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Retail Sales and Fed Policy: Is the U.S. Consumer Spending?

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August 28, 2015

It’s been a busy month in the market and an even busier week. As we exit summer and head into fall trading, many  questions remain unanswered. Although we just emerged from another earnings cycle, one major unknown still looms on the horizon: what will the Fed do in its September meeting?

In the minutes from the most recent FOMC meeting, committee members cited gains in employment and income, high household net worth, and low gas prices as potential tailwinds for consumer spending moving forward:

“An improving job market should, in turn, help support a faster pace of household spending growth. Additional jobs and potentially faster wage growth bolster household incomes, and lower energy prices mean consumers have more money to spend on other goods and services. In addition, growing employment and wages should make consumers more comfortable in spending a greater portion of their incomes than they have been in the aftermath of the Great Recession.”

As we hit the home stretch leading into the September Fed meeting, let’s take a quick look at the current state of the U.S. consumer and implications for the future path of consumer spending.

While a variety of reports and announcements make headlines throughout the month, there is no one single indicator that will let you know exactly where the economy stands or where it is heading. Many economists and traders look at multiple indicators to piece together their assessment of the economy.

Although the initial impulse may be to jump directly to motor vehicle sales—the largest component of the retail sales report—let’s start instead with jobs and income reports. Jobs and income drive consumer spending of any kind. For the jobs report, the weekly jobless claims number is convenient in that it gives us a peek at the job market in between the monthly employment situation report. However, the week-to-week shifts can be fairly volatile. To smooth the number and make it a little more digestible, look at the general trend in the four-week moving average of initial claims. Over the course of the past year, the general trend in the average is moving lower. Taken at face value, this may indicate strength in the labor market. Note that the most recent readings indicate a bounce off the recent low for the average of 266,000.

FRED - 4 Week Moving Average of Initial Claims

FIGURE 1: STRONG LABOR. Over the course of the past year, the general trend in the average is moving lower. Take at face value, this may indicate strength in the labor market. Source: Federal Reserve Economic Data, 4-Week Moving Averages of Initial Claims. For illustrative purposes only.

Another shortcut to gauge the health of the labor market is the Diffusion Index for Total Private Employment—a rarely discussed number in the monthly Employment Situation Report. Readings in the diffusion index above 50 indicate  a greater percentage of industries reported hiring versus layoffs. In the most recent Employment Situation Report, the Diffusion Index for Total Private Employment in July came in at 64.4—a solid increase from the previous reading of 60.6 in the June survey.   

Next, determine if the outlook for the labor market can actually translate into what really matters—money in the pockets of consumers.

To focus on what consumers earn that they can actually spend and the underlying strength in that number, we can look at two items: Real Disposable Personal Income and Average Hourly Earnings of All Employees.

Average Hourly Earnings and Real Disposable Personal Income

FIGURE 2: SPEND TREND. To focus on what consumers earn that they can actually spend and the underlying strength in that number, we can look at two items: real disposable income and average hourly earnings. Source: Federal Reserve Economic Data, Average Hourly Earnings of All Employees: Total Private and Real Disposable Personal Income. For illustrative purposes only.

Although we saw a plunge in these measurements for employment and income around March of this year, things seem to have stabilized in the releases that followed. To understand how this translated into actual spending, look at retail sales, specifically the Advanced Monthly Sales for Retail and Food Services report.  

As of the most recent release, motor vehicles and parts dealers comprised about 20% of spending, which is generally expected. At times, vehicle and parts sales numbers can be somewhat volatile and make deciphering the retail sales trend tricky. To get a less noisy reading, look at Retail and Food Services excluding Motor Vehicles and Parts Dealers. Think of that number as core retail sales.  

Retail Sales and Food Services

FIGURE 3: CORE RETAIL SALES. To understand how this translated into actual spending, look at retail sales. Source: Federal Reserve Economic Data, Retail Sales and Food Services Excluding Motor Vehicles and Parts Dealers. For illustrative purposes only.

Consistent with our initial observations on employment and income, there was a significant drop in year-over-year growth heading into spring, but it seems to have rebounded nicely since then. Some of this drop can be explained by lower levels in the Gasoline Stations component of the report, which was down 15% in the latest report. It’s worth noting this component generally only accounts for 10% of the headline number.

All this feeds into what investors really want to know: how do these data points translate into sales and profits for U.S. firms? The Bureau of Labor Statistics issues Industry Reports with interesting information on the Retail Trade Sector. This sector comprises establishments engaged in retailing merchandise and rendering services incidental to the sale of merchandise. The caveat to this sector is that the merchandise is sold “without transformation.” In other words, it’s the sale of the final product that consumers can use as is. Sales in this sector for 2014 were $1.9 million. Analysts polled by Thomson Reuters currently project this number to be $2 million for 2015, an increase of 5%. On the earnings front, analysts are looking for a similar 5.2% increase over 2014.

All components of the S&P 500 are assigned to one of nine sectors. In its top 10 weighted names, the Consumer Discretionary Sector (ticker: IXY) includes Amazon, Walt Disney, Comcast, Home Depot, McDonald's, Starbucks, Nike, Time Warner, Lowe’s, and Priceline. Despite the recent volatile markets, the Consumer Discretionary Sector is still up over 5.5% year to date, while the S&P 500 as a whole is now down nearly 3.5%.

Consumer Discretionary Sector vs. S&P 500

FIGURE 1: UPS AND DOWNS. Despite the recent volatile markets, the Consumer Discretionary Sector is still up over 5.5% year-to-date, while the S&P 500 as a whole is now down nearly 3.5%. Chart source: TD Ameritrade's thinkorswim® platform. Not a recommendation. For illustrative purposes only. Past performance does not guarantee future results.

As we move into the final two quarters of the year, it will be interesting to see if the labor market can find additional traction, and if this in turn drives spending by the U.S. consumer. Developments in this arena could be a key area for investors and policy makers alike to scrutinize.