US Retail Sales Make StrongGains...

US retail sales rang up strong results in August. The cash for clunkers program aided auto sales to a greater extent that most economists had anticipated. Sales rose by 2.7% month-over-month boosted by vehicle sales which rose by 10.7% on the month. Most major categories of sales rose in the month; furniture and electronics was a minor exception dropping by 0.1% and building materials was a major exception falling by an outsized 1.2% on the month. Stripping out gasoline stations where sales rose 5.1% mostly on higher prices and removing motor vehicles as well left retail sales up by 0.6% on the month. That particular sub-group exhibits improving sequential growth rates as well.

Year-over-year sales declines are still severe and that is a legacy of the severity of the recession and its impact on the consumer. Over 7miln jobs have been lost in the business cycle and that is a huge loss of income and of spending power for those consumers. But while the Yr/Yr drops are severe there are also some distortions. Nondurable goods sales excluding gas stations are down by only 0.9% Yr./Yr. Durables spending is down by 5.8% Yr/Yr on large declines in building materials and in furniture. The boost to vehicle sales this month leaves them lower Yr/Yr by just 1%.

The messages from this report are that the consumer sector has been hit hard by recession. Cash for clunkers has boosted auto’s up form weakness overall and has given those sales a huge boost in the month- a boost that is likely not sustainable – that’s the bad news looking ahead. Still, the August results leave sales in the new quarter (Q3) expanding at an annual rate of 9.5%. Extracting the vehicle component that growth rate comes down to 2.7%. Ex food and energy sales are up at a pace of 8.5% in Q3 and estimating the inflation impact leaves real core sales up at a pace of nearly 7% at an annual rate in Q3 compared to Q2. This is the compounded growth rate for Q3, two months into the quarter. But a drop off in auto sales is likely to trim this impact of quarterly consumer spending on retail sales by the time the quarter’s final numbers are in.

While it is good news for August and it the best news may be that sales have spread beyond autos, and have done so without a government help plan. The real question is how far will auto sales fall when the cash for clunkers program ends? There will be a spillover of some sales into September but Q4 will have to do what it can without any boost from this special program. All that raises some questions about the future, despite some nice improving fundamentals for the economy. The downside of government support programs is that those programs one day end… a second downside factor is that somebody has to pay for them.

In the September ZEW survey, released today, German analysts and institutional investors were only slightly more optimistic about the next six months than they were in August. The ZEW balance of optimists over pessimists rose only 1.2 percentage points from 56.1% to 57.7%. The views of the financial community tend to be considerably more volatile than the views of those engaged in industry, trade and services. The latter represented in the IFO measure of German economic opinion, were still showing an excess of pessimism regarding the outlook for the next six months of 7.7% in August. The two measures are shown in the first chart. The correlation between the two series is only .41 suggesting that the two groups frequently differ as to the outlook.

The German investors were also subdued in appraising the current situation. The excess of pessimists regarding the current situation declined only 3.2 percentage points to 74.0 from 77.2 in August. Again, the views of the financial community are more volatile than those of the participants in the IFO survey. The excess of pessimists among the latter was only 31% in August. In contrast to their often divergent views on the outlook the two communities tend to view the current outlook similarly. In spite of the greater volatility, the views of the financial community move in the same direction as that of the business community, as attested by the high degree of correlation--.94--between the two series shown in the second chart.

According to the President of ZEW, Prof, Dr. Dr. h.c. mult. Wolfgang Franz, "The economic expectations for Germany are consistent with the picture that the Germany economy is recovering, but at a slow pace."

The PPI headline spurted by 1.7% in August as the core rose by 02% and core for consumer prices at the producer level edged up by just 0.1%. Finished energy prices rose by 8% in the month. The headline displays an accelerating pattern of growth rates for 12-month to 6-month to 3-month rates of inflation. But the core pattern has been more settled and core pattern for consumer prices at the producer level has been even more tranquil.

We learned from the last time energy prices spiked in the recession that a transmission of their gains to the core was not automatic. Rising energy prices have both inflationary and deflationary effects. When consumers and firms do not have the power to bargain for wage and price hikes, as is the case now, it is more likely that rising energy prices impact growth adversely instead of impacting inflation positively.

Still what we are seeing here are volatile price movements. Energy prices have had a standard deviation of 5 percentage points on the month to month percentage changes since the recession began. That kind of volatility tends to impart considerable uncertainty into the headline PPI each month.

The 8% m/m rise in energy prices in August is the largest since a 10.2% gain in November 2007. Energy prices are up in four of the last five months and in six of the last eight months. Prior to that energy prices had fallen for five months in a row.

Spot oil prices on world markets, however, have been hovering around the $70/bbl mark for a number of months. Oil prices have been playing catch up since the recession has come off its worst of times and oil prices have bounced and are trying and find a new higher equilibrium.

For now the core PPI price patterns are reassuring. Since global oil price trends are not running away we can look for the energy market in the US to find a level that is consistent with global prices and for the energy component of the PPI to settle down. It does not look very inflationary now in this economy but we are looking for recovery to set in. As that happens the risk will multiply and the potential for inflation to take root will improve somewhat. I am no inflation monger. But circumstance will change. For now inflation is not the worry, it’s just a bad monthly result in the least important of all US inflation reports.

Long live the CPI and the PCE deflator where trends are more important. In that regard the tranquil inflation embedded in core consumer prices at the producer prices level is reassuring.

Inventories fell again in the current month. Still the 1% drop while large is the smallest drop in eight months. Inventories average a 1.3% monthly decline in Q2 so in Q4 inventories are improving by 30% over the previous quarter.

The inventory conundrum - For the impact on GDP, it is not the change in inventory levels that matters but the change in the change. If inventories fall by the same amount in each month of Q2 and in Q3 the change in inventory investment will be zero (the same amount of investment in each quarter). The fact that inventories are falling by less in Q3 is the key to seeing there is a boost in GDP in the offing even though inventories are still falling. Right now the average drop per month in Q3 is $13bln compared to a drop of $18bln in Q2. Annualize that difference and you get a large swing. Still you still have to inflation-adjust those numbers and remember, it is only one month in the new quarter. But you get the picture. Inventories are a positive factor already.

I to S ratio is LOW - In the table above we show the percentile standing of the I-to-S ratio in its three-year range. For retailers it is the lowest inventory-to-sales ratio in three years. Wholesalers have inventories at a mid range mark, while for manufacturers inventories are still in the top 22% of their three year range (78th percentile) relative to sales.

Sequential growth trend is your friend-- The sequential growth rates show that the pace of sales has moved from the negative to the positive from 12-months to six-months to 3-months across manufacturers, retailers and wholesalers. This is good news. The pace of inventory declines for the most part seems to have plateaued as three month growth rates are even with six month growth rates for the major business sectors.

The end of days…the dog days -- Despite the fact that inventories are still declining you cans see the whites of the business expansion’s eyes. The end of recession is at hand; the start of recovery is in play. Sales are on an upswing across sectors the I-to-S ratios are mostly low and the pace of the inventory decline is flattening out. These facts should make inventories a positive factor for growth in Q3 and could make them a powerful factor for Q4 growth as well. Remember that inventories are still falling and the rebuilding process has not yet begun, so this switch powered eventually by inventory growth, not just slower paring, could go on for some time.