Orlando's Outlook: Christmas was mediocre—will consumers remain weak?
Bottom line Retail sales in January were much weaker than expected, capping off a mediocre Christmas season that was positive, to be sure, but certainly softer than each of the past two years. Sales from the three-month Christmas season are very important, as consumer spending still accounts for 70% of Gross Domestic Product (GDP), and the soggy January results were disappointing after relatively healthy November and December trends. As we look out onto the horizon, however, numerous warning signs give us pause regarding the potential strength of the consumer in the early stages of calendar 2013. These include a sharp rise in gasoline prices, a spike in the savings rate to a three-year high, the economic impact from the expiration of the Social Security payroll-tax holiday, a decline in the ISM services indicator, a significant divergence in consumer confidence, and several fiscal-policy initiatives down in Washington, such as a broad round of tax hikes as part of the fiscal-cliff compromise on New Year’s day and a proposed increase in the national minimum wage.
Christmas 2012 was not a disaster The Commerce Department reports that total retail and food service sales for the three-month period of November and December 2012 and January 2013 rose by 4.46% on a year-over-year basis to $416.6 billion, compared with a 6.7% gain for Christmas 2011 and a 7.2% increase for Christmas 2010. So this past Christmas wasn’t a disaster by any means. But given the strength in Back-to-School (BTS) spending this past July, August and September, we believe that Christmas 2012 would have been much stronger, except that our elected officials in Washington shot the economy in the foot with their fruitless, protracted fiscal-policy intransigence.
January retail sales were soft Nominal retail sales for January rose by an in-line 0.1%, compared with solid gains of 0.5% for each of December and November. But January’s core retail sales—which strip out volatile auto results—were a tick stronger than expected, rising by 0.2%, compared with a 0.3% gain in December and flat results in November. Adjusted core retail sales—which strip out the results from both gasoline and auto sales—rose by only 0.2% in January, which was half of what was expected, while December and November were very strong, with gains of 0.7% and 0.8%, respectively. Finally, so-called “control” results—which strip out autos, gasoline and building materials, and feed directly into the Commerce Department’s quarterly GDP calculation—rose by a disappointing 0.1% in January, which was two ticks light, compared with solid gains of 0.7% in each of December and November.
Why is Christmas a three-month retail season? November includes the important post-Thanksgiving weekend, which enjoyed relatively solid Black Friday brick-and-mortar sales and Cyber Monday online spending. December contains Christmas, of course, although the first half of the month was soft, due to the psychological chilling effect associated with the then-looming fiscal-cliff negotiations in Washington. Fortunately, sales did manage to recover in the final week leading into Christmas. Gift cards, however, only count when they’re redeemed, typically in January—not when they’re purchased, which is why we need to fully evaluate all three months to get an accurate picture of the relative strength or weakness of a particular Christmas season. January’s strength in general-merchandise and department-store sales—up 1.1% and 1.0%, respectively—supports our thesis, as consumers cashed in their gift cards to take advantage of post-holiday bargains.
But there are numerous warning signs out on the horizon, which suggest that January’s relative weakness in consumer spending bears watching:
Social Security taxes rise As part of the fiscal-cliff compromise finally reached on New Year’s Day, President Obama allowed the Social Security payroll tax holiday to expire after two years, which increased the tax rate back to 6.2% from 4.2% on earned income up to the Social Security wage base of $113,700 in 2013. For an average American worker earning $50,000 per year, that amounts to $1,000 less consumer spending over the course of the full year. Moreover, because of the late date of the partial fiscal-cliff deal, the Internal Revenue Service (IRS) did not begin accepting and processing 2012 tax returns until Jan. 30, which will likely slow refunds and additional consumer spending in coming months.
Gasoline prices moving higher Gas is now priced at a national average of $3.64 per gallon, which is 13% higher than its mid-December trough of $3.22 per gallon, largely due to the cold weather and difficult winter conditions in the Northeast and Midwest. The rule-of-thumb is that every $1-per-gallon increase in the price of gas at the pumps withdraws $140 billion in discretionary spending from the economy. While that’s bad enough, if geopolitical risks should suddenly flame out of control with Iran and their nuclear ambitions, then gasoline prices could easily go vertical back towards $4 per gallon or higher, which would certainly have a deleterious impact on both GDP and consumer spending, as consumers and businesses would have less disposable cash to make discretionary purchases.
