Is Retail Spending on the Ropes?

It was another week of muted stock market gains with decent economic and earnings news, and more big buyouts tempered by additional bad news out of Europe.

Retail sales in particular were better than expected, although not quite as robust as I had hoped. However, that positive retail news was tempered slightly on Friday as an alleged internal  Wal-Mart (WMT) e-mail (as reported by Bloomberg) characterized February month-to-date sales as a "total disaster."

Initial unemployment claims and a sharply higher level of voluntary job quitters suggested continued improvement in U.S. labor markets. Manufacturing data was mixed, with industrial production for this month looking modestly weaker, but earlier months were revised sharply upward.

Even news from the Treasury Department was better, saying that the government actually produced a surplus for January, the first time that has happened since 2008. The good news was that tax collections were up a lot and spending grew, but not as fast as tax collections. Recall that federal government spending actually shrank in December, almost single-handedly torpedoing the fourth-quarter GDP report.

Speaking of government austerity hurting growth, European fourth-quarter GDP growth rates announced this week were a disappointment. Following last week's soft European bond market (which raises the cost of debt to countries that can ill afford it) the weak economic data was an unwanted surprise. On an annualized basis, GDP in the eurozone dropped 2.4% (compared with a 0.1% decline in the U.S., which will likely be revised to a small gain). That is the third quarter in a row of economic decline for the 17-country bloc. For all of 2012, the European economy declined 0.5%.

Unfortunately, the fourth-quarter declines were not limited to the southern periphery, either. Germany showed a decline of 2.3% and France a decline of 1.1%. While the data was certainly unwelcome, there is a certain rearview mirror element to the GDP data. More forward-looking data from Markit (manufacturing data) has been ticking up since October. China, a major market for European goods, is also showing signs of improvement. Business, consumer, and market sentiment in Europe has also been improving.

The data also provides a cautionary tale to U.S. legislators who try to cut government spending or raise taxes too quickly in a weak economic environment. The United Kingdom, perhaps a leader in government spending cuts, is now on a triple-dip recovery. In the U.K. there has been a pattern of spending cuts, which in turn hurt consumer incomes and reduced tax collections, necessitating even more spending cuts and tax increases in an attempt to balance the government's budget. And it sure doesn't help that everyone in Europe is going on a diet at the same time.

In the U.S., consensus wisdom is that the $85 billion of sequestration (across-the-board spending cuts) scheduled for 2013 will be put in place beginning in March, which has most economists trimming their growth forecasts by a couple of tenths. Keep in mind that this $85 billion is in addition to approximately $235 billion of new taxes and spending cuts implemented earlier this year. However, many questions remain about the month-to-month implementation of the sequestration, which is likely to happen later in the fiscal year. By then a new budget must be agreed to (or the government will face a shutdown in May) that may or may not include elements that effectively stop the full implementation of the sequestration.

Retail Slowing: Normal Reversion to Average, or Payroll Tax Effect?
Analyzing the consumer is always the most important part of economic analysis because it comprises such a large part of GDP. Unfortunately, no single report does a great job of doing that analysis, and the one that probably does the best job, the personal consumption report, comes a full month after the month is already over. Other reports have their faults, too. The shopping center data is exceptionally timely, but it lacks the breadth of store coverage. This week's official government report probably includes too many categories (some of which aren't used in the GDP report) and is not adjusted for inflation/deflation.

Usually, I can manage to piece together a decent opinion on the consumer by mixing and matching the various reports. This month it's a real struggle filled with many contradictions, as I discuss below. The CliffsNotes version is that the payroll tax seems to have slowed consumer spending some, but it was far from the disaster that many predicted. On the other hand, weekly data suggests that February may see more of an impact than January. The good news is that consumers have a few tailwinds that could help offset the very well-known issue of the 2% payroll tax increase.

Retail sales in January grew a modest 0.1% in January compared with more robust growth of 0.5% in both November and December. However, that number looks a little more benign if one excludes autos, in which case sales were down 0.1% in November, up 0.3% in December, and up 0.2% in January, hardly the Armageddon that many had feared with the higher payroll taxes.

Even looking at the all-in headline number for retail sales, it is fairly typical to have two or three above-trend months (November and December) followed by a stinker or two (January and maybe February). The year-over-year data, averaged, is even more optimistic. So depending on the time and category lens that one uses, retail sales were off sharply, steady-state, or improving nicely.

The year-over-year data seems to suggest that the retail economy is picking up steam, with the economy improving for three months running. Looking at the data this way seems a little like cheating because the payroll tax only shows up in one of the three months of the average. The truth here probably lies between the month-to-month number and the year-over-year data, neither of which quite tells the whole story.

