Web-based selling is still a relatively new way of retailing and has yet to be tested by a true economic contraction. So while theories are plentifuly and varied, there’s no historical standard to point the way this time.

Experts agree that online stores continue to do well despite the current slowdown in U.S. consumer spending, but their reasons for the continued success of Web-based retailers differ.

“Store sales will be hit harder than Internet sales because affluent shoppers, who form the core of online buyers, tend to ride out economic downturns better than lower- and middle-income consumers,” said Jeff Grau, eMarketer senior analyst.

But others believe that bargain hunting, not higher incomes, is driving Web traffic.

“Disposable incomes are being squeezed and what is drawing people online is the perception that the internet is cheaper and that they can shop around to get bargains and lower prices,” said Malcolm Pinkerton, senior retail analyst at Verdict Research. “Broadband is also cheaper and it has broadened the spectrum of people who can shop online.”

It’s likely to be a combination of both, as even higher income consumers search for ways to offset the crippling cost of gas.

Online is Big Business

There were $127.7 billion in U.S. e-commerce sales in 2007, according to eMarketer data. The research firm estimates that number will hit $146 billion in 2008. But while those numbers are impressive, online sales only account for about 4% of total U.S. retail sales.

First quarter sales for Amazon.com Inc. (AMZN), one of the best-known names in online retailing increased 37% to $4.13 billion in the first quarter of 2008 compared to $3.02 for the same period a year ago.

“Our sales growth this quarter was driven by low prices and millions of in-stock items available for immediate shipment,” said Chief Executive Officer Jeff Bezos, founder of Amazon.com, in the company’s earnings release statement. “We’re grateful to our customers.”

Traditional retail outlets such as Wal-Mart Stores Inc. (WMT) have been able to cut costs and continue sales growth with heavy discounting. Wal-Mart sales grew 10% in the retail giant’s fiscal first quarter. But Wal-Mart is the exception, not the rule, as other retail businesses such as The Home Depot Inc. (HD) and J.C. Penney Co. Inc. (JCP) have posted losses and sales declines.

Penney is hoping the Web holds the key to improved sales for the struggling clothing and home furnishing retailer. Online sales are the fast growing division for the firm and management is allocating the marketing budget accordingly.

“We see JCP.com as the No. 1 priority as we go forward as far as where that money will go,” Mike Boylson, executive vice president and chief marketing officer, said Tuesday in a keynote address to the Internet Retailer Conference & Exhibition in Chicago, Internet Retailer reported.

No One Knows What the Online Future Holds

Even with more traditional retailers jumping on the Internet bandwagon, the recent rapid growth in online retail sales is going to slow, according to a recent eMarketer report. Sales growth in 2008 is expected to slow to 14.3% from a growth rate of 19.8% in 2007. Future projections see a similar steady decline (see chart below).

“A drop in the number of new online buyers is an inevitable sign of the maturation of the online retail channel,” said Grau. But as more people gain Internet-access, “Retail e-commerce could get a boost from underserved consumer segments such as seniors and Hispanic-Americans.”

More people are jumping on the net daily. Philadelphia already offers free wireless Internet access to its residents. As the price of computers comes down and if more cities follow Philly’s lead, millions of consumers who didn’t have access to the Web before could become new online shoppers.

“Online retail sales are maturing and the lion’s share of future growth will primarily come from existing buyers spending more in the online channel,” Patti Freeman Evans, senior analyst at JupiterResearch, said. “Assuming growth continues in a similar trajectory over the coming decades, U.S. online retail sales will plateau at 10% to 15% of total U.S. retail sales, barring a dramatic change in the online shopping experience that promotes an inordinate spending shift among buyers”

Technology is always changing and an “inordinate spending shift” doesn’t seem too far out of the realm of possibility. Just a decade ago, a phone like Apple Inc.’s (AAPL) new 3G iPhone seemed impossible. If more and more people are carrying full Internet-access around in their pockets, it’s almost impossible to predict what the effect will be on Web-based retail sales.

Source: Online Retail Sales Shake Off Weak U.S. Economy and Continue to Grow

American Airlines, Continental and Delta have all announced cutbacks due to rising fuel costs.

Consumers are also being squeezed. USA Today reports that summer airfares in the US are set to rise by as much as four times thanks to spiraling oil prices.

