Equity View: Was the Retail Sales Rebound Really So Great?

Summary

• A 3% gain in January retail sales sparked both optimism about the consumer and concerns about inflation and the Fed.
• Both are probably misplaced. In real terms, retail spending has been flat for nearly two years as real incomes have lagged inflation. The consumer is hurting.
• The inflation problem has been less about excess demand and more about supply chain constraints and rising input costs – both show signs of easing.

Market Implications

• The good news is that, as supply chains normalise, companies can produce more.
• The bad news may be that strapped consumers cannot buy those goods, leading to rising inventories, layoffs, and that recession people feared during 2H 2022 – unless real wages rise sharply.
• This scenario may take several quarters to play out. Meanwhile, we expect equities to trade in the range of the past two quarters.

Retail Sales Pops, But Are People Better Off?

The latest retail sales print – up 3% in January and 6.4% over the past year – generated positive buzz in the business press. It implied the consumer is still going strong, and that augers well for the economy.

Meanwhile, the CPI was up 0.5%, implying solid real growth in spending.

The bigger picture is less constructive, however. You could easily interpret January’s big jump as a ‘catchup’ of soft retail sales in recent months as much as an expression of resurgent consumer confidence.

Parsing the data more closely, the big gainers in January were autos and eating out (Chart 1). Autos were up 6.5%; eating out jumped a whopping 7.2% (Happy New Year!). Excluding those categories, retail sales were up 1.5%. Over the past year, eating out soared 25.2%.

We do not think the bulge in restaurant sales will last long. Restaurant owners have probably capitalised on the post-Covid surge in demand to drastically boost prices. This writer has noticed, for example, that a breakfast meal that used to run about $12 with tip has suddenly become upward of $20 or more… This incentivises you to eat out less – or have dessert at home, at least!

Auto sales is more of a wildcard as supplies of new and used autos remain tight. Our best guess now is that auto makers will soon face a choice between higher prices and lower volumes or higher volumes and moderate price increases.

Bottomline, the January surge in retail sales will likely soon ease, along with optimism about the health of the consumer.

Real Retail Sales Flatlined in Early 2021

The longer-term perspective is more interesting.

Since March 2021, retail sales are up 11.4%. But adjusted for inflation (using the CPI), retail sales are down 1.8% (Chart 2). Growth in retail sales has been primarily due to higher prices; volumes are actually down.

There are different ways to interpret this.

• Due to labour shortages and supply constraints, demand has exceeded producers’ capacity, so prices have risen due to a demand-pull phenomenon.
• Alternatively, prices have risen due to supply constraints and shortages of raw materials, producing cost-push inflation. Meanwhile, real wages have actually fallen 3.3% over this timeframe, limiting consumers’ ability to increase the overall volume of goods they buy.

We can debate which is the more correct narrative. The answer is probably a combination, although we lean toward the latter. In this scenario, consumers are holding back on buying goods partly because they are shifting back to services and partly because they simply lack the resources.

In either scenario, as supply chains heal, companies should be able to produce more goods. We see some risk that companies end up with unwanted inventory that consumers cannot afford. This could lead to layoffs – and the recession that everyone feared late last year. The working assumption has been that the recession would be mild, especially if (as many seem to believe) the Fed soon eases.

But what if many of the people laid off are older and marginal workers who simply drop out of the labour force? What if the unemployment rate remains low (recall the unemployment rate is unemployed people in the labour force as a percent of the labour force), and the Fed – trying to boost unemployment – does not cut rates?

None of this is constructive for corporate earnings or equities.

This Scenario Could Take Months to Play Out

We are now riding a wave of optimism that the underlying economy is robust and that inflation and Fed policy will normalise in coming months or quarters. Perhaps markets see something that many more bearish Street analysts are missing – certainly there are a variety of articles and views on both sides of this divide these days.

The headline retail sales data supports the normalisation narrative.

But the underlying detail and trend of recent quarters points to significant weakness and growing likelihood that the recession scenario does come – if later and differently from what people expected a few months ago.

This scenario may take a few more months or quarters to play out. Meanwhile, investors should remain vigilant about potential downside risks even as markets subscribe to the potential upside scenario.

Over a 30-year career as a sell side analyst, John covered the structured finance and credit markets before serving as a corporate market strategist. In recent years, he has moved into a global strategist role.

Photo Credit: depositphotos.com

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)