There are also a few tell-tale signs that the report will be subject to some important revisions. For example, the grocery category was one of the best performing categories, yet the food and beverage category, which is dominated by the grocery portion, was one of the weakest performers. Did consumers give up drinking in January? And then the government data was somewhat contradicted by the International Council of Shopping Centers, which placed January as one of the best performing months in some time. Below I quote from the ICSC report:

"Despite the 'fiscal drag' from higher payroll taxes in January, consumers were shopping and hunting for those clearance items in January while an active flu season lifted drugstore sales revenue. U.S. comparable‐chain‐store sales for January posted a strong 4.5% gain measured on a year‐over‐year basis by ICSC Research's tally of 22 major retail chain stores. This was the strongest increase since September 2011 (plus 5.5%) and was boosted by the strongest monthly gain in drugstore sales (plus 2.9%) since August 2011 (plus 4.7%). Over the past year, drugstore sales have been held back by  Walgreen's (WAG) decision to withdraw from the  Express Scripts prescription network, which the company reversed later in the year. Excluding the drug store segment, industry sales rose by 5.1% on a comparable‐store basis in January, which was the strongest showing since August 2012 (plus-6.0%).  Macy's (M) CEO summarized his company's performance by noting, 'Simply put, January was an outstanding month.' His comment seemed appropriate for the industry as a whole, too. Looking ahead to February sales, ICSC forecasts that sales will increase by about 3.5% (excluding drugstores)."

The news wasn't entirely contradictory. Department stores, which are overweighted in the ICSC report, were indeed one of the better performers in the official government report. On the other hand, the weak clothing and drugstore numbers don't make a lot of sense given the cold and volatile weather, and an active flu season. Also note that January's worst performers were December's best performers, suggesting a reversion to sustainable averages. That's probably why it makes the most sense to focus on three-month average aggregate data. Month-to-month data is just too jumpy and subject to weather whims.

Weekly Shopping Center Data Shows Some Weakness
For almost the last three years, a five-week average of shopping center same-store sales have been solidly stuck in a 2.5%-4.0% range. This week we are near the bottom of that range at 2.6%. Individual weekly readings have been under 3% for three weeks in a row and the average is in danger of tipping out of the normal range as early as next week. (I think a healthy Valentine's Day rush will ultimately save the day, but who knows?) The Nemo Storm disaster in the Northeast may have been as much a culprit for poor results this week as the payroll tax. In that case, we should see a quick rebound next week.

Wal-Mart's Alleged February Disaster
As this column was going to press, an internal Wal-Mart email, initially reported by Bloomberg, suggested that the first two weeks of February were a disaster for the retailer, sparking a late day market sell-off, especially in retailer stocks. At press time, Wal-Mart is making little comment other than to say internal comments are often taken out of context. 

Even if the memo proves to be completely true, I still contend that retail sales overall will not be drastically affected by the payroll tax increase. Unfortunately, Wal-Mart hit the trifecta on three potentially negative events: the payroll tax increase, rising gasoline prices, and delayed tax refunds. I could probably throw in Nemo, too, but Wal-Mart likely has fewer outlets in the Northeast than some other retailers. Higher payroll taxes will disproportionately hit low-income earners compared with higher-income earners who may not even notice the increase. High gas prices have always hit Wal-Mart particularly hard because many consumers drive long distances to get to Wal-Mart stores.

Sometimes consumers opt to make fewer trips to Wal-Mart when gasoline prices are high, and sometimes they purchase goods at closer stores even if prices are higher.

Finally, one of the unintended results of the fiscal cliff fight was a multiweek delay in the ability to file for a tax refund. Instead of filing returns as soon as W-2s are available early in January, filers had to wait until the very end of the month, delaying those all-important refunds. (Again, those refunds are a really big deal to low-income earners.)

Consumers Have Some Help and Some Hindrances
While the retail news is mixed, I think there are more tailwinds than headwinds for the consumers in the months ahead. Often lost in the shuffle of the fiscal cliff and the payroll tax increase is that the minimum wage went up in several states in January, and there was a meaningful cost of living increase for those receiving Social Security. Continued home price and stock market price appreciation is putting more money in consumer's pockets, too. Steady employment gains are certainly providing another boost. Moderation in inflation has also been a big help to consumers during the last three months, although rising gas prices may endanger that track record.

Industrial Production Nothing to Write Home About
Industrial production fell 0.1% in January, below consensus forecasts for 0.2% and my hope that we would do even better than that. Frankly, the weakness looked relatively broad-based with just a few exceptions (furniture and appliances, textiles, apparel, and energy were up). And the overall number would have looked even worse without a big weather-related jump at utilities. Autos looked particularly weak at negative 3.2%, especially in light of above expectations sales for January. I am guessing the seasonal factors are askew yet again.

That said, production is not the growth engine it had been. Production was up 6.3% in 2010, 4.1% in 2011, and just 2.8% in 2012 on a fourth quarter to fourth quarter basis. The January figure suggests growth slowed further with year-over-year growth declining to 2.1%. However, by year-end I suspect that IP growth will be running closer to 3% as the auto industry is projected to have another good year overall, despite a poor production start in January. Homebuilding-related product growth should also accelerate throughout the year. A pickup in China as well as some positive purchasing manager reports, both regionally and nationally, also suggest better days ahead.

