Orlando's Outlook: Consumer not dead yet
Bottom line With apologies in advance to Mark Twain, rumors of the untimely demise of the American consumer—due to tax hikes, late refunds and rising energy prices—appear to be somewhat premature. To that point, we received three significant data points just this week—April’s retail sales and leading economic indicators and May’s preliminary Michigan sentiment reading—which collectively suggests that the transitory “Spring Swoon” we’ve been forecasting will be just that—temporary in nature, to be followed by stronger economic growth in the second half of the year. That, in turn, has fueled a continued surge in investor confidence, which has helped to drive the S&P 500 to our full-year target price of 1,660 before we’ve even hit Memorial Day. Go figure.
'Mapril' retail sales trends improving Regular readers of this space know that investors need to study the combined retail-sales results of both March and April (“Mapril”) to properly gauge consumer sentiment and spending trends, because of the seasonal distortions of the Easter calendar shift (Easter was on March 31 this year versus April 8 last year) and weather distortions (March was very cold this year, compared with the warmest March on record in 2012). For these reasons, Easter is essentially a two-month retail season.
- Nominal retail sales rebound Headline retail sales for April rose by a stronger-than-expected 0.1%, which was much better than the consensus expectations for a decline of 0.3%. March remained very soft, as results were revised down a tick to a decline of 0.5%, while February was revised up a tick to a very strong increase of 1.1%. Categories such as building materials, apparel, autos and general merchandise enjoyed solid month-over-month rebounds of more than 1.0% in April, which offset a sharp 4.7% decline in gasoline sales.
- Ex-autos still soft Auto sales have generally softened during this “Spring Swoon” over the past two months. But April’s core retail sales—which strip out volatile auto results—posted a better-than-expected decline of only 0.1%, compared with consensus expectations for results a tick worse. March suffered through a much-worse decline of 0.4%, while February—which was the peak of the auto cycle to date—enjoyed a strong gain of 1.1%.
- Ex-autos & gas soar Adjusted core retail sales, which strip out the results from both gasoline and auto sales, rose by a strong 0.6% in April, double consensus expectations, compared with no change in March and a gain of 0.3% in February.
- Control group bounces Finally, so-called “control” results—which strip out autos, gasoline and building materials, and feed directly into the Commerce Department’s quarterly Gross Domestic Product (GDP) calculation—rose by a surprisingly robust 0.5%, which were two ticks stronger than the consensus estimates. That compared with gains of 0.1% and 0.5% in March and February, respectively, both of which were revised several ticks higher.
Positive GDP revisions? Because consumer spending accounts for 70% of GDP, the improving trend for retail sales in April, and the upward revisions to control results in February and March, may help to offset weaker trends in government spending, manufacturing, inventories, corporate cap ex, and net trade. So when we get the first revision to first-quarter GDP on Thursday, May 30, economic growth may be unchanged to down only slightly from the flash report of 2.5% growth. At this point in time, we are still forecasting a sequential second-quarter decline to growth of 1.7%, but we continue to expect a second-half rebound, back to perhaps the 2.5% level, or so.
Why were we concerned about the low-end consumer? The bottom 60% of wage earners in the U.S. accounts for 40% of all consumer spending, and we believed that the following issues could negatively impact their ability to spend in the early part of the year:
- 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.
- Late federal tax refunds 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 January 30, which slowed refunds into April. So that timing issue likely hurt March consumer-spending results, but boosted April trends.
- Rising gasoline prices Gas rose by 17% from the national unleaded average of $3.22 per gallon in mid-December to $3.79 in late February, largely due to the cold weather and difficult winter conditions in the Northeast and Midwest. Every $1-per-gallon increase in the price of gas at the pumps withdraws $140 billion in discretionary spending from the economy. But gas prices then slipped by 8% to $3.50 per gallon by the end of April, which boosted consumer spending.
High-end consumers hurt, too The top 20% of wage earners in the U.S. disproportionately account for 40% of all consumer spending, and this group felt relatively poorer at the beginning of the year, due to several tax-law changes. But this hit should fade over time, in our view, due to a positive “Wealth Effect” associated with rising equity and real estate prices.
- Reinstated 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 rose by 0.9% to 2.35% on taxable income above $200,000 for individuals and $250,000 for families.
- Reduced up to 80% of allowable itemized deductions and phased out all personal exemptions on taxable income above $250,000 for individuals and $300,000 for families.
- Flexible spending health-care accounts were cut in half to $2,500 per year.
- The top rate on long-term capital gains and dividends rose 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%.
Confidence tide is turning The good news, in our view, is that the negative consumer sentiment resulting from poor fiscal policy decisions in Washington—raising tax rates and cutting government spending amidst a sluggish economy—may be starting to turn more positively. Witness three recent data points:
- Michigan sentiment soars The Thompson Reuters/University of Michigan consumer sentiment index has been very choppy since last November, but the preliminary May reading released this morning boasted a much stronger-than-expected surge to a six-year high of 83.7, up from 76.4 in April. The trick, in our view, will be future readings over the next few months. Will consumers build on their new-found confidence, or retreat like a scared turtle pulling back into their protective shell, as has been the pattern over the last several months?
- Consumer confidence jumps, too The Conference Board’s consumer confidence index followed a very similar suit with its recent April reading, which surged to a much stronger-than-expected five-month high of 68.1, compared with an upwardly revised 61.9 reading in March.
- LEI surges The Conference Board reported this morning that their Leading Economic Indicators (LEI) leapt by a larger-than-expected 0.6% in April, which was its strongest monthly gain since February 2012, versus a 0.2% decline in March. This is an important leading indicator (hence the name), which augurs well for stronger economic activity over the next three to six months, supporting our thesis for a second-half rebound. Seven of the 10 April indicators were positive, led by a rise in housing permits, lower interest rates, and a decline in initial weekly jobless claims.