“The sector-wide downturn is pretty textbook,” says Theo Casey in Fleet Street Daily.

Airliners tend to suffer most in a weak economy. The airlines biz is very cyclical, i.e. very sensitive to the business cycle. Revenues tend to pick up in times of economic expansion, and fall in periods of economic contraction. Airliners also are at the mercy of the oil markets, which are at all-time highs.

This isn’t just a recession. This is a recession combined with the raw asset prices getting too high to handle. Lower revenues were already on the cards with the threat of UK, US and Eurozone recessions. But throwing in oil prices that range from $125 – $135 a barrel, the problem is made much, much worse.

In terms of affordability, air travel has flown in the opposite direction of things like higher education, houses, and designer jeans,” says Andrew Gordon in Investor’s Daily Edge.

People have to fly. And, globally, it’s inevitable that they’ll be flying in greater numbers. Higher prices may slow this trend, but it won’t reverse it. Flying is already taking off in Asia. For example, China’s domestic airline industry is just a fifth of the size of the U.S.’ domestic market, but it’s growing much faster. In 20 years time, it’ll be about half the size of the U.S. market.

And market liberalization is in the air. Many more markets will soon receive a strong boost as governments ease regulations. New Open Skies agreements between the European Union and the United States and Canada are a start. Further market reform will open up Asian and North African markets. The result? The global airline industry will outperform the world economy in the coming years.

The airline industry isn’t so much broken as it is overcrowded. It’s mainly a matter of too many seats available for too few customers. If the industry continues to consolidate, supply and demand should rebalance. Then investors will be able to focus on the solid fundamentals of the industry – reasonable prices and growing demand.

“We’re going to have some more bank failures that will come back more to historical norms and may go above that with time,” said John Dugan, the US comptroller of currency in an interview with the Financial Times. “That is a natural consequence of the economy going from historically exceptionally benign credit conditions to something that is more normal to something you would get in a downturn.”

Dugan said the failures could come as a weakening economy puts pressure on badly underwritten loans, particularly in commercial real estate.

There are plenty of bogeymen stalking the US economy.

“Let us assume that the unthinkable happens,” says Marc Faber in The Daily Reckoning. “China’s economy slows down sharply, or even contracts – and there are reasons why it could. Commodity prices slump and bring about economic hardship in the resource-producing countries. Imports of capital and consumer goods from Europe and Japan decline. We would then have the perfect setting for a global economic contraction with dire consequences for corporate earnings and asset prices.”

“We’re not predicting this, says Bill Bonner. “We’re sticking with our middle-of-the-road forecast…for neither worldwide prosperity nor worldwide ruin. But there are risks from both directions. And while most people expect a mild recession and quick recovery…almost no one expects the kind of global meltdown Marc imagines. We could see oil below $50…the Dow below 5,000…Wall Street wiped out…and 20 million US families busted.”

“Let us assume that the unthinkable happens,” our old friend Marc Faber begins. “China’s economy slows down sharply, or even contracts – and there are reasons why it could. Commodity prices slump and bring about economic hardship in the resource-producing countries. Imports of capital and consumer goods from Europe and Japan decline. We would then have the perfect setting for a global economic contraction with dire consequences for corporate earnings and asset prices.”

We are on our way down to the Eternal City. The schools in Paris are out for Spring Vacation, so we are taking advantage of this break in educational tedium to learn something.

Elizabeth is an especially keen learner. She is sitting next to us on the airplane, reading a history of the early church. Soon, she will be asking questions about papal succession…schisms…councils…and architecture, vainly trying to improve us with bits of unwelcome knowledge.

But we are using this time in the jet stream to profit from a vacuum in the news stream. That is, cut off from our usual sources of misinformation, we have nourished our thinking with thought. And what we are thinking about is: what if we are wrong? (Since we are often wrong, time spent considering the alternatives is rarely wasted. Often, it ends as prophecy.)

Our theory is that the war between inflation and deflation leaves millions of casualties, but no clear winner – at least not for a while. Instead, prices for U.S. stocks, houses and labor are marked down…while commodities, oil, gold (and even some emerging markets) go up.

But we could be wrong in either direction. Either inflation or deflation could soon emerge victorious. Most analysts think inflation will be the clear winner – with big boosts, not only for commodities, but for the economy and stocks… and maybe even houses. They think the financial industry has bottomed out and will soon get back on its feet and begin inflating the whole economy.

