +5.6%. This trend further translates into a 7.1% decline in spending.

3. Long-term re-evaluation of essential vs. non-essential spending. Based on available data, it is currently not possible to quantify the impact of reductions in spending on non-essential consumer products, including discretionary and semi-discretionary CPG products.

Resulting from the loss of access to mortgage and consumer debt and the low probability of a sharp improvement in employment market, there is broad consensus that consumer spending is unlikely to return to pre-2008 levels in the foreseeable future.