The United States has a very consumer-oriented economy, with consumer spending accounting for more than two-thirds of all economic activity. As such, we can look at retail sales numbers and even the earnings reports of the nation's top retailers in order to see the overall direction of the economy. Unfortunately, the numbers that have been coming in are not at all good, which may be confirming that the economy is much weaker than what is widely reported.
Over the Memorial Day weekend, Jim Quinn of The Burning Platform reviewed the first quarter (or second quarter or third quarter, depending on retailer) earnings reports from many of the nation's top retailers. This is what he found (with some clarifications by me):
- Wal-Mart's (NYSE:WMT) profit fell by $220 million year-over-year and the traffic that it witnessed in its stores declined by 1.4% year-over-year.
- Target's (NYSE:TGT) profit declined $80 million year-over-year and its store traffic fell by 2.3% year-over-year.
- Sears Holdings (SHD) lost $358 million in the most recent quarter as its comparable store sales fell by 7.8% at Sears and 5.1% at Kmart.
- J.C. Penney (NYSE:JCP) lost $358 million in the most recent quarter.
- Kohl's (NYSE:KSS) saw its operating income fall by 17% year-over-year as its comparable sales fell by 3.4% year-over-year.
- Costco's (NASDAQ:COST) profit fell $84 million year-over-year. However, Costco did see its comparable store sales increase by 2% year-over-year.
- Staples' (NASDAQ:SPLS) profit fell 44% year-over-year and the company plans to close 140 stores this year.
- Gap's (GAP) income fell 22% year-over-year and that company's same store sales also declined.
- American Eagle (NYSE:AEO) saw its profits decline 86% year-over-year and the company plans to close 150 stores.
- Aeropostale (NYSE:ARO) lost $77 million as its sales fell by 12%.
- Best Buy (NYSE:BBY) saw its sales decline by $300 million year-over-year. The company also saw its margins decline and comparable store sales decline by 1.3%.
- Macys' (NYSE:M) profits were flat year-over-year and comparable store sales fell by 1.4%.
- Dollar General's (NYSE:DG) profits fell 40% year-over-year as comparable store sales fell by 3.8%.
- Urban Outfitters' (NASDAQ:URBN) earnings fell 20% year-over-year.
- McDonalds' (NYSE:MCD) earnings decreased by $66 million year-over-year and U.S. comparable store sales fell by 1.7%.
- Darden Restaurants (NYSE:DRI) saw its profits decline by 30% as same restaurant sales fell by 5.6%.
- The TJX Companies (NYSE:TJX) missed earnings expectations as both sales and earnings were flat year-over-year.
- Dick's Sporting Goods (NYSE:DKS) missed earnings expectations as sales of golf supplies plummeted.
- Home Depot (NYSE:HD) missed earnings expectations as customer traffic only increased by 2.2% year-over-year.
- Lowes (NYSE:LOW) missed earnings expectations as customer traffic was flat year-over-year.
As should be immediately obvious, these were very poor results from many of the nation's largest retailers. In many cases, management at these companies blamed the extremely harsh winter conditions that were present in much of the United States for their companies' poor performance. Admittedly, there is likely some truth to this. The harsh winter resulted in the average American family needing to spend much more money than normal to heat their homes. As a result, these families had less money to spend at stores and because the stores listed above cater primarily to the middle-class, these stores would naturally see less business as many of these families cannot afford to see their bills increase substantially and still keep spending like normal. We can see some indication of this by the fact that retailers that cater primarily to wealthier individuals did quite well during the quarter. For example, Neiman Marcus' comparable store sales increased by 5.5% over the prior year quarter. Burberry (OTCPK:BBRYF) also reported quite strong results and is opening more stores. The weather did not appear to have any impact on these retailers because the customers that they cater to have considerably higher incomes and would thus be more able to absorb the impact of higher heating bills. However, by investigating further, we can see some trends that may prove to be negative to some of these retailers over the longer term.
One of these trends is the overall decline in the discretionary spending power of the majority of America's citizens. This is due to the fact that the median household income in the United States has not kept up with inflation. This chart comes from the Federal Reserve Bank of St. Louis and shows the Real Median Income in the United States over the 2000-2012 period.
Source: Federal Reserve Bank of St. Louis
As the chart shows, the real median household income has been steadily declining over the past decade. While there was a slight reversal of the trend during the middle of the decade, at no point did the median household have a higher real income than it did in the year 2000. In fact, the median household had a significantly higher real income during the depths of the Financial Crisis than it does today. Unfortunately, the data for 2013 is not available so we cannot be certain what happened in 2013. The U.S. Census Bureau will publish the data for 2013 in September of this year. Therefore, a definitive statement cannot be made at this time. However, we can look at ancillary data and see that any improvements in the real median household income are likely to be slight.
