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Consumers Not Running Scared

Jason Stipp
Robert Johnson, CFA

Jason Stipp: I'm Jason Stipp for Morningstar. We got the government retail sales report for June, and it was pretty disappointing no matter how you slice it. So what's going on with the consumer right now? To get some insights, we're checking in with Morningstar's director of economic analysis, Bob Johnson.

Bob, thanks for being here.

Bob Johnson: Great to be here.

Stipp: So we have the retail sales report for June. You look at it in a number of different ways. Top line though was disappointing. It was the third consecutive decline. What did it look like at the very top, and then how do you look at the report, as well?

Johnson: It was down 0.05%, and it's a third decline in a row as you mentioned. And this is a measure of retail sales, which accounts for about a third of total consumption that goes in the gross domestic product report. So it is an important report. It was down on a month-to-month basis, that is comparing June with May, and almost every category was down with maybe the exception of online buying. Otherwise almost every category was down, which really kind of came as quite a surprise.

Stipp: You make a few adjustments in the way that you look at the data. You take a certain slice of it, and it was also showing some deceleration there, as well. What trends are you seeing in the way that you look at the data?

Johnson: It isn't nearly as bad when you do look at it on the year-over-year moving average basis, because odd things happens in months. But we were kind of in the 6.0%-6.5% range for growth in retail sales year over year, now we're kind of in the 4.0%-4.5% range. The peak came last October when gasoline prices were really high, and as they came back down a little bit, now we're down in the 4.0%-4.5% range. But it is more than gasoline. I will be honest with that, but certainly falling prices in general probably explain about at least half of that decline from 6.5% to 4.5%.

Stipp: So [besides] gasoline, there were some other areas that were down big, and we have some explanations for some of those. Let's walk through some of them; you mentioned gasoline. For home and garden, it's the summertime and folks should be out in their yards, but it didn't perform well.

Johnson: No, I think it was down 1.8% or something like that, which is horrible, and it is a volatile series. But what happened with that number is that with the drought throughout the country, the stock of merchandise available to sale is almost nothing, and people don't want to put in stuff figuring it's going to die because of the heat anyway. So that's really hurt and people. Maybe hoses are up a little bit, but you certainly need lawn-mowing equipment and weeding stuff. The weeds can't even survive in this drought. So, that's a relatively big category; it just looked abysmal this last month.

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Stipp: Drugstores were also not looking very well. What's behind the drugstore sales?

Johnson: That one continues to be pummeled by this whole issue of a lot of drugs coming off of patent and then moving to generic. It's depressing drugstore sales 5% to 10%. It's a lot. Don't worry too much about the drugstores; they make nicer profit margins on the generics. But on the top-line retail sales data, we're getting killed right now by drugstores because they are seeing weakness as a result of this trend. On top of it, we had a mild flu winter or a mild flu season; things just added up. Everything went wrong for the drugstores.

Stipp: It's important to realize about this report again that it's not adjusted for price differences. So if folks are spending less money for cheaper generic drugs, that's not going to show up here. It's just going to look like fewer sales for those drug stores.

Johnson: Yes.

Stipp: Electronics, another one that had been really kind of strong for a while with consumers getting those gadgets, also looks weak. Why weakness in electronics?

Johnson: There are a lot of things that have come together to make that number look weak. On the computer side, you've got the Wall Street Journal saying, if you're buying a laptop you've got to wait, don't buy a computer whatever you do because there's a new operating system coming from Microsoft. You've got a new version of the iPad coming out. So on the computer side of it, you've got everybody saying, "Hold on a little bit." Then you go to the smartphones, and certainly on the import numbers we saw the other day, it was a clear indicator that something is slowing in the smartphone market. Again maybe it's waiting for new products, but I'm thinking maybe it's a little bit of a saturation in that market.

Usually Blackberries were [owned by] few executives, then it was the soccer moms. But now everybody's got a smartphone. It's almost hard to live without one. So I think that category has gotten more saturated and so you're seeing less growth there. Finally, you've got televisions.

Stipp: Flatscreen TVs.

Johnson: Flatscreen TVs, where you're seeing I think probably market saturation.

Stipp: And lower prices, as well, right?

Johnson: Dramatically lower prices. TVs are down about 20% year over year for the same TV. I don’t think that even fully captures how much they are down. Again even with a cheap TV just how many rooms can you put a flatscreen TV? I mean do you really need the 80-inch TV? And so I think that certainly hurt that category. So you've got a combination of I think volume growth, which is probably still a little bit there, but then you've got falling prices that are the final coup de grace on the numbers for electronics.

Stipp: I know that we also sometimes remove autos from the report because there's volatility there. We think that people are going out and buying autos, but it didn't really show up in this particular report. Why didn't the autos look better in this report?

