July retail sales fail to stick landing – U.S. economy still medal hopeful

15 Aug 2016

Key takeaways

  • July retail sales data questioning the strength of the U.S. consumer
  • After a disappointing May jobs report, the employment picture has improved
  • Consensus estimates are pointing to a plateau in earnings decline in the second quarter of 2016

Full commentary

With one week of the Rio Olympics already underway, it can only mean one thing: mid-August is here; and with it, the end of the second quarter earnings season. As we finish off the earnings season, there seems to be a slight disconnect between the macro data from this past week and the message from corporations, which points to wage gains and strong growth in certain industries and regions. While recent payrolls have reflected some gains and wage increases, which should translate into stronger consumer spending power, the macro data is showing spending levels less robust than expected. Consumers have been the main driver for the U.S. economy as business capital investments declined, and given that we are not anticipating any meaningful pickup in business investments due to broader global macro and political uncertainties, the consumer will need to continue carrying the torch for the U.S. economy.

Following strong spending in the second quarter, July retail sales data showed that the U.S. consumer pulled back in the third quarter so far. Retail sales were flat in July, following an upward revision to June’s already strong numbers, and were below consensus expectations. Home improvement sales appeared to have also moderated in July, showing some pullback from a strong gain in the prior month. While trends decelerated for the most part, core retail sales, a good measure of underlying consumer demand, increased in July, but were also below expectations. Apparel and non-apparel department stores sales, which are in a secular decline, remain weak, while on-line shopping continues to take share from traditional channels.

After a disappointing May jobs report, the data from the last two employment reports were strong, alleviating fears of a slowing labor market. The JOLTS, a measure of job openings and labor turnover, increased in June. As shown in the chart of the week, the quit rate, which represents voluntary separations by employees and can therefore serve as workers willingness to leave jobs, has steadily increased over the last few years. However, second quarter labor productivity decline was worse than expected, and represented the third consecutive down quarter. The weak productivity growth has received a great deal of attention as potentially being problematic for the U.S. economy.

As we approach the tail end of the second quarter earnings season, results are ahead of expectations, with 70% of companies beating consensus earnings. However, this marked the fifth consecutive quarter of year-over-year earnings declines. Corporate management teams have played a good game of managing street expectations. Second quarter growth rates remain negative for both revenues and earnings; however, the declines were less than levels seen in the first quarter. Earnings estimates are pointing to an improvement in the second half of 2016, with overly aggressive growth rates forecasted in the fourth quarter for both revenues and earnings. In order for full year 2016 consensus estimates to be met, earnings growth rates will need to accelerate from a low single digit decline in the second quarter to a high single digit increase in the fourth quarter. We would characterize the tone from management teams on the outlook for the rest of the year as cautiously optimistic. Corporate management teams remain concerned about macro and political uncertainties. Several teams pointed to lower than expected spending from industrial customers, as investments are scaled back. We also observed similar themes from lodging companies where management cited lower business travel and demand as reasons for the sector’s second quarter earnings miss and the lowered full year 2016 outlook. For the credit investor, second quarter earnings season showed continued deteriorating cred it profiles, a familiar picture, which we have seen for the past couple of years. Bank sector results reflected a challenged top line, but relatively stable credit quality, and full year earnings guidance was largely reiterated.

Consumers have been the primary driver of U.S. GDP growth in the first half of 2016. In order to meet full year expectations, continued strong spending is needed for the remainder of the year, as business spending will likely stay weak in light of global political and macro uncertainties. Corporate management teams seem content to allocate cash flow and capital to fund M&A and stock buybacks, rather than increasing their capital expenditure budgets. Nonetheless, while the July retail sales data was disappointing and represented a modest negative for 3Q GDP data, we believe the pieces are in place to support healthy consumer spending.

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