Savings rate spikes The personal savings rate surged to a three-year high of 6.5% in December, up from 4.1% in November. In all likelihood, this savings spike was related to tax-optimization strategies employed by many companies, which accelerated dividend payments and paid huge special dividends to shareholders and bonuses to employees, to avoid the huge increase in marginal and dividend tax rates that many had correctly feared President Obama would seek to implement in 2013. The recipients of these accelerated payments by and large pocketed them rather than spent them, due to the ongoing economic uncertainty surrounding fiscal policy in Washington.
ISM service index slips The Institute of Supply Management’s non-manufacturing business activity index—a proxy for economic activity in the service portion of the economy, which accounts for about 80% of all U.S. economic activity—peaked at a very healthy 60.9 in November 2012, but has since fallen to 56.4 in January. While the current reading still implies economic growth because it remains comfortably above the 50 threshold, this sharp contraction over the past two months bears careful watching.
Divergence in consumer confidence The Conference Board’s index of consumer confidence peaked at 73.1 in October 2012, but has since plunged by nearly 20% to 58.6 in January 2013, its weakest reading since November 2011. We believe that this decline accurately reflects a lack of confidence in Washington. Similarly, the University of Michigan’s consumer sentiment index had peaked at 82.7 last November, before falling by almost 14% to January’s preliminary reading of 71.3. But the final January 2013 sentiment reading stabilized at 73.8 before rising today to a surprisingly robust 76.3 preliminary reading for February. So with the Conference Board’s February reading coming up in less than two weeks, we’ll be watching closely to see if we are approaching a positive inflection point in consumer confidence and sentiment, which could contribute to better consumer spending trends.
Fiscal-cliff deal hurts consumer spending There were several tax-law changes implemented at the beginning of the year that have the potential to negatively impact business and consumer spending:
- Reinstate a top marginal rate of 39.6% (up from 35%) on taxable income above $400,000 for individuals and $450,000 for families.
- Medicare tax rises by 0.9% to 2.35% on taxable income above $200,000 for individuals and $250,000 for families.
- Reduces up to 80% of allowable itemized deductions and phases out all personal exemptions on taxable income above $250,000 for individuals and $300,000 for families.
- Flexible spending health-care accounts will plunge from $5,000 to $2,500 per year.
- The top rate on long-term capital gains and dividends rises from 15% to 20% on taxable income above $400,000 for individuals and $450,000 for families, plus a 3.8% surtax for the Affordable Care Act, for a new total rate of 23.8%.
These tax changes will largely affect the top 5% of American taxpayers, who enjoyed family income of $159,000 or more in 2010, according to IRS data. While this top 5% of taxpayers as a group earned 33% of total income in the U.S. in 2010, which is the latest year of available data, they also collectively paid 59.6% of all income taxes collected in the United States due to the existing progressivity of the U.S. personal tax code. The aforementioned tax-law changes that were put into place on New Year’s Day will likely push this rate of total taxes paid by the top 5% up toward 70%. In our view, this steeper progressivity will likely hurt consumer spending and GDP growth.
President proposes sharp minimum-wage increase In his annual State of the Union speech earlier this week, President Obama proposed a 24% increase in the national minimum wage from $7.25 per hour to $9.00, to be phased in over the next several years, as he no doubt envisions stronger economic growth and more robust consumer spending resulting from such a policy. The actual economic result, however, is likely to be higher levels of unemployment and weaker consumer spending. In an economy that is underperforming with 2% GDP growth, 7.9% unemployment and 1.4% core inflation, most companies are simply not in a strong enough competitive position to pass on these higher mandated labor costs in the form of higher prices. So the more likely end result is that companies will terminate some of their existing low-wage employees or refrain from adding a needed marginal worker, to avoid increasing their expenses and taking a hit to their profitability.