Johnson: You know, autos have been a real stalwart of this recovery. For the numbers that I look at, which come out the first day of the month after the [previous] month is over from the manufacturers and what they actually sell, we actually even on an seasonally adjusted basis went up from May to June. But this report actually showed a downward move. Maybe it's pricing. Maybe there were more incentives offered, and that brought the price down. Maybe it was a mix issue where they bought cheaper cars this time around; I don't know.

Stipp: Are fleet sales potentially responsible for some of the volume?

Johnson: Yes. Maybe Hertz or somebody took a bunch of the volume this time around which is not a positive sign for the group. But nevertheless, maybe that partially explains some of the numbers because even in the recent industrial production report, auto production is booming and set kind of a new high recovery.

Stipp: There might be some fuzziness in the auto numbers. We have seen some weakness and can explain why we've seen some weakness in some of the other categories. If consumers are spending less in some of these categories and we know why, why aren't they spending more in some of the other categories? Why didn't we get a lift from the other portions of the retail sales report?

Johnson: Well, I think there are probably a couple of things going. With gasoline prices, we always kind of make a big deal about putting more money into consumers' pockets, but I think volatile gasoline prices have kind of conditioned consumers. I think when prices go up a little bit, [consumers] say, "They are probably coming down a little bit. I'm not changing the way I living. I'm not canceling my subscription. I'm not buying something cheaper because gasoline prices are up." And then I think when prices fall they don't immediately say, "I've got this new money in my pocket. I'm going to spend every dime of it just because it happens to be here."

Now there is a little bit of that, that goes on, obviously. But I think that it doesn't all flow to the bottom line right away.

Stipp: Consumers know those prices are volatile, so they are not going to make big spending-pattern shifts because gas is cheaper for a few weeks.

Johnson: On the margin it absolutely does have an effect, and you can see it. But is it big enough to offset some other things? Not necessarily.

My other pet theory is that auto sales, new-home sales, and existing-home sales have been up almost all year. And as people plan for making those type of purchases, actually take the time to be looking at new houses and shopping for cars, those are all things that take away from other shopping time, if you will, and I think that that certainly had an impact on the retail sales. They've been focusing on the big-dollar, big-ticket items.

A lot people are saying, "Oh, the consumer is scared." Well, if the consumer were scared he wouldn't be buying a house at a level 40% higher than a year ago, and auto sales wouldn't be at a near a record high for a number of units in this recovery. Those two facts don't mesh. So, I don't think it's a scared consumer. I just don't think we've seen the full effects yet of the falling gas prices and the better consumer incomes that we've started to see.

Stipp: And on the homebuilder front, we had another piece of data this week that would also tend to suggest that consumers are out there looking at those homes, right?

Johnson: Yes, they are looking and maybe even doing a little bit of buying according to the builder sentiment report. That index went up to 35. To give you some idea, during the recession it got as low as 10, and even a couple of years after the recession, it was still in the low teens.

So that number just absolutely got cratered, and now we're back up to 35, which is up from 29 in the prior month, and expectations were that the number would come in at 30. And this is not a number that's easy to game like the University of Michigan Consumer Confidence; when I say confidence, you know how much I hate those indexes. But this one actually takes hard metrics: how many people came through your homes, how many people have put in offers. All that kind of stuff goes into this report. Certainly the numbers look better. It was across all four regions of the country that they measure, every one of them [improved], and the west was up a dramatic 11 points.

So, it certainly tends to indicate to me that people are spending more time looking at housing, and maybe that's taking away [from retail sales]. The good news is that that housing data six to nine months after when the housing stuff picks up, then you start to see some of the furniture numbers and some the other numbers begin to go up, too.

Stipp: Potentially it could help employment, as well, in those later stages?

Johnson: Absolutely. You know what, one of the grand mysteries to me is that we had a couple of good months of construction numbers in January and December--and I think the reason was weather was a little warmer--and since then we've had basically four months of decline in construction employment. At the same time, we've seen this dramatic increase during the last four or five months in housing starts. It just doesn't quite fit. Maybe laying a foundation doesn't take many people, but the finishing steps do. So, again, this is something that may turn up later in the year.

Stipp: Bob, it sounds like a lackluster retail sales report, but it's certainly interesting to dig into some of the trends. One of the takeaways as you'd say, retail sales are a little bit weaker, but not because the consumer is running scared?

Johnson: No, absolutely not, and the weekly data is certainly supportive of things not getting any worse from here. We've had a couple of months of weekly data that actually looked pretty good.

Stipp: All right, Bob, well thanks for the insights on the all-important consumer and retail sales data for June.

Johnson: Thank you.

Stipp: From Morningstar, I am Jason Stipp. Thanks for watching.