Stagflation Fears Not Valid Yet
The two top stories of the day on Wednesday were the retail sales report and the CPI report. The combination of a weak consumer and heightened inflation brings about the fear of stagflation which is a stagnant economy and high inflation. This is probably an extreme worry because we’re far from reaching that state. Two weak retail sales reports don’t mean the economy is weak and a few inflation reports that beat estimates doesn’t mean inflation is getting out of control. In fact, economists were begging for inflation last year. It’s only a few tenths of a percent higher than last year.
I think stocks recognized that the situation isn’t as dire as some fear because it was up nicely. The S&P 500 was up 1.34% and the Nasdaq was up 1.86%. Chipotle stock was the biggest winner as it was up 15.4%. It did well because the company named a new CEO on Tuesday evening. The company is still trying to get passed its woes that came from health issues at the restaurants. The best sector of the day was the financials which was up 2.32%. The worst sector was the utilities which was down 1.19%. This is purely a play on yields as the financials are helped by higher yields because of the increase in their net interest margins. The utilities are hurt because higher yields provide more competition for investment as the utilities are mainly owned because of their high dividend yields.
The 10 year yield closed at 2.90%. It is only 10 basis points away from the peak in 2014. Since I think the economy will be stronger this year and because it is later in the cycle, I wouldn’t be surprised to see yields eventually pass 3%. In the near term treasuries are very oversold though. The increasing yields are driven by increases in real yields and the breakeven inflation rate which is now at 2.07%. It’s still below the high it made at the beginning of the stock market correction in early February.
Weak Retail Sales Report
As you can see from the chart below, the U.S. retail sales fell 0.3% in January which is the biggest drop since February 2017. Q1 2017 GDP growth was only 1.4%. It was the weakest growth rate of the year. It was slowed down by the 1.1% consumer spending growth which was the weakest report since Q2 2013. We’re far from being done with the whole quarter, but this month’s report is a bad sign for Q1 2018 GDP growth. The good news is the tax cut effect may not have kicked in yet. With decent wage growth and a tax cut, the only trends that can stop consumer spending growth this year are an increased savings rate, which seems doubtful given the increases in the stock market, and heightened inflation. As you can tell from that point, a bear market in stocks could cause a recession. Wage growth coming with inflation means real wages are stagnant.
Getting back to the report, it missed estimates for 0.2% growth. The miss was driven by declines at auto dealers and home centers. Making matters worse, the December retail sales growth was revised down from 0.4% to flat. Retail sales excluding autos were flat in January which missed the expectation for 0.5% growth. I’m expecting weak auto sales in 2018 even though I think the consumer will be strong. The auto cycle was on its last legs in the end of 2016 as dealers gave out record incentives. It had started to fall back in 2017, but then it was helped by the hurricane. The hurricane came at a great time for the sector, but it’s only a temporary boon. Auto dealer sales were down slightly in December and fell 1.3% in January.
The table below gives all the specifics of the report. Building materials and garden sales from dealers fell 2.4% month over month. Keep in mind, these numbers are seasonally adjusted, which means month over month numbers are valid, despite December being helped by the Christmas season. The Christmas sales were great early in the season as November had 0.8% growth, but they tailed off near the end. Unsurprisingly, the internet retailers had a monster January. Sales were flat month over month, but they were up 10.2% year over year.
Was The Weakness Caused By Bad Weather?
The big debate over this January’s retail sales report is if inflation hurt growth. The savings rate probably didn’t hurt results because the savings rate fell to 2.4% in December. We’ll know for sure when we figure out what the rate was in January. The bulls are blaming the harsh winter for the weakness. That’s somewhat fair because year over year growth was 3.6% (both Januarys had bad weather). However, that doesn’t explain the weakness in December since the major northeastern storm and the bitter cold temperatures were in early January. Gasoline sales were up 1.6% month over month and 9% year over year. That does more to support the inflation argument than it does to support the bulls’ perspective. Apparel sales were up 1.2% because they were boosted by higher prices, furthering the inflation narrative.
Besides the weather effect, the other argument the bulls have is that this report is advanced, meaning it will get revised before it’s finalized. If it’s revised upwards, the bearish case will take a hit. I’d need to see another two months of weakness to become more bearish on the economy. Last quarter saw 3.8% annualized consumer spending growth, so I’m not ready to throw in the towel yet.
Conclusion
I’m expecting heightened inflation in 2018, so that report, which I’ll go into more detail on in my next post, wasn’t a surprise. I was surprised by the weak retail sales report, but I won’t change my perspective based on it because these reports can be volatile. The stock market didn’t seem to mind. If the labor market was week, it would pay more attention to this result because it would support fears. The inflation report was believed because the market is already expecting higher inflation in 2018.
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