Should You Ignore Recent Retail Sales Weakness?
Over the past several weeks I have heard repeated comments that you should ignore the recent retail sales weakness for a variety of reasons such as cold winter weather, consumers don't believe the drop in gas prices, etc. Putting aside the fact that cold weather almost always occurs during winter (which is why the data is seasonally adjusted to begin with), or that more than 70% of Americans are living paycheck-to-paycheck, should we dismiss the data entirely?
Scott Grannis recently penned:
"Retail sales in the first quarter of this year were obviously impacted by lower gasoline prices and bad weather. Both of those have faded in importance, however, so it's important to see if there has been any change in the underlying trends. As I see it, nothing much has changed. The economy continues to grow, but at a disappointingly slow pace compared to other recoveries."
(Note: I have replicated Scott's original analysis and added recessions and deviation for clarification)
Scott is correct in the context that retail sales were impacted by lower gasoline prices over the last couple of quarters as gasoline prices are a direct input in retail sales. (read more here) However, once you strip out that impact it is hard to blame the rest of the decline simply on weather. Yes, the Northeast was blasted by very cold temperatures and snow, but not the South and Southwest. Given that California and Texas are heavily populated states with high levels of consumption, weather does not completely explain the drop. This is particularly the case when you factor in the aforementioned seasonal adjustments.
The real point I want to make is that the analysis above does not tell us very much at all. As noted by the highlighted circles, linear retail sales do not provide much of a signal to warn of the onset of economic recessions.
In December of 2007, I penned that:
"We are currently either in, or about to be in, the worst recession since the 'Great Depression.'"
One of the primary reasons for that call was the quarterly decline in retail sales at the time. (Remember, retail sales comprise about 40% of PCE which makes up almost 70% of GDP.) My good friend Doug Short recently charted the current status of quarterly retail sales quite nicely.
I added the red lines to Doug's chart to point out the importance of the data. While much of the analysis from the mainstream focus on near-term events to suggest reasons for continued economic optimism, it is well worth noting that the overall TREND of the data suggests a much more cautious view.
It is worth noting that quarterly retail sales are at levels that have preceded the last two recessions. One problem with retail sales data is the shortness of its history, however, the substantial decline in retail sales trends clearly suggests that the weakness in consumption is more of an overall economic issue rather than a one-off weather related event.
After three straight months of negative retail sales data, it is not surprising to see a "bounce" in activity. The question going forward whether or not that bounce is sustainable?
Mutual fund company Natixis recently conducted a survey of 750 investors that had over $200,000 in investable assets. (As discussed previously, it's hard to believe that these individuals are contained within the top 10% of the population)
"While investors may be looking for returns, they are 'extraordinarily optimistic about their investment prospects in both the short and long term,' says Natixis. Respondents say they need 10.1 percent return on their investments, and 81 percent of them feel their expectations are realistic.
Fifty-four percent expect their returns this year to be better than 2014.
Stocks will be the best-performing asset class this year, according to 45 percent of the respondents, followed by 17 percent who say cash will be the top performer."
While it has been repeatedly stated that individuals have "missed out" on surging asset prices, it has only been those with little or no money actually to invest with. However, for those that are invested, they are as optimistic as at every previous bull market peak in history. As shown in the chart below from the American Association of Individual Investors (AAII), individuals are at the highest levels of stock allocations, and lowest cash, since the financial crisis.
Let's do some rough math.
Historically, stock price appreciation has roughly equated to the growth in the economy plus inflation. That has been about 6% on average from 1900-2000. Throw in dividends, which averaged about 4% during that span, and you get to 10%.
Currently, economic growth is running at about 2%. Let's round up inflation to 2% and add dividends of 2%. That's a rough expectation of 6% going forward which will disappoint those expecting 10% annually.
Valuations are another problem. As discussed previously, from current levels of valuation in the markets forward expected returns are likely to fall to just 1-2% annualized. After dividends that is 3-4%.
The reality is that investors have NEVER achieved 10% annualized returns, even during the ripping bull market of the 90's. Over the next decade there will likely be another very nasty, mean reverting event, that will once again devastate investor capital, psychology, and long-term returns.
Why this lesson is never learned is beyond me.
What Is The Real Unemployment Rate?
Each month the Federal Reserve, the financial markets, and investors are glued to the release of the latest BLS employment report. (This is probably the single most overly analyzed and least important of all economic indicators.)
The current 5.5% unemployment has been widely touted as a "sure sign of economic recovery" and that the Fed's monetary policy interventions have clearly worked. However, is that really the case?
One of the issues that has been widely discussed is the shrinkage of the labor force which may be obfuscating the true level of unemployment in the country. With 1-in-4 individuals on some sort of government assistance and 93 million no longer counted, it is hard to suggest that 94.5% of the working age population is gainfully employed.
I have discussed many times previously the labor force participation rate of 16-54-year-olds, the ones that should be working, is lower today than it was at the peak of the financial crisis. Also, the number of individuals over the age of 65 that are still working, when they should be retiring, is at the highest levels on record. All of this suggests that something is not quite right with a 5.5% unemployment rate.
To this point, the chart below shows the difference between the current unemployment rate and the unemployment rate including all those "no longer counted" as part of the labor force. (Source: Research Affiliates)
"In fact, most of the drop in the unemployment rate can be attributed to people leaving the workforce rather than job creation. A huge 'shadow inventory' of unemployed workers hangs over the labor market, unrecognized in the official numbers. An improving economy could encourage many non-participants to return to job-seeking status. If the labor participation ratio were to return to its 2008 level, today's unemployment rate would sit at 10.4%! This shadow inventory helps explain the tepid wage growth we have seen even as the job market becomes tighter, and it will likely continue to keep a lid on wage growth going forward."
It also explains why economic growth, and retail sales show above, has remained substantially weak since the end of the financial crisis.