The view Marc is putting forward is the opposite one – that deflation will be the clear winner, dragging the whole world economy into a slump, with lower prices for commodities as well as stocks and property.

Marc notes that much of the world’s earnings come from the energy exporters – Russia and the Arab countries — and finished product producers in Asia, notably China.

Both depend on the same foreign buyers.

In the weekend news, for example, we discovered that the emerging markets are now using more oil than the United States. They use more oil because their economies are growing – because they are still moving products to the United States. In a real downturn, the United States (and other developed nations) would stop importing so much oil…and so much merchandise from China, which would have the consequence of reducing energy consumption by China too. Result: lower energy prices and a worldwide recession…maybe even the worst worldwide depression in history.

What might be the consequences of such a depression? In the United States and Europe, probably nothing catastrophic. People in the developed nations live with a thick cushion under their derrieres. The bench might grow harder and less comfortable; assets would fall in price; earnings would decline (both for businesses and individuals); otherwise, life would go on as before.

In the emerging markets, on the other hand, billions of people now sitting precariously on the edge of modern life might get pushed off. The artificial boom – brought about by excessively low lending rates in the West – caused millions of people in the emerging markets to abandon their farms and move to the cities.

For the first time in human history, the planet now has more people living in cities than in the countryside. These people can no longer ‘get by’ as subsistence farmers. They no longer have any land to subsist on. Instead, they rely upon a sophisticated, globalized economy for their daily bread. And if that economy should break down, they could go hungry…or starve.

Already, there have been food riots in various parts of the globe – and this while the world economy is still growing! Think what they will do when the economy shrinks…when their earnings (which have been going up by 10% per year and more) begin to fall…when there are no jobs for them in the cities…and nothing to eat. Ah, dear reader, then it gets interesting.

We’re not predicting this. We’re sticking with our middle-of-the-road forecast…for neither worldwide prosperity nor worldwide ruin. But there are risks from both directions. And while most people expect a mild recession and quick recovery…almost no one expects the kind of global meltdown Marc imagines. We could see oil below $50…the Dow below 5,000…Wall Street wiped out…and 20 million US families busted.

But that is the good news. In the emerging markets it could be much worse – worse than the Great Depression of the ’30s. And there is also the political risk.

What do governments do when faced with economic collapse and social unrest? Hemingway described it:

“The first panacea of a mismanaged government is inflation of the currency. The second is war. Both bring a temporary prosperity; both bring more permanent ruin.”

That is, they do just what Ben Bernanke and John McCain have already promised. They dump money from helicopters and “bomb, bomb, bomb…bomb, bomb Iran.” Imagine if China’s, and Russia’s leaders are as simpleminded as America’s. Surely, they are…

*** News comes that one in fives soldiers in Iraq has mental problems. In the high command, the ratio must be even higher.

*** And our Pittsburg correspondent…with sad news from Zimbabwe.

“Pity poor Zimbabwe….” writes Byron King, referring to a story in the Times of London :

According to the paper, “South African dockers are refusing to unload a Chinese cargo ship carrying 77 tonnes of small arms destined for Zimbabwe.”

“The arms, including three million rounds of ammunition suitable for AK47s and 1,500 rocket-propelled grenades, were ordered by the Zimbabwean military at the time of the March 29 election – which Britain and other Western powers have accused Robert Mugabe of trying to rig.

“The arms arrived at Durban, South Africa, on Wednesday aboard the Chinese-owned An Yue Jiang and must be taken by road to landlocked Zimbabwe, where the Government has been accused of arming rural militias before a possible run-off vote for the presidency. The opposition Movement for Democratic Change (MDC) has even accused Mr Mugabe’s Zanu (PF) of preparing for a ‘war’ against the people.”

“Poor Zimbabwe,” Byron continues. “So far from God. So near to Robert Mugabe.”

Let us assume that the unthinkable happens: China’s economy slows down sharply, or even contracts – and there are reasons why it could. Commodity prices slump and bring about economic hardship in the resource-producing countries of the world. In turn, these countries’ imports of capital and consumer goods from Europe and Japan decline.

We would then have the perfect setting for a global economic contraction with dire consequences for corporate earnings and asset prices.

