Consumer Still Hemmed In

Jason Stipp: I'm Jason Stipp for Morningstar. We got the government's July retail sales report this week, and it was better than a lot of economists were expecting. But is the consumer ready to break out on the upside?

Here to offer his take is Morningstar's Bob Johnson, our director of economic analysis.

Thanks for being here, Bob.

Bob Johnson: Good to be here.

Stipp: Before we talk about some of the consumer data we got, you just want to remind everyone how important it is to keep your eye on the consumer. We get a lot of data, but the consumer is really the one you want to key in on.

Johnson: Right. If you can only focus on one thing, it really does need to be the consumer. The consumer is 70% of the GDP report. It's really what drives the economy. A lot of people say, what about China or Europe? Well, Europe is about 3% of our GDP and China is 1%--tiny factors compared to what the consumer does.

Stipp: Even manufacturing, we're not going to see manufacturing open up new factories or have overtime workers unless they're seeing the consumer demand for those products.

Johnson: Absolutely. This business of everybody tracking all the manufacturing data is really not very helpful, because they're not going to build stuff unless it's being demanded by somebody.

Stipp: We can keep our eye on the consumer with some recent data that we got. The retail sales report was the most recent. But let's start with the GDP consumption component and where that came in. What is it telling you right now about where we are compared to the recent past and the recent trends.

Johnson: Consumption includes both goods and services, but the consumption number in the latest quarter was running at about a 1.7% annualized rate. Now, that's been in a range of 1.5% to 2.9%, so you can see we're not on the bottom anymore as we had been for a few months. Now we've come back again, but we're still at the low end of the range at 1.7%. We certainly aren't creating new ground, or doing absolutely wonderfully. In fact, the consumption number was a little slower in the second quarter than it was in the first.

Stipp: So a lot closer to the bottom than we are to the top of that range on that metric.

Johnson: Exactly.

Stipp: Let's look at the retail sales report. It was a 0.4% increase for the month [excluding autos and gasoline]. When you look at that data, what is it telling you and where are we in the retail sales report range?

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Johnson: It's the same type of story. The 0.4% is the monthly report, sequentially, and I like to look at the data year-over-year and average it. And I toss out the autos, which I measure a different way, and gasoline, which is volatile. The retail sales were up about 4.1% [using that calculation methodology]. That sounds pretty good, but the range over the last 12 months has been 3.7% to 4.6%, so we're in the middle of the range and almost right on the average of 4.2%. So we're not breaking new territory, but we're doing fine.

Stipp: The retail sales report had some interesting trends in the underlying sectors. Some areas you thought would have been a little bit better were weak in July.

Johnson: I think there is a problem always looking at the monthly retail data, because it is so volatile and things might get counted in one month instead of the other. For example, … the buildings materials, furniture, and autos have been the real drivers recently and have been the top performers. Really they moved the whole retail sales report up and down. They all actually had a negative month in July after a very good June. Now, I think … if you averaged June and July for those categories, you're probably fine. But just to put it out there, things that have been the key drivers of consumption have actually slowed down, and that's not a good thing. There has been a little bit of a changing of the guard, but whether it's just noise or whether it's some kind of new reality, I don't know.

Stipp: Since it has been a driver, it's definitely one we want to keep an eye on in future reports.

Restaurants were also one that you were curious about, because we've seen a lot of restaurant hiring. Are we seeing sales at restaurants justify that hiring?

Johnson: We finally saw an up month in restaurant sales [in July]. We were up 0.6%, which is one of the better performers in some time for that category. In fact, the month before we were negative. So we're back to where we were a month and a half, two months ago, but they're still not really great numbers, and certainly the employment data keeps going up and up and up, which continues to be a little bit of a mystery to us. Certainly hours worked have come back [up] a little in restaurants, but not enough to justify the type of hiring that we've seen.

But we do like to look at restaurants. You know how much I hate the formal consumer confidence surveys, but people going out to eat is an indicator of both free cash flow and consumer sentiment. That number looked a little better. So if I had to pick the one most positive thing in the whole report, it was that restaurant number.

Stipp: We get more recent data on the shopping centers, as it comes out every week. What is that trend saying, and is it something similar there, where we're off some of our lows, but we're still closer to the lows than the highs?

Johnson: Yes, same darn story. We got just under 2%, and the weekly reading I think was 2.5% up this most recent week, and the moving average is at 2.3%, which is still way low, because the lowest we got is 1.7%, and a typical high might be more like 4%. So at 2.5%, we're stuck at that bottom end of the range, not the top end of the range.

Stipp: Looking ahead, are there any reasons to think we'll start to move up the range or maybe get closer to the top than the bottom? What are the pros and cons for the consumer right now?

Johnson: There are a bunch of them. Obviously, a better stock market and better housing prices should be a big plus, and why that hasn't seeped a little bit more into the furniture category is a little bit of a mystery to me, and even some electronics, which tend to be [somewhat] new housing related. So they haven't moved just yet.

Employment--numbers of jobs--is going up, which is good, but the wage income for July looks a little bit soft to me based on the hours worked and the hourly wage. So no help there, at least for the next month or two.

I'm also worried a little bit about student loans that have gotten so high that it makes it hard for people just starting out to spend a lot of money. Typically, new [graduates] setting up new households are a big help to the economy; instead, they're tending to move home because of their loans or because they can't find a job. So that's certainly weighing.

And on the other end of the scale, I think we've had a few more retirees this year. When you retire, you tend to be a little bit more careful with your money and you have less you have to spend on clothing and transportation, so that hurts just a little bit in terms of the numbers. So those are things holding us back.

On the positive side, inflation is down, oil prices are down a little bit, and those are also very important.

Also, back on the negative side, weighing on the numbers a little bit is the payroll tax situation. And now a little bit more of the income tax situation. I think people in the higher brackets, as they come up upon the October deadline that they have for filing their extended tax returns, as they begin to bring the numbers together for that, and do their tax planning for year-end, I think that could cause the higher end of the market to be a little bit more concerned.

But keep in mind that real disposable income is only up 0.7%. And I mentioned the consumption numbers are … a little closer to 2%. So we've been out-spending our incomes. The reason income is so low is because of the payroll tax, and the further we get away from that date, the more people have gotten used to and adapted, the less of a factor it is going to be until it completely burns out somewhere in January or February of next year.

Stipp: Some headwinds, some tailwinds for consumers. Probably no reasons to think that the consumer is going to break out of this range anytime soon. So definitely temper your expectations for what consumer spending might do in the future.

Johnson: And I think it speaks to some of what the Fed might do. I think they'll see numbers good enough so that they'll want to cut some of their more controversial bond-buying programs, but indeed still have reason to keep the overall rates low.

Stipp: All right, Bob--a good overview on the consumer. Thanks for joining me today.

Johnson: Thank you.

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