What does the latest retail sales report tell us about the US economy ?

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The first week of the Rio Olympics is behind us; mid-August is here and with it, the end of the second-quarter company earnings season. There now seems to be a slight disconnect between the latest macroeconomic data and the message from many corporations which points to higher wages and stronger growth in certain industries and regions.

A better tone in the jobs market is not yet reflected in spending

While recent US payroll reports have reflected a bounce (see exhibit 1 below) and wage increases, which should translate into greater consumer spending power, recent macro data is showing spending levels less robust than expected. Consumers have been the main driver of US growth as business capital investment has declined. As we do not expect any meaningful pickup in business investment due to the broader global macroeconomic and political uncertainties, it is up to the consumer to continue carrying the torch for the US economy.

US retail sales report suggests consumers are taking a breather

Following strong spending in the second quarter of 2016, July retail sales data, published on 12/08/16, showed the consumer pulled back so far in the third quarter. Sales were flat and below consensus expectations. However, this data follows three months of gains plus an upward revision to June’s already strong numbers. Home improvement sales moderated and apparel and non-apparel department store sales, which are in a secular decline, remained weak. At the same time, online shopping continues to take share from traditional channels.

Productivity remains the achilles’ heel

After May’s disappointing jobs report, the data from the last two reports has been strong, alleviating fears of a slowing labor market.

Exhibit 1: Since the upset in May, employment reports have relieved concerns over a slowing labor market (the graph shows monthly changes in non-farm payrolls and the unemployment rate between August 2014 and July 2016). 

US labor market statistics graph fftw

Source: BNPP IP and Bloomberg as of 5 August 2016

On a positive note, the quits rate, reflecting voluntary separations by employees as established in the Job Openings and Labor Turnover Survey, has steadily increased over the last few years (see exhibit 2 below). It can be seen as a measure of confidence in the US economy by gauging workers’ willingness to leave jobs in the expectation that they can find work elsewhere.

Exhibit 2: The rising trend in the ‘quits rate’ may be a sign that workers are confident of finding work. Note the stable trend in the number of layoffs and discharges. Data from the Job Openings and Labor Turnover Survey (JOLTS) by the Bureau of Labor Statistics (seasonally adjusted in thousands for the period from January 2006 through July 2016)

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However, the decline in labor productivity in the second quarter was worse than expected. This is the third consecutive negative quarter. Weak productivity growth has received a great deal of attention as potentially being problematic for the US economy.

Q2 2016: the fifth consecutive quarter of earnings declines

While second-quarter company results have generally been ahead of market expectations, with 70% of companies beating consensus estimates, reported revenues and earnings were down from the year-ago quarter, marking the fifth consecutive quarter of year-over-year declines.  However, the slippage was less than the levels seen in the first quarter.

Earnings estimates are pointing to an improvement in the second half of 2016, with overly aggressive growth rates forecast in the fourth quarter for both revenues and earnings. For full-year 2016 consensus estimates to be met, earnings growth rates will need to accelerate from a low single-digit decline in the second quarter to a high single-digit increase in the fourth quarter.

We would characterize the tone from management teams on the outlook for the rest of the year as cautiously optimistic amid concerns over macroeconomic and political uncertainties. Several managers pointed to lower-than-expected spending by industrial customers as investment is scaled back, while others cited lower spending on business travel as a reason for the lowered full-year 2016 outlook.

For the credit investor, the latest earnings reports showed a deterioration in credit profiles, a familiar picture which we have seen for the past couple of years. Bank sector results reflected a challenged topline, but relatively stable credit quality and full-year earnings guidance was largely reiterated.

So it is up to the consumer

To meet full-year expectations, continued strong spending is needed for the remainder of the year. As for business spending, corporate management seems content to allocate cash flow and capital to fund M&A and stock buybacks rather than increasing their capital expenditure budgets. Nonetheless, while July’s disappointing US retail sales report was a modest negative for third-quarter GDP, we believe the pieces are in place to support healthy consumer spending.

 

This article was written by Uma Rickheeram, Head of US Credit Research, in New York City on 15 August 2016

 

For more on the US jobs market, read these articles:

Let the Games Begin (includes remarks on the US non-farm payroll report for July 2016), written on 8 August 2016 by Ken O’Donnell

US jobs strength only complicates Fed decision-making (about the US non-farm payroll report for June 2016), written on 8 July 2016 by Rena Walsh

Weak US jobs report pushes back prospect of Fed rate hike (about the US non-farm payroll report for May 2016), written on 9 June 2016 by Ken O’Donnell

Uma Rickheeram

Head of US Credit Research

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