Retail Sales Continue to Grow—and Raise Questions About the Consumer
American Century Investments
April 21, 2011
Last week, the U.S. Commerce Department released its monthly report on retail sales for March. With gasoline prices up almost a dollar over the past six months and consumer demand already challenged by sagging home prices plus high unemployment, investors and analysts were eager to see if the streak of eight months of positive growth in retail sales through February could be sustained in March. And the answer was “Yes, but barely.”
Rising Gasoline Prices Had an Impact
The topline results from the Commerce Department report were that retail sales grew by +0.4% in March versus February. That extended the positive growth streak to nine months but was well below the 1.1% increase in retail sales that occurred in February versus January. But the growth rate for March decreased to +0.1% if retail sales from gasoline stations was excluded. Spending in particular categories such as automobile sales, online retailers and large department stores actually declined for March.
The rates of growth look much better when calculated on a year-over-year (e.g., March 2011 versus March 2010) basis—though this sets the bar much lower in terms of a base period since unemployment was above 9.5% for much of last year versus 8.8% last month. On this year-over-year basis, March retail sales were up +7.1% but still down relative to year-over-year February (+9.1%), January (+8.2%) and December (+7.8%) figures.
Given the mixed nature of the results, it’s not surprising that analysts had a variety of both “good news” and “bad news” spins on the report. Nearly everyone agreed that high gasoline prices have had a negative impact on the ability of consumers to spend. In addition, some worried that higher food prices, now beginning to show up on store shelves, could have a similar effect going forward. In addition, a few analysts noted that March is typically the month when tax refunds and returns inflate consumers’ wallets and result in a temporary jump in spending. Instead, they speculated that (this year) much of this money had been put to use in continued efforts by households to cut debt.
On the positive side, some analysts believe the decline in March growth could be explained by the Easter holiday season being so late this year (which typically falls in late March or early April and boosts March retail sales), or the unusual winter weather that carried over into the month. It is interesting to note that retail sales of home furnishings jumped dramatically in March (+3.6% versus February). That’s the largest single percentage monthly increase for this category of retail spending since July 2004—nearly seven years ago. Normally, new furnishing sales trend with housing sales, but this is clearly not the case in the current environment where home sales and prices remain depressed. It may be that consumers put aside some tax refund, year-end bonus or other money to spruce up their homes as “frugality fatigue” grows after so long a recession and slow a recovery. If true, this could be is a positive indicator for future spending and (pent-up demand) if the current recovery continues and accelerates.
Lower Retail Inventories Could Be a Positive Sign
Retail sales represent one side of a coin for the economy—household consumption. The other side of the coin is production (to fulfill consumption demand) which generates jobs and income. The question regarding growth of retail sales for March and its longer-term trend is whether it can be sufficient to lead to growth in corresponding production and new hiring.
The chart below plots month-to-month growth in retail sales from January 2008 through March 2011, and a broad measure of retailers’ ability to satisfy sales demand, their inventory to sales ratio. This statistic (provided by the Department of Commerce) measures the value of inventory (product in stock) that retailers are carrying and divides this number by their current sales rates. A high inventory to sales ratio is a negative sign for new orders by retailers, especially when they see their sales levels falling. But on the other hand, a low inventory to sale ratio is a bullish sign, especially when retailers see their sales growing.
As the chart below illustrates, the inventory to sales ratio rose in 2008 from about 1.5 (which had also been its average for much of the prior five years) to 1.62 in November 2008 as retail sales growth (the bars in the chart) slumped severely. Retailers responded by drastically cutting back on new orders and deep discounting on existing merchandise in order to bring their inventory levels down as the Great Recession unfolded.
What has occurred since July of last year is that retail sales began a nine-month (to date) growth spurt while retailers have remained cautious in replenishing inventories. The result is that by February of this year (the most recent month of data available), the Inventory to Sales ratio had declined to 1.31, its lowest level in over a decade. This is potentially a very bullish sign for the economy (again, conditioned in the short term on what happens to affect consumer spending in other areas such as energy and food pricing) because continued growth in retail sales should stimulate a reinforcing cycle of inventory restocking that would lead to new employment, rising income and further increases in consumer spending.
Where Spending Occurs Also Tells a Story
Consumers not only have the freedom to spend or not spend discretionary income but also where they spend it. And over the past year, the fortunes of retailers defined by their market category or focus provide an interesting insight into the minds of consumers’ values and spending preferences post the Great Recession.
In the chart below, we’ve plotted the one-year (March 31, 2010, to March 31, 2011) total returns (price appreciation plus dividends) of retailers in three categories: (1) luxury and high-end; (2) large broad-line department stores (middle market); and (3) extreme value discount stores. One can quibble with whether, for example, Saks is truly a high-end retailer or Wal-Mart is a large department store. But the purpose of the analysis is to show that—over the last four quarters—high-end and low-end retailers have generally outperformed their middle-market competitors.
One explanation for the positive performance of many high-end and luxury (specialty) retailers (such as Burberry, Coach and Hermes) is these are global retail brands which have benefited from growing wealth, affluence and the size of a growing upper middle class in countries like Brazil, Russia, India and China (the BRIC nations). At the other end of the retailing spectrum, extreme value discount stores—while often bare bones and lacking aesthetic appeal in their stores—have become a new mainstay for U.S. consumers seeking to cope with stagnant or severely lower incomes in the wake of the Great Recession and bursting of the U.S. housing bubble. Caught in between have been the traditional large department stores (and even price discount stores, notably Wal-Mart which once defined the category of value discounting with their “Everyday Low Price” strategy.)
The future fortunes of large, broad (middle-market) department stores and retailers is a complex question with many angles, but one of the most important ones is linked to the future fortunes of the U.S. economy and consumer. A decidedly improved economy in terms of growth and reduced unemployment could help these retailers recapture some or all of the share of wallet (spending) they enjoyed prior to the Great Recession. On the other hand, a slower evolution of recovery and growth (especially if wages remain stagnant, unemployment high and inflation rising) could present headwinds, especially against the lower market extreme value discounters. As the first quarter 2011 earnings season unfolds, the earnings per share and sales per share for the companies in each retail category defined above will add further insights into the health and mindset of the U.S. consumer.
In addition, the relative futures of both middle market and extreme value discount stores may also reflect a structural change in the mindset of consumers based on the pain caused by the Great Recession and diminished employment and wage growth prospects many believe it has left in its wake. This change of mindset has been called the “New Normal” by some. And this describes a lower growth, lower profit, lower returns and lower wage growth economy for the U.S. versus the happier but (in hindsight) illusory days of high growth, ever increasing asset prices and easy credit. According to this change of mindset, consumers who 10 years ago would never have considered shopping at a Family Dollar or Dollar Tree store are now regular customers. If the New Normal is a broad structural change in mindset for consumers and their spending habits, the implications for all retailers are considerable.
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