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The Conundrum Of Retail Sales

Lance Roberts
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Over the last few days, there have been numerous articles puzzling over the surprise drop in latest retail sales report.

"At first blush, the January U.S. retail sales data were disappointing. So, the early evidence confirms the Visa survey that the savings from the plunge in energy costs is being put into the cookie jar instead of being used to buy more cookies." - David Rosenberg

"U.S consumers are getting more caution about how they spend their savings from low gas prices." - Akin Oydele

Of course, the fact that retail sales did not surge is not much of a surprise for several reasons:

1) Considering that labor force participation for the key employment group aged 16-54 is near the lowest levels since the late 70's, the demand for gasoline has fallen due to fewer people driving to work. The large group of non-counted but unemployed individuals combined with increased levels of productivity due to technology remains an impediment to increased spending that is derived from production. (An individual must produce first in order to consume.)

Employment-16-54-020915

2) Unlike an IRS tax refund which is "pre-spent" by individuals who eagerly anticipating the arrival of those dollars; when one fills up at the gas station there is no visible "refund." As Wells Fargo's Mark Vitner recently stated (via Business Insider):

"For starters there is simple arithmetic. While the typical consumer will save between $500 and $800 this year from lower gasoline prices, they do not receive a check up front. Instead, the savings accrue gradually as they fill up their tanks from week to week. On a weekly basis, the saving work out to between $10 and $15, which is meaningful for lower and middle-income households, but not enough to finance a spending spree, particularly right off the bat."

3) Lastly, as I discussed previously, since gasoline sales are a part of the retail sales calculation a reduction in dollar sales of gasoline will only lead to a redistribution, not an increase, of spending in other areas of the economy. Therefore, $10 saved at the gas pump, which reduces gasoline sales, is offset by a $10 increase elsewhere in theory. However, the net economic impact is $0 as no "additional" spending was created.

"Increased consumer spending is a function of increases in INCOME, not SAVINGS. Consumers only have a finite amount of money to spend."

Graphically, we can show this by analyzing real (inflation adjusted) gasoline prices compared to personal consumption expenditures (PCE) which comprises almost 70% of the GDP calculation. 

Gasoline-Prices-PCE-021715

The vertical orange line shows peaks in gasoline prices that should correspond (according to mainstream consensus) to a subsequent increase in retail sales. However, the data suggests that rising gasoline prices (which leads to higher dollar sales of gasoline, and more jobs in the energy and related businesses) is better for the economy.

However, whether or not lower gasoline prices is being saved or spent the real story is what retail sales are telling us about the overall economy. In December of 2007, I wrote in my weekly newsletter (subscribe for free e-delivery) that "we are in or about to be in the worst recession since the great depression."

While there were several economic reasons for that call at the time (consumer confidence, auto sales, and ECRI leading index all declining) one of the main reasons was the decline in retail sales. As shown in the chart below, when the 3-month average of the annual change in retail sales has declined below 2% the economy has been susceptible to a recession.

Retail-Sales-3moAvg-021715

Currently, consumer confidence, auto sales, and other important economic indicators suggest that a recession is not imminent. However, the current level of retail sales is suggesting that the economic environment is significantly weaker than headlines would suggest. It also suggests that a 5.7% unemployment rate is likely not reality either.

Lastly, it is important to notice that the 3-month average of the annual change in retail sales "spiked" just prior to the onset of an economic recession.

While I am not suggesting that the economy is on the verge of an immediate recession, I am suggesting that the "conundrum" between lower gasoline prices and retail sales is not really one at all. Furthermore, the real story behind the weakness in retail sales also suggest that something is "amiss" within the broader economic backdrop. When combined with the deterioration in earnings, the risk of a "gotcha" moment in the market has risen markedly.

As always, economic data is slow to develop and are horrible measures for "timing" market turns. This is especially the case when data used today is consistently revised, modified and recalculated from one period to the next.  However, the data can provide some evidence as to the overall trend of growth of underlying variables to help make better decisions about the long-term expectations of returns from underlying investments. After all, given that the financial markets should be a reflection of underlying economic activity, this only makes sense.  But given the repeated interventions of global central banks over the last few years, the deviation between the markets and underlying economic activity can remain "irrational longer than would otherwise be logical." 

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