US Perspectives: Consumers Back in the Saddle Again

The data looked stunningly good across a range of indicators last week.

Robert Johnson, CFA 21.12.2010
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Last week's set of economic data was stunningly good across a range of indicators: retail sales, inflation, and even the previously faltering manufacturing sector.


The retail news was particularly strong as the sector posted its fifth consecutive month of sequential growth in excess of 6% on an annualized basis. That should provide for more growth in both employment and the manufacturing sector in the months ahead.


Clarity on the Bush tax cuts and unemployment benefits, sharply improving markets, and new stimulus money (in the form of a 2% cut in the payroll tax) should give consumers even more cash to spend in the months ahead.


Businesses appear to be doing their part, too. Strong results out of software powerhouse Oracle demonstrated that businesses have not let up on the pedal with regard to capital spending, especially for technology-related goods. With the Fed reporting record cash balances at the corporate level, corporations certainly have the capacity to spend even more.


Manufacturing seems to have found a bottom, too, as industrial production grew again and better purchasing manager reports indicated the potential for continued improvements in manufacturing. Inflation also remained well under control as consumer prices increased around 1% on a year-over-year basis, as they have for the past several months. However, recent jumps in food and energy prices could potentially mean that we have seen the low for year-over-year inflation growth for this cycle.


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Europe has yet to come to grips with its long-term debt issues, although they have put a major band-aid on short-term issues. China continues to grapple with inflation that is considerably higher than the government would like to see. That in turn continues to flame fears that China will take steps to slow growth in one of the economies that has been a major engine for the worldwide recovery.


Longer-term interest rates in the United States are sharply higher over the last couple of months, with the 10-year bond now almost a percentage point above its low this fall; it now stands at just under 3.4%. This won't do wonders for a housing market that, while struggling, seems to have hit bottom.


Retail Sales Growth Off to the Races

The best news of the week was the retail sales report from the government. While a decent report was widely expected based on the week before last week's reports from individual stores, retail sales managed to surprise on the upside, jumping 0.8% in November. Just as importantly, prior months' data were also revised upward, triggering another potential increase in the third-quarter GDP numbers when the final version is released this week. October's number was revised to a remarkably strong 1.7%. The improvement was relatively broad-based, with only furniture, electronics, and building materials showing small declines.


Retail Soft Spots: Furniture, Electronics, Building Materials, and Restaurants

It appears that consumers may have stocked up on their electronics goods earlier in the year and are returning to more traditional items, especially apparel, this holiday season. Best Buy's stock was caught in the middle of that trend last week. A backdrop of falling electronics sales combined with an extremely competitive retail environment caused a decline in the most recent quarterly sales report. That in turn caused a tailspin in the stock.


Furniture and building material sales likely suffered from a weak fourth quarter for both new and existing homes. The only other real disappointment in the report is that restaurant sales grew only 0.1%. Usually when the economy picks up, restaurant sales are one of the better performers; this recovery they've been lagging. The casual dining segment (think restaurants like Applebee's and Ruby Tuesday has done better, but a lot of quick service restaurants (like Burger King and Wendy's/Arby's that are more tied to employment cycles continue to struggle.


Retail Bounce Looks Real This Time--Best Holiday Since 2005?

One of the more impressive aspects of the retail sales report is the strength of results over the last five months. This spring I was faked out by strong retail sale reports in February and March that very quickly reversed in May and June. While the spike was not as great this time, the recovery appears to be more durable than it was this spring. The outlook for December remains good, too, based on anecdotal evidence as well as weekly reports from the International Council of Shopping Centers.


A strong December would bring the string of improvements to six months. Note, however, that an early start to the holiday season probably artificially boosted November sales and is likely to mean a smaller increase in December, as shown below. I am optimistic, however, that sales will not collapse in December. In my opinion, a lot of the early season buying represented "gifts" consumers purchased for themselves, while more traditional holiday presents for others remained to be purchased in December. Strong recent results caused the International Council of Shopping Centers to boost their holiday sales forecast by 0.5% to the 3.5%-4% range. If these forecasts come to fruition, this would be the best holiday season since 2005.


Strong Retail Sales Growth Continues


Sequential Growth (%)

Jan 2010


Feb 2010


Mar 2010


Apr 2010


May 2010


Jun 2010


Jul 2010


Aug 2010


Sep 2010


Oct 2010


Nov 2010


Dec 2010 (E)


Source: Source: St. Louis Federal Reserve


But Retail Stocks May Not Collect All the Benefits of Improved Sales

Retail stocks have reacted well to the news. However, it is not entirely clear how much of the increased revenues are due to very attractive pricing and special promotions that could potentially affect retail profit margins. Certainly new smartphone applications that allow on-the-spot price comparisons have aided consumers in their battle with retailers, as detailed in a recent Wall Street Journal article.


