Things are getting really bad – latte sales are down

As rising mortgage, fuel and food costs begin to bite, consumers are tightening their belts. But despite this, most people are still just too optimistic on the UK economy at the moment…

This is one Bank Holiday that retailers won't be looking forward to.

Rising mortgage bills, fuel costs, and food bills are really starting to bite out there on the High Street.

Yesterday, Land of Leather, the sofa retailer, warned that sales had plunged by 32% in the 12 weeks to last Sunday compared to the same quarter in 2007. The chain is holding a 12-hour sale today, in the hope of building up some steam in the Bank Holiday weekend.

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Now, the news that a sofa company is in trouble during a property sales slump doesn't come as a surprise. Interestingly, kitchens group Howden Joinery is still doing well, with same-store sales up 5.9% year-on-year, though that may be down to desperate sellers attempting to update hard-to-shift properties.

But forget furniture. The really worrying thing is that we've all started cutting back on lattes

Starbucks is no longer an affordable luxury for some people

Starbucks (NASDAQ:SBUX) has warned that UK sales are starting to turn down. Chief executive Howard Schultz, quoted in the Evening Standard, told analysts that he had seen "some early signs of softness in traffic in our UK stores Starbucks coffee and premium coffee experience has, over time, been an affordable luxury. And at this time, it isn't for some people."

It looks like all those personal finance articles on budgeting you know, the ones that point out that if you spend £2 each working day on coffee, that's more than £40 a month - are taking their toll. And no wonder. £40 a month is just about enough to offset a decent chunk of your increased mortgage payments, if you've just come off a fixed rate.

Some analysts argue that the coffee industry is in some way immune to the slowdown. "When times are tough, people might stop buying designer shoes but they will still go to the shopping centre and buy a coffee," said Jeffrey Young of market research group Allegra Strategy.

Why? Why will they still buy a coffee? There can be few things more easily substituted than a coffee from Starbucks, or Costa or wherever. For a start, you can drink coffee for pennies at home. Or you can do without it all together. People talk about the morning latte as being something almost indispensable these` days, but that's just force of habit. It's amazing what you can do without when your wallet makes you put your mind to it.

Coffee's an obvious expendable item, but there are plenty of others. Fashion's another victim. The last four weeks have been a "graveyard," according to Bhs and Top Shop owner Sir Philip Green. As Evening Standard writer Gideon Spanier points out, those who are surviving best are the stores offering cheap and cheerful goods Primark for example (owned by AB Foods) saw sales rise 25% in the 24 weeks to March 1st and online retailers, such as ASOS, which recently reported sales up 80% year on year.

Even these might struggle in the coming months. As Anthony Hilton reports, the nation is "tightening its belt". As he says, the recent hopes from bankers that they might be over the worst sound premature. But " even if true it looks increasingly likely that for the rest of the economy the troubles are only just beginning."

Why markets are still too optimistic on the UK

What does this all mean? Well, as ever, I'd keep avoiding retailers and other consumer-facing stocks, even the ones that have already fallen substantially. Why? Because just as few people in the markets realised how quickly and devastatingly the property market would turn, most people are still just too optimistic on the UK economy at the moment.

It may not feel like that, with the government in turmoil and bad news headlines everywhere, but the market is still in glass half-full' mode. As the news on the economy continues to get worse, and more and more people realise this isn't easily resolved, that attitude will gradually shift. But for just now, there are still too many ready to "buy on the dips" rather than "sell into the rallies." So that means the most vulnerable stocks still have further to fall.

As for what you can buy in a downturn, we suggested some defensive stocks in a recent MoneyWeek cover story .

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Turning to the wider markets

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Yesterday the FTSE 100 closed unchanged on the day at 6,087.3.

Housebuilders were hammered as downbeat broker comments, suggesting that Spring sales reservations have collapsed compared with last year, prompted further selling. Retailers were also under pressure on consumer spending fears. In contrast British Airways soared 7% in response to potential co-operation talks with US rivals.

Euroland stock markets were closed to celebrate 1st May.

Wall Street enjoyed a 1.7% rally following the previous day's Fed rate cut, rising 190 points and breaching the 13000 barrier for the first time since early January. The broader S&P 500 also put on 1.7%, gaining almost 24 points to end the day at 1,409, while the tech-heavy Nasdaq fared even better, adding 2.8% to close at 2,481.

In Asia this morning, Japanese stocks followed the US lead, with the Nikkei 225 climbing 2% to close at 14049. In Hong Kong, the Hang Seng improved 1.9% to 26241.

Brent spot was trading this morning at $110.46, while spot gold stood at around $856. Silver was trading at $16.31.

Turning to forex, this morning sterling was trading broadly unchanged at 1.9748 against the dollar, but was appreciating against the euro, rising above 1.28 for the first time since late March. The dollar was last trading at 0.6456 against the euro and 104.75 against the Japanese yen.

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John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.