Retail Sales Head Fake, But Bigger Problems Ahead

Summary

• Fedspeak and weak retail sales triggered recession fears and a big equity selloff yesterday.
• But a closer look at retail sales shows that the decline was concentrated in the troubled auto sector and (surprise!) housing-related goods.
• Meanwhile people seem to be buying food and eating out – strongly suggesting that spending is simply shifting from goods to services, not falling – at least yet.

Market Implications

• We expect investors will soon discount the decline in retail sales.
• Higher services spend implies ongoing inflation in services. That in turn suggests the Fed will indeed engineer a recession at some point – the question is when.
• Until then we look for equities to trade in the range of the past six months.

Retail Sales Headwind Likely Temporary

Two catalysts drove yesterday’s selloff in equities (SPX -2.5%; NASDAQ 100 -3.25%) – a further parsing of the Fed’s meeting and an unexpected 0.6% decline in retail sales, vs -0.2% expected.

The knee-jerk selloff was because, together, these factors spell rising recession risk.

Ongoing speculation about the Fed is hardly going away. Depending on which way the wind is blowing, equities will rally or sell off as new notions about Fed policy enter the narrative. In our view the Fed is dead serious, and it is a mistake to try to fight the Fed on this one. Markets, however, so far have thought otherwise.

The retail sales effect, on the other hand, will not persist (Table 1). A closer look at the details shows that the decline was concentrated in the auto sector (-2.3%), and slower spending for furnishings and building/gardening materials (-2.2%). This was partly offset by higher food and restaurant spending (+0.9%).

Given the slowdown in housing, it cannot be a surprise that people are spending less on housing-related goods.

There is tremendous relief that used car prices are coming down, now 15% off the peak in early 2022. But they are still 40% higher than pre-Covid levels. And new car production is still below 14mn SAAR – compared to pre-Covid level around 17mn.

Bottomline? The auto sector continues to be a mess, and a hugely distorting factor in the economic data. Our guess is that markets will soon discount this factor.

And as the higher spend on food and eating out shows, we are seeing a shift in spending from goods to services. That in turn suggests ongoing services inflation and Fed pressure to bring it down.

For now, we see equities continuing the dance between good economic data and worries that the Fed will indeed engineer a recession.

We believe a recession is coming. The question is, how long does it take to get there?

Investors should take advantage of rallies to reduce equity exposure.

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.

(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.)