U.S. Government Runs a Surplus in January, Both Spending and Taxes Up
It's probably not a big deal, but the U.S. federal government ran a $3 billion surplus in January, the first time that has happened since 2008. The deficit in the same period a year ago was $29 billion. Tax revenue was up 26%, only some of which was related to the 2% payroll tax increase. Spending was up a more anemic 3%, though at least the figure was still up.

For the first four months, only one of which included the new payroll tax, the deficit shrank from $349 billion to $290 billion, putting the planned deficit reduction from $1,089 billion in 2012 to $845 billion for 2013 within easy reach with the payroll tax increase. One word of caution: I am not so sure what role the delayed tax refunds might have played in the January surplus.

The unexpected surplus for January may enable the U.S. to avoid having to deal with debt ceiling issues until sometime this summer. Interestingly, the state of California also showed a sharp increase in tax collections for January, driven primarily by higher income tax collections (versus sales taxes or corporate taxes).

Employment Data Looking Slightly Better
Initial unemployment claims have been volatile the last few weeks, but I am pleased to see the weekly figure drop so sharply again, this time to 341,000. This means that the four-month moving average has been stuck in the low 350,000 range over the last month, well off the 370,000 range we experienced for most of 2012. 

In other good news, the Job Opening report suggested that more people were voluntarily leaving their jobs, often one of the truest indicators of consumer confidence. One wouldn't tend to voluntarily leave a job unless they felt they were well enough off not to work at all, or that another job would be relatively easy to find. Currently, 53% of all separations are voluntary, versus a recession low of 37%, not far off the pre-recession level of 57%. However, the same report showed there was no increase in job openings during December, which means that it's hard to expect acceleration in hiring over the short run. 

Next Week It's All About Inflation and Real Estate Data
Both the Producer Price Index and the Consumer Price Index are scheduled for release next week. The CPI is probably the most predictive indicator of economic decline that I follow. Inflation rates of 4% on a three-month averaged, year-over-year basis are almost always associated with a recession. Though, inflation may not be the root cause of most recessions, it does represent the proverbial straw that breaks the camel's back. For example, the housing industry began slowing as early as 2005, but the economy as a whole didn't peak until late 2007 and early 2008 when inflation spiked. 

Although, the U.S. came close to 4% inflation in 2011, we didn't quite breach that mark, but the economy did slow a bit. Currently, year-over-year inflation is running at a 1.9% rate. If forecasters are right about the 0.1% monthly increase in the CPI for January, that year-over-year rate would drop to 1.7%, clearly in the safe zone for economic growth. The projected 1.7% annual increase is well below the 4.0% average (which is skewed by double-digit increases in the 1970s) rate of price increases since 1960. Inflation has only been lower than that 1.7% approximately 20% of the months since 1960.   

By category, gasoline, although up in price during January, is up a little less than most Januaries. The latest PPI suggests that food prices should be relatively tame in January, though a freeze in California could skew those numbers. Unfortunately, with a huge gasoline price spike in February, a month that typically sees prices decline, we may have seen the last of the large improvements in CPI for another few months.

Housing Data Could Take a Pause; Don't Panic
With weather returning to a more normal cold and snowy pattern, I suspect real estate data could look a little soft here for the winter months before a renewed bounce this spring. There is a chance that the market might not react well to the data, especially now that the world has woken up to the fact the real estate market has bottomed and is now an important of the economic growth story for 2013. Also weighing on the sales data is a shortage of supply. Until prices move enough to draw in more sellers or more builders, some of the volume-based data could look a little soft. Therefore, I will be looking at dollars transacted and not just the unit growth figures with which the market is so enamored.

The week kicks off with builder sentiment data, often a good indicator of new home sales that are due later in the week. Sentiment is expected to move from 47 to 48. A reading of 50 indicates that as many builders are seeing improvement as declines. Given that the fiscal cliff was resolved in January, the mortgage deduction appears to be safe for now, and prices are higher, builders should be at least a little more optimistic.

Housing starts had a huge--and expected--jump in December, and analysts are generally expecting a return to more normal growth levels in January. Starts in December soared to 954,000, the high-water mark for 2012 and the recovery as a whole. Investors are expecting starts to drop back to 918,000, based on slower growth in permit data in that same report, as well as the magnitude of the spike. I will also be carefully analyzing the mix of new and single family starts, with the volatile multifamily sector showing unusual strength in recent reports. New permits are also included this report.

New home sales will also be announced. Given that the report includes homes already finished as well as homes not started and excludes apartments, the new home sales report is of little value. The main thing I look at in that report is the average and median prices of homes sold. The mix of homes bought off the lot and those not even started can also prove interesting.