Initial Unemployment Claims Resume Decline

I haven't talked much about recent unemployment claims lately because a year or two into a recovery, initial unemployment claims improvement always stalls out. Initial claims make their biggest improvement within the first six to 12 months before typically stalling out for one to two years. This cycle was no different; claims peaked in March 2009, with 0.49% of the population making a new weekly claim before the ratio fell dramatically to 0.34% in January 2010. Since then the ratio has jumped to as high as 0.38% before falling back to 0.34% again currently. In other words, the rate of initial claims is basically unchanged over the last year.


However, the improvement has been quite notable in recent weeks, falling from 0.38% in September to 0.34% in December. A fall back to 0.31% by the beginning of February is a real possibility (that translates into about 390,000 weekly claims). My optimism is based on improving mass layoff reports from the government and monthly data from Challenger Gray and Christmas' layoff report. High seasonal adjustment factors during the next couple of months may also tend to keep a lid on the reported unemployment claims number. At that point, things could stall out again as the ratio approaches typical cycle lows of between 0.25% and 0.30%. Seasonal factors, which are tending to overstate some of the improvement currently, will also reverse themselves by mid-February, further contributing to the potential for another stall in initial claims improvement.


Manufacturing Finds a Near-Term Bottom

Many analysts have been fretting about the manufacturing sector over the past several months, and in fact we did see a couple months of declines in industrial production. That trend reversed itself in November as industrial production managed to increase 0.4% following a 0.2% decrease in October. The good manufacturing news came despite a temporary decline in auto production that brought it almost exactly back in line with auto sales. This follows several months where production exceeded sales, perhaps related to the stockpiling of new models that are now shipping. Bad weather and holidays may hold back December's number as well, but then I'm looking for better car production numbers again in 2011.


Regional purchasing managers reports for early December also managed to show some signs of life after a couple of dismal months. The Empire state report in particular made one of its biggest month-to-month swings in history, moving from negative 11 to positive 11, while the Philly Fed report showed a healthy increase to 24 from 22. The new orders component of both indexes sharply improved, which bodes well for production and employment in the months ahead.


Another good omen for manufacturing was a surprising decline in the inventory/sales ratio, which is still amazingly close to its all-time low for the month of October. A large part of the decline was due to retailers (as opposed to manufacturers and wholesalers, who reported flat inventory/sales ratios). The end of the inventory replenishment cycle might not be complete just yet. Lower inventory data means the improved end-user demand that we are now seeing will more quickly turn into either increased production or an increase in imports.


Another Upward GDP Report Expected, Personal Spending Should Accelerate

This week brings a lot of data; unfortunately almost all of it will come on Thursday, the day before Christmas Eve.


On Wednesday, the third and final revision of the GDP report for the September quarter will be released, and I expect a revision from growth of 2.5%-2.8% based on revised retail sales data. Recall that the very first version of this number rushed out in October showed only 2.0% growth. Also, based on strong retail sales data and an improved import export figure in October, I expect GDP growth to rocket to 3.5% for the fourth quarter, which will be reported in late January. The risk in my forecast is to the upside.


GDP Growth Accelerating Again


GDP Growth (%)

3Q 2009


4Q 2009


1Q 2010


2Q 2010


3Q 2010 (E)


4Q 2010 (E)


Source: Bureau of Economic Analysis
Morningstar Estimates


Personal spending and income data are also due this week. I am expecting some divergence here, with sharply accelerating spending and mediocre income growth. November's lousy employment report is a key driver for consumer incomes; the minimal improvement in the number of jobs and a flat wage rate and flat hours don't bode well for the wage component of consumer incomes. The consensus estimate of a 0.3% increase in consumer income looks too high to me.


Meanwhile, the strong retail sales report points to potentially better performance in the spending category. The consensus for consumer spending is an increase of 0.4%, and I believe this figure might prove a bit light given the retail sales report cited above. Though I usually worry about a divergence in income and spending (over time they tend to move together), I am less worried this time around. I think the November employment report, which drives the income report, was unduly negative in November and is likely to reverse itself in December. Also, the recently approved stimulus bill (oops--I mean tax bill) will provide more income to consumers and the wherewithal for more spending early in 2011.


Durable goods orders for November are also due this week; I expect a flat result versus the consensus of a 0.4% decline following a larger decline of 3.4% in October. Usually large negative numbers tend to reverse themselves in subsequent months. Furthermore, both the regional and national purchasing managers' reports have been more bullish on orders lately. Whether that improvement came soon enough to help November durable goods numbers remains an open question.



This is an edited version. The article originated from Robert Johnson’s column at

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Robert Johnson, CFA  Robert Johnson, CFA, is director of economic analysis with Morningstar.

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