Strong Consumer - But Signs Of Weakness From Small Businesses

Redbook Same Store Sales Growth Solid Again

When investors heard the news that there would be a tariff on consumer goods starting in September, we thought there would be a decline in spending growth. Especially immediately after it was implemented. Then there were reports that retailers weren’t fully passing on the increased costs to consumers. That hurts their margins, but not consumer spending growth. 

With the addition of accelerating real wage growth, it’s difficult for me to predict any decline in retail sales growth in September. Obviously, we haven’t gotten the official results from August yet, but based on the Redbook reports, I doubt there will be a major decline.

Those who follow the University of Michigan consumer sentiment reading are expecting major retail sales weakness in August and potential weakness in September because that report showed optimism waned considerably. However, keep in mind that the University of Michigan index is correlated with the stock market. There was volatility in August. 

With the stock market near its record high, there shouldn’t be as much weakness in September. Also, investors shouldn't be bearish on stocks because they have fallen. That’s circular logic. We’ve seen solid results from the Conference Board consumer confidence index which is correlated with the labor market. I trust the labor market more than the stock market. Especially since stocks can have extreme movements while reports like the 4 week moving average of jobless claims have been consistently bullish for most of this expansion.

With that in mind, let’s look at the first Redbook yearly same store sales growth report from September. In the week of September 7th, which includes the Labor Day holiday, Redbook same store sales growth fell from 6.5% to 6.4%. This was a very good report. This is 3 straight reading with solid growth. Clearly, the tariff’s implementation in September did nothing to affect the consumer. 

It's what was expected to occur after the news that retailers holding back on raising prices in August. If the tariffs stay in place for a few months, there will be an impact on prices which will hurt the consumer. The larger the tariffs, the more pervasive they are, and the longer they last, the more likely they are to have a big impact on consumer spending.

If I was to predict when Trump will make a deal based solely on when these tariffs start to hurt the consumer, I’d say he will make a deal in Q1 2020. However, this fall, stocks might decline in anticipation of further tariffs if a deal isn’t made. If negotiations fail, stocks will fall more than they did this spring when the negotiations were disbanded because the stakes are much higher as more tariffs are set to be put in place. If the market gets volatile enough, it could hurt consumer spending earlier than Q1 2020 even if there isn’t a big impact on prices.

Some Weakness In Small Business Confidence

NFIB small business optimism index was strong, but there were nuggets of weakness to pay attention to. With the trade war escalating, it’s not a surprise to see some weakness in this report. The overall index fell from 104.7 to 103.1 which slightly missed estimates for 103.5. There were sharp declines in a few categories. This was masked by the solid headline index. 

Specifically, the net percentage expecting the economy to improve fell 8% to 12%. I focus on this reading the least because I can do the analysis on the economy myself. However, it’s not as if that was the only weak reading. Those expecting real sales to be higher fell 5% to 17%.

Current job openings fell 4% to 35%. We can review job openings further in a subsequent article as the July JOLTS report was also released on Tuesday. As you can see from the chart below, the yearly growth in hiring plans implies weakness in non-farm payrolls. However, this is slightly misleading because the hiring plans index only fell from 21 to 20. Yearly growth cratered because the comp went from 23 to 26. Growth will rebound in September if this index falls less than 3 points.

Let’s quickly look at the good parts of this report. The percentage of small firms expecting improvements in earnings trends increased 3% to -1%. That’s interesting because the tariffs are squeezing some firms. As you can see from the chart below, the percentage of small firms with plans to raise average selling prices and the percentage raising selling prices are falling. 

7% of small firms named increased costs as the most important reason for lower earnings. That was tied for the highest percentage. The best explanation for improved earnings expectations despite the decline in small firms raising prices is that tariffs aren’t large or pervasive enough to increase overall inflation. After all, August CPI is only expected to be 1.8%.

Another positive reading in this report was the 2% rise in the net percentage of small businesses expecting improvement in credit conditions. The report stated, “Credit conditions are about as supportive as they have ever been in the 46-year survey history.” This supports the narrative that the Fed doesn’t need to cut rates. 

On the other hand, if the Fed never cut rates in July or guided for further cuts this year, stocks would be lower and financial conditions would be tighter. I think the Fed is taking the right approach. Cut rates modestly as the economy slows, but recognize the best policy for the economy would be an end to the trade war.

Conclusion

You can spin these 2 reports positively or negatively. They probably won’t change your opinion if you are bullish or bearish. Bullish spin is that consumer spending growth is still strong. Without the decline in small business expectations for the economy, the NFIB index would have met or beaten estimates. 

Bearish spin is that small businesses see a negative catalyst coming in the trade war and the Fed can’t do anything to stop it. Decline in yearly hiring growth for small businesses is signaling negative monthly job growth in the BLS report is coming this fall. 

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