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Consumers Fight Through Inflation Headwind

Jason Stipp

Jason Stipp: I am Jason Stipp for Morningstar. We got government retail sales data for March on Wednesday. It showed a top-line 0.4% increase in the retail sales for the month of March, but there's certainly more to the story than just that top-line number.

Here with me to dig into the details is Morningstar's Bob Johnson. He's our director of economic analysis.

Thanks for joining me, Bob.

Bob Johnson: Great to be here.

Stipp: So we did see 0.4%, that was an increase, that was the top-line number.

It was on the top line a slowing of growth than we had seen over the last few months, but there's more to the story than just that top line number. What we're looking at in the report?

Johnson: It's always a very complicated report to analyze. This is the government report and includes restaurants, which is a typically a services thing, the stuff you actually buy in the store, the stuff you get from non-store places like Amazon.

So, it's a pretty comprehensive set of numbers, and it's very hard to analyze. So, the way I like to look at the number is let's exclude autos, which are captured somewhere else we've talked about, and gasoline, which really kind of inflated the number this month.

Stipp: Sure, because of the inflation that we've been seeing in the commodities.

Johnson: Exactly. So, looked at that way, retail sales have gone 0.9% growth in January, 0.8% in February, and 0.6% in March, so a little bit of slowing in trend, but those are really pretty phenomenal numbers on the surface. Even the 0.6% annualizes into over 7% of growth, which is pretty compelling.

Stipp: So when you strip out some of those more volatile things like you'd mentioned the autos and the gasoline, what are the consumers spending on, then? What is making up that 0.6% growth in those other areas?

Johnson: A couple of categories were particularly strong, and I'm going to put them in two ways. One was housing and one is going to be in the restaurants.

On the housing side, I've been waiting for this to happen for sometime. As people don't move, I've been waiting for them to spend more money on the homes that they already own, and we finally begin to see some of that this month.

The building materials category was up 2.2% on a monthly basis; so it annualizes into a huge number if you start multiplying that by 12. It's a volatile number, but that's a great number.

Furniture was up well over 3%. People are finally beginning to spend to furnish their homes. So people aren't moving, but they're spending more on what they already have.

The second category I'd like to talk about is restaurants. And we've talked about restaurants again and again, and for so long it was like, "sorry, Jason, they are not up this month," but we've had two good months in a row--1% growth this month on top of the 1.8% last month.

So, consumers are beginning to spend again. I always talk about not liking the reported confidence number, but I like to watch little fun things on the side, and certainly people have been more willing to go out to eat, and that was a really nice number to see for a second month in a row that really indicates that we've got some confidence and really maybe this oil thing hasn't begun to bite yet.

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Stipp: So, I just wanted to talk a little bit about the oil thing and the inflation. So, when you look at the numbers, obviously you took gasoline out, because that had inflated the numbers in March.

If you take out the whole inflationary picture, what did sales look like in March versus what we had seen before?

Johnson: Well I like to look it at over quarters, and I would say that the March-quarter numbers overall, including today's number, will look just slightly better in nominal terms than they did in the December quarter. So, actually retail sales are clipping up; they were already at a pretty good rate, and now they clipped up a little bit more in the March quarter.

The bad news is that there is some inflation in there, and so you strip the inflation out, and the numbers don't look quite as good, that's for sure. It always gets a little tricky, if you've got low inflation for some period of time, and it's the same month-to-month, and it's the same year-over-year, the numbers get pretty easy to analyze; you don't have to think too hard about it.

But now when you start having things happening, you have to say "well now, wait, what day did they measured that on, and is that included in that or not in that."

But you do strip out inflation and the retail sales don't look nearly as robust.

Stipp: Okay. So, obviously having finished the first quarter, we'll be getting a GDP report coming up soon. We know that the consumer is a big part of that GDP report. When you are looking at inflation and seeing the effect that this might have when we get that report, what are you expecting for first quarter?

Johnson: Well, the consumer may have grown in the 3.5% to 4% range in real terms, inflation-adjusted, in the December quarter, probably it's going to look a little bit more like 2% in the March quarter, and the reason for that is because of the higher inflation numbers. So, you have to dial back the numbers a little bit.

So inflation will affect the numbers--instead of being kind of a 3% or 4% number in the first quarter, we're going to see a 2%. For the full year, I'd been thinking 3.5%-4% on GDP; well given that we're going to get off to a little bit of slow start here, it looks little bit more like 3.5% to me for real GDP growth.

Stipp: Okay. So, you had mentioned before that even when you take out some of these more volatile areas of the spending, the areas that are affected by the commodity increases, consumers still are spending on some of those other categories. But at what point are you worried about inflation really slowing down spending on things like restaurants and spending on things like home goods and such?

Johnson: Well, it will depend on how much it spreads to other categories. Does it stay in commodities and oil, or does everything start going up--that is certainly, one of the issues that you have to ask. The second is, what is the trend in some of those commodities?

Starting with the commodity prices, I think, maybe we'll have a little respite there. We've had a perfect storm in agricultural commodities--floods in Australia, droughts in the Southwest here in the United States, issues in Europe. Kind of the perfect storm, everything where it will make energy prices go up, have gone up. So, I think, if we have even a slight approach to normal that crops may come back in a little bit here in the next three or four months--not in the next one or two months. So, that's one thing that's out there that will certainly help on the inflation front.

On the commodity side, as QE2 expires and some of the expansionary monetary policy, which we've already seen Europe raise their rates and a few things happened worldwide, and some of those foreign economies slowed just a little bit, some of the pressure comes off some of the commodities. We get copper, we get cotton coming in a little bit, and so maybe we've seen the worst of it.

Stipp: Okay. So, certainly something we'll have to keep a close eye on, but there could be some signs for a little bit of relief there.

So, the last thing I wanted to mention is, we're starting just now getting into the earning season, and I know that inflation had been on the radar of our stock analysts, how inflation is going to affect companies, in addition to how it's going to affect the consumers. Do you expect to see inflation really wreaking havoc on earnings report that we're going to start to see here?

Johnson: Well. I think it's going to be a little bit more problematic than it's been. I think we're going to have some issues there. We saw already Alcoa kick things off on Monday, and certainly the news there is that, prices of aluminum were up, but so were input costs.

So, the margins didn't expand as much as maybe some hoped, and they took it to the stock a little bit. So, clearly people are worried about inflation as we go through here. We're going to just take it and see how it happens on one by one basis.

Stipp: All right, Bob. Well, thanks for the insights, the extra context around the retail sales report that we got, and for joining me today.

For Morningstar, I'm Jason Stipp. Thanks for watching.