Orlando's Outlook: 'See you in September'

Bottom line In light of very disappointing retail sales for May—and sharp downward revisions into negative territory for April—consumers are reciting lyrics from the Tempos’ popular June 1959 hit “… bye-bye, so long, See you in September, See you when the summer’s through …” In retrospect, relatively robust January, February and March retail-sales results were more likely due to a warm winter and an early Easter. While we absolutely expected that April’s results would be weak due to the Easter calendar shift, we also expected a rebound in May—boosted by shopping for Mother’s Day, summer vacations and camp—which clearly didn’t happen. So what’s on the immediate horizon? June and July tend to be relatively unimportant summer clearance months, so we really don’t expect consumers to regroup in any significant fashion before the important Back-to-School (BTS) season kicks off in August, at the earliest. Because consumer spending accounts for 70% of Gross Domestic Product (GDP), this view certainly weighed heavily upon our recent estimate reductions for second- and third-quarter GDP. Despite the economy’s temporary soft patch, however, we believe that consumers have simply hit the pause button, and that consumer spending may benefit in coming months from declining energy prices, low interest rates, and falling nominal and core inflation trends. If we’re right that these macro variables will help to reverse what we expect will be soft April-through-July retail sales results during BTS, then that also bodes well for critically important holiday spending, which historically is 80-90% positively correlated. 

May retail sales were surprisingly weak Nominal retail sales for May fell by 0.2%, while April was revised down from a preliminary gain of 0.1% to a decline of 0.2%. That compares with headline sales for March, which were revised down from a gain of 0.7% to a gain of 0.4%. May’s core retail sales, which strip out volatile auto results, plunged by 0.4%, while April was revised down from a preliminary gain of just 0.1% to a decline of 0.3%. March was revised down from a stronger gain of 0.8% to a 0.5% increase. Adjusted core retail sales, which strip out gasoline and auto sales, fell by 0.1% in May, while April was revised down from a muted 0.1% gain to a 0.1% decline. March results were similarly revised down from a solid gain of 0.8% to a still-healthy increase of 0.5%. 

Industry comparable-store sales better in May than April The International Council of Shopping Centers (ICSC) reports that industry comparable chain-store sales rose by 1.7% in May versus only a 0.6% gain in April. That compares with solid gains of 4.1% in both February and March, according to the ICSC’s index of 22 retailers, which excludes sales from Wal-Mart because the industry bellwether doesn’t report monthly results. Luxury goods and the wholesale clubs remain the industry’s strongest categories. Total nominal store sales for May rose by 3.6%, versus a 2.2% gain in April and compared with gains of 6.1% and 6.6%, respectively, in March and February. 

Energy roundtrip After a 45%, five-month surge from $77 per 42-gallon barrel last October to $111 in early March, crude oil prices (West Texas Intermediate) have now completed a volatile roundtrip, plummeting by 30% to $77 per barrel over the past four months. Over this time, the national average price for a gallon of unleaded gasoline has fallen by 12% from $3.95 to $3.45, which suggests that retail pump prices may continue falling towards $3.00-3.25 per gallon throughout the summer, following the decline in WTI with a lag. In our view, lower energy prices serve as a tax cut for businesses and consumers, and this could help to spark stronger spending, economic growth and renewed job creation in the second half of 2012. 

Interest rate plunge boosts refis Benchmark 10-year Treasury yields plunged from 2.40% in mid March to a record low of 1.45% in early June. Treasury rates have since backed up to about 1.65% currently, but this broad move down has dragged mortgage rates to record lows: 30-year, fixed-rate mortgages are now at 3.79%; 15-year, fixed-rates are at 3.16%; and jumbos are at 4.38%. This trend has helped to spur an increase in refinancing activity, and we expect that the savings from lower real-estate financing costs will stimulate stronger consumer spending.  

