U.S. Retail Sales Pose a Dilemma

With flat January retail sales and a 0.1% overall rise in February, retail sales have little lift in Q1. The February retail sales report, with no revisions to the main headlines over the past two months - an unusual development, leaves us with two months of a very flat consumer. This in turn raises questions about growth in the economy at large since it has been banking on continued consumer strength.

With the huge drop in durable goods orders the outlook for capital spending is poor. Housing started off the quarter looking good but has since beaten a deep retreat. With GDP= C+I+G+(X-M) the question is: where is growth coming from? Take “C” for example, consumption: the retail sales portion is flat for two months running. Services spending, the half of consumption that always slips in under the radar, is probably still firm. But the “I,” for investment has three weak prongs: Business fixed investment is weak if capital goods orders are to be believed; inventories have been pared back (they are up slightly in January); residential investment is that well known story of the ongoing lethargy in housing or worse. Government is usually a GDP positive but is plodding. The X-M portion of GDP (called net exports, or the GDP version of the current account in real terms) has provided some stabilization to GDP growth since imports (M) have been weak due to weak domestic demand and exports have held up as foreign growth has been firm. That combination produces a push to GDP; since imports are a subtraction and weak imports aid US GDP growth. But it’s clear that the economy will not grow for long on its international portion alone. While CEOs at the Round table last week expressed a desire for more capital spending, what we have in hand are weak trends. And that puts more of the focus back onto the consumer.

Q1 Consumption Arithmetic. Fortunately Q4 growth was ‘back-loaded,’ exporting momentum to Q1. Here’s how that works. Since GDP is a quarterly variable we look at its components by quarter and play the game, ‘what have you done for me lately?’ also known as ‘what will GDP be this quarter?’ What matters for each component is its average for the quarter. Since consumer spending spiked at the end of Q4, it left a high level of spending in December 2006. Thus even with next to no growth in January and February the level of spending in February is still 4.5% above the Q4 average. So overall nominal retail sales are up at a 4.5% nominal pace in 2007-Q1 as a result of the high pace of growth in December of 2006. But that crutch is becoming overused with the February weakness.

Cold weather did sucker-punch housing this months so we have a basis for believing there was a noticeable adverse weather effect in play. On top of that, as we know, housing is being battered by an ongoing retrenchment. We see both of these factors at work in the retail sales report in building materials where sales plunged by 1.4% in February alone. Sales also fell sharply for furniture and electronic goods. Motor vehicles sales were, however, strong with a rise of 1.0%.

Nondurables limped to a gain of 0.1% in February and were actually weaker excluding gas station sales that jumped by 1.2% (-0.1% for retail non-durables sales excluding gas station sales).

With the contribution in from the December sales spurt still in play, 3-mo sales trends are still reasonably firm (saar growth of 4.9%). But if monthly sales do not perk up soon the December effect will cease to help and retailing will then appear to be faltering. Come March, December’s gain will play against three month growth since we will then be measuring growth from the elevated December base and December’s strength will play against us - so far we have no lift from that point on.

Still, a sag in the winter months is not decisive. December sales were very strong, leaving fewer goods to clear out in January and February. February is a short month with myriad holidays leaving a lot of the work to be done by seasonal factors. Complicating this is the cold snap in March. Winter this year has been backloaded. March has come in less like lion than like a Polar Bear, let hope by month’s end we do not have bi-polar bear.

All this complicates getting a good look at how the economy is really doing. To be sure with business investment surprisingly weak, a pick up from the consumer is essential or the economy bears are going make another run for the money. It sure complicates the Fed’s job especially with poor trends in productivity, labor costs and labor compensation. For now we can only watch and wait and hope that the slow growth is a product of bad weather.

The ZEW Indicator of Economic Sentiment for Germany, which assesses the outlook in the next six months, based on the opinions of investors and analysts, rose 2.9 points in March to 5.8%. While the current level is a substantial improvement over the pessimism reached last November when pessimists exceeded optimists by 28.5%, it is well below the long term average of 33.2%. On the other hand, the fact that the participants became more positive during a survey period which included a sharp down turn in world stock markets and only a partial recovery, was in itself a pleasant surprise. Many observers had expected the indicator to decline.

The assessment of current conditions declined slightly to 69.2% from 70.9%, the first decline since June 2005. The indicators for the outlook and current conditions are shown in the first chart.

The ZEW Financial Markets Survey also asks its participants to report on the outlook and current conditions in the entire Euro Area. The assessment of the outlook for the entire Euro Area declined in March 5.1% from 6.8% in February and the appraisal of current conditions rose marginally from 66.7% in February to 66.9% in March. The indicators of current conditions and the outlook for the Euro Area are shown in the second chart.

The indicators for the Euro Area, of course, include those for Germany, but the differences between the indicators of the Euro Area and those of Germany can shed some light on the performance of Germany relative to the rest of the Euro Area. From the appraisal of current conditions in the total area and in Germany, we can infer that the participants had rated conditions in the Euro Area outside of Germany higher than those in Germany until November, 2006. Since then, the appraisal of current conditions in Germany has been higher than that for the whole region, as can be seen in the third chart. Similar inferences can be derived from the appraisals of the outlook in the two series. The outlook for Germany was less positive than that for the whole area indicator until about mid 2005 when it became more positive than the whole area indicator. It remained more positive from then until June 2006. After that until this March of this year, the German outlook for the German economy appeared to be much less positive than that for the Euro Area as a whole. The divergence may have been due, in part perhaps, to the prospect of the January 1, 2007 increase in Germany's VAT. Since the effects of the higher VAT appear to have been less onerous than expected, optimism in the German outlook has has become modestly more positive relative to the whole area, as can be seen in the fourth chart.