Retail Sales: Both Bad and Good?

Today’s retail sales report was greeted with a mixture of relief and optimism: most analysts had feared the worst. Instead sales dropped from August to September by only 1.5%. That a decline is treated as a good result goes to show just how fragile things remain.

The source of all the pre-report angst was the end of the ‘cash-for-clunkers’ auto program. During the summer months that program, part of the stimulus, had boosted car sales way above their recent trend levels, and was strong enough to push overall sales into positive territory for some time. The underlying, non-auto, sales had continued to sputter somewhat, so the termination of the program was being greeted with trepidation all around.

Yes overall retail sales are still way down from their 2008 levels: the drop over the past twelve months is now 5.7%, but the most damage last month was indeed from the cash-for-clunkers program: auto sales plummeted 11.8% – they had risen 8.8% in August. This wild swing in car sales masked the good news: sales of everything else ticked up slightly, by 0.5%. This is a modest enough increase, but after the persistent weakness we have seen over the last year even this slight improvement is sufficient to boost morale. Practically every category of sales saw some increase which is encouraging as we enter the traditional end of year selling season. The only major general category of sales that declined was in home and garden goods, which fell a further 0.2% in September to bring their annual drop to about 13% – clearly the continued problems in real estate are depressing that market.

It remains obvious, from the data, that consumers are being cautious: low end stores and bargain shopping dominate the improvement. Sales at high end luxury goods stores are mired in a long decline and show no sign yet of breaking out.

Given that consumption accounts for about 70% of GDP any sign of life has to be good news. So my take on today’s report mirrors that of the media: this is clearly a positive piece of news. Naturally I throw in my normal caveat: one month is not a trend, and it is crucial that consumption picks up steam over the next few months if we are to experience a sustained recovery. Some analysts are looking for consumption to grow around 3.5% over the third and fourth quarters. Since that would include the cash-for-clunkers sales I think it is being a little too ambitious to argue 3.5% for both quarters. Nonetheless we should see something above 2.5%.

Add in the ongoing inventory adjustment – stocks were depleted yet again last month and sales-to-inventory ratios are still very low by historical standards – and it is very clear that the economy is now growing. This retail sales report simply reinforces that view.

But.

The momentum has to build. Early next year the inventory adjustment will have been made, and businesses will return to looking at ongoing sales for indications about whether they should ramp up production. Absent strong consumption they will tend to stay within a more defensive mode. That would jeopardize the recovery since it seems very likely that business investment will remain weak throughout next year – businesses need not invest given their current excess capacity; state and local governments will still be cash strapped; real estate investment is likely to sink further -especially on the commercial side; and trade, while improving, will not be enough to keep us afloat by itself.

So it comes down to consumers and the stimulus program as the two supports of growth later in 2010.

We know the stimulus package is doing its part – although I think politics will dictate the need for a second dose, probably in the form of job tax credits. Today’s news gives us hope that consumption may do its part as well.

So I will reduce my expectation of a double dip recession from a 40% chance to a 30% chance. That is pending a look at next months data. Right now the most likely outlook is for a modest GDP growth cycle: 1.5% to 2.0% in 2010. That’s on the low side of the average forecast by most analysts, and is about 2% below our ‘normal growth rate. My main reason for staying on the skeptical side is that throughout history recessions with a big credit crisis component have, without exception, been much deeper and longer than other recessions. Since this was the second worst credit collapse in our history I think an element of caution is amply justified.

Plus I am clearly more concerned about the overhang effects of unemployment than the others are.

Still the worst seems to be past us. That alone is something to cheer.