Inflation continues to slow The decline in energy prices has reduced nominal near-term inflationary pressures. Month-over-month headline inflation in May for the retail Consumer Price Index (CPI) and the wholesale Producer Price Index (PPI) actually fell by 0.3% and 1.0%, respectively, while on a year-over-year basis, CPI rose by 1.7% versus a 2.3% increase in April, and PPI increased by 0.7% compared with a 1.9% gain in May.  Core year-over-year inflation (which excludes volatile food and energy price changes) has flattened out as a result, with the retail CPI unchanged at a 2.3% gain for the past three months, while the wholesale PPI is unchanged at a 2.7% increase for the past two months. The Personal Consumption Expenditure (PCE) index—the Fed’s preferred measure of inflation—ticked down to a 1.9% year-over-year core gain in April. Lower inflation will permit higher levels of discretionary business and consumer spending.

Auto rebound expected In a powerful cyclical rebound from deeply depressed levels, auto sales surged by 65% over the past three years to 15.03 million units in February 2012. But we believe that the spike in gas prices caused a 9% decline over the past three months, to 13.73 million units in May. We are now below replacement demand, which is at 14.0 million units. With the average age of the U.S. fleet currently at 10.8 years, and with the normal historical age of the fleet at between 7-8 years, we believe that there is tremendous pent-up demand for new cars and trucks. With interest rates falling, auto financing readily available at its best pace in five years, and with gas prices clearly rolling over, we expect a resumption of strong auto sales in the second half of 2012, which will boost business and consumer spending, economic activity and job creation. 

Housing gains The National Association of Home Builders’ (NAHB) Housing Market Index (HMI), which is a measure of builder confidence, spiked to a five-year high of 29 in June from just 14 last September. This index had peaked at 70 in July 2005 and troughed at 9 in March 2009. Also, housing permits (another important leading indicator) rose by nearly 8.0% in May to 780,000 units. In addition, mortgage delinquencies fell to another cycle low of 7.40% in the first quarter of 2012 from 7.58% in last year’s fourth quarter and from a peak of 10.06% in the first quarter of 2010. Moreover, affordability is at record highs, household formations are rising, and new-home inventories are at record lows. Residential investment leapt by 19.4% in this year’s first-quarter GDP, a positive trend that should continue.  

Consumer confidence divergence The puzzling divergence in consumer confidence over the past several months between the Conference Board and Michigan indices may be resolving itself. The University of Michigan consumer sentiment index leapt to 75.3 in February from its near-cycle low of 55.7 in August, and continued to grind higher to a reading of 79.3 in May, which represents a four-year high. But Michigan’s preliminary June reading fell sharply to 74.1. The Conference Board, in contrast, had soared from 40.9 in October 2011 to 71.6 in February, before rolling over to 64.9 in May. Continued improvement in consumer confidence and sentiment should also contribute to more robust consumer spending trends.

LEI gains in May The index of Leading Economic Indicators (LEI) posted a surprisingly strong 0.3% rebound in May, compared with a 0.1% decline in April, the index’s first negative reading in a year. Building permits, interest-rate spreads and new manufacturing orders were the strongest of the index’s 10 components, while stock-price declines in May and the length of the average workweek were the most negative components. Stock prices, however, have rallied by about 5% thus far in June. This positive LEI rebound suggests that GDP growth will strengthen in this year’s second half.  

Weekly claims moving in the wrong direction The fly in the ointment, however, is the initial weekly jobless claims, which are an important leading economic and employment indicator. They had bottomed at a four-year low of 351,000 in mid February, but they have since surged to 387,000 for the week ended June 16, which is also the survey week for the June payroll report. At this point, we’re expecting a sub-par 75,000 to 100,000 nonfarm payrolls when this metric is reported on Friday, July 6, which is only marginally better than May’s brutal gain of only 69,000 jobs. So while we still expect that job creation will start to reaccelerate in coming months, it clearly won’t be in June. An eventual strengthening in employment should generate stronger consumer spending.