Now, I concede that this scenario is not very likely to occur. However, on a recent visit to Dubai, I could see how it might unfold. I have been traveling to the Middle East since 1977, and I experienced first hand the oil boom of the late 1970s and the collapse in equity and real estate prices when oil prices fell in the early 1980s. About three years ago, on a visit to the Middle East, I felt that the gigantic equity boom would come to an end.

In 2006, most of the Middle Eastern stock markets declined by 50% or more, though the economies didn’t suffer. Yet, over the last three years, it has seemed to me that there is something not quite right about the enormous construction and economic boom that Dubai and other Middle Eastern countries are experiencing. (The world’s tallest buildings are going up there….) What if oil prices were to decline? But why would oil prices decline? Obviously, oil prices would decline because of diminished demand for oil from China and other rapidly growing emerging economies.

But why would demand for oil from China slow down or decline? Obviously, because of an economic recession! The assumption that the Chinese and other emerging economies will continue to expand rapidly may prove to be very deceptive. In recent years, the US has experienced a credit boom and China has had a capital spending boom. Both could come to an end at about the same time! I also wish to stress that there is enormous connectivity between all the world’s economies and that it would be wrong to assume that the present financial crisis, whose epicentre is the United States, couldn’t be followed by financial and economic crises elsewhere.

Also, if the Dubai boom was an isolated event, I wouldn’t be particularly concerned. But everywhere I travel I am left with the uncomfortable feeling that the current boom is surreal and unsustainable. The INDABA – the annual conference for natural resources professionals – which I attended earlier this year in Cape Town, has become a huge circus reminiscent of the consumer electronic shows held in Las Vegas in the late 1990s.

And whereas I have a relatively positive view of commodities, I doubt that all these mining executives (predominantly promoters and liars) will make as much money as they hope to, simply because exploration and mining development costs are soaring. Every major city around the world is also experiencing a huge condo and office construction boom, and in resort areas there are enormous developments of secondary homes.

Should the financial sector contract, as I believe will occur for several years, will all these new offices find tenants? I also wonder if all the condo and second home buyers are aware of the maintenance costs of their units and that in over-supplied markets prices can decline sharply.

Lastly, I think that investors fail to appreciate fully the process of deleveraging after a period of accelerating credit growth. In a credit-driven economy, a deceleration of credit growth will depress all asset prices and tip the economy into recession. In this respect, I am particularly surprised that analysts still expect S&P 500 earnings per share to increase to above US$110 in 2009.

Over the past few months, I have discussed corporate profits a number of times and shared with my readers my concern that we are in the midst of an earnings bubble, which has been driven largely by an explosion of financial sector earnings.

Richard Berner, chief economist at Morgan Stanley, recently published an excellent study entitled “Downside Risk for Corporate Profits”, in which he opines: “I think the earnings outlook will disappoint.

“The US economic outlook has darkened and fading operating leverage, dwindling pricing power, and deteriorating credit quality will squeeze margins. Despite the benefit of a weaker dollar, slower growth abroad seems likely to tame the overseas earnings boom” (Morgan Stanley Research North America, US Economics, March 17, 2008). In

Berner’s view, “the combination of slower growth and high operating and financial leverage in Corporate America made a contraction in earnings unavoidable even if the economy skirts recession”. (He is referring here to the corporate earnings decline in the fourth quarter of 2007.) “Lower marginal but higher fixed costs have increased operating leverage. Corporate America’s ability to exploit that leverage propelled earnings to record levels when growth was healthy. Strong increments to revenue went straight to the bottom line…. But leverage – both operating and financial – works both ways. Slower growth means that operating leverage is working in reverse, with decreases in revenues going right to the bottom line.”

Berner’s two principal concerns about US corporate profits relate to “operating leverage” and the fact that the “strength of overseas earnings” is about to be “challenged”. Operating leverage is at present far higher than in the 1990s, which, according to Berner, could mean that “a deeper recession, especially one that spreads abroad, would promote a much more serious profit squeeze.”

Berner shows that overseas earnings have increased from 15% of overall earnings 20 years ago to 31.5% at present, as “growth abroad – and the higher oil price that comes with it – are powerful engines for US earnings”. I may add that a weak dollar is another extremely powerful driver of overseas earnings as a percentage of total earnings. Also, that “growth abroad – and the higher oil price that comes with it – are powerful engines for US earnings” supports my view about the extreme connectivity we now have between economies in the global economy.