One piece of evidence can be gleamed by looking at the Civilian Labor Force Participation Rate. This chart, also from the St. Louis Fed, shows the Civilian Labor Force Participation Rate over the 2000-2012 period.
Source: Federal Reserve Bank of St. Louis
The civilian labor force is defined as those Americans over age 16 that either have a job or are looking for a job and are not employed in a non-civilian capacity (such as military) nor are institutionalized. As the chart shows, this figure has also been steadily declining since 2000 and currently stands at a level well below where it was following the much publicized layoffs of the Great Recession. Like the household real median income graph above, this chart from the Federal Reserve Bank of St. Louis only extends to 2012. However, in this case, we do not have to wait to get more current numbers as the Bureau of Labor Statistics publishes the labor force participation rate on a monthly basis. Here are the latest numbers:
Source: Bureau of Labor Statistics
As this chart shows, there were a few periods in 2013 when the labor force participation rate improved from month to month. But overall, the rate was lower than in 2012. The same thing occurred in the first three months of this year, with the numbers showing some improvement over December's horrible figure but overall the numbers remained lower than in most months in 2013. The most recent figure showed a noticeable decline over the figures that were posted in the first quarter of 2014, dropping to 62.8%. It is worth noting that, prior to 2013, the last time the labor force participation rate was as low as 62.8% was in March of 1978.
At this point, some readers may note that the April jobs report was quite good as it showed that there were 288,000 jobs added in the month and that the unemployment rate fell by 0.4% to 6.3%. However, as Dave Manuel points out, the report actually showed that the number of people that are defined as unemployed fell by 733,000 in April while the number of people defined as not in the labor force increased by 988,000. The number of Americans that are employed actually fell by 73,000. The May jobs report meanwhile, was slightly below expectations with the economy adding 217,000 non-farm payroll jobs compared to the consensus estimate of 218,000. In May, the civilian non-institutional population rose by 183,000, the size of the civilian labor force increased by 192,000, and the number of employed Americans increased by 145,000. This shows us that the opportunities for the average family to increase its income through the acquisition of a better paying job still remains somewhat limited.
This means that, overall, the amount of real income that the average American household brings home has been declining given the lower percentage of employed people relative to the population as a whole. In addition, there are several items that have seen their prices rise at a rate that has greatly exceeded the published rate of inflation.
Source: Zero Hedge
As the chart shows, college tuition and medical care have been rising at a rate that greatly exceeds the rate of inflation and have been for a number of years. This has not been as much of a problem in the past as it is today because over much of the time period shown by the chart, there was real wage growth in the United States. As has already been shown, that is not the case today.
The rising prices of these two items has decreased the discretionary purchasing power of the average American household even more than the decrease in median real household income has. This is because the rising costs of medical care have caused the price of health insurance to rise at a rate that exceeds the inflation rate. As most Americans have health insurance, the need to pay these rising premiums has caused the disposable income of the average American household to decrease further than the amount indicated by the decline in real median household income.
The rising cost of college tuition has also lowered the amount of discretionary income that many American families have. One reason for this is that these high costs have forced many people to take out student loans in order to afford to attend college. As colleges hike tuition at a rate exceeding the inflation rate and the real income of the average American family declines, students are forced to take out larger and larger loans. This has caused the amount of student debt outstanding to balloon to its current level of $1.1 trillion. These larger and larger loans necessitate higher and higher monthly payments which drain further cash out of incomes that are declining in real terms.
The trend of inflating college tuition and healthcare prices has been going on for quite some time but there are also some strong inflationary trends that have taken hold just recently and further drained the discretionary purchasing power of the average American family. One of the most significant of these is in food. Anyone that has been to a grocery store in the past few months has likely seen this first hand. Since the beginning of 2014, the CRB U.S. Spot Foodstuff Index, an index that tracks the spot prices of ten basic food staples, increased by 19% in the first quarter.
Source: Zero Hedge
As most rational people would prioritize buying food before the durable items that are found in many stores, an increasing amount of the average American household's income had to go to buying food in the first quarter than in the previous one. This, obviously, leaves much less money available for other things. This, in turn, means that the median American household cannot spend as much money at their local mass market retailer as it could previously. At least, the median household cannot spend as much without going into debt. However, consumer debt has been increasing at a fairly rapid rate and that is the reason why we have not seen the top line revenues of many retailers fall as much as we would otherwise expect given the numbers. This chart from the Federal Reserve Bank of St. Louis shows this increase in consumer debt in graphic detail.
Source: Federal Reserve Bank of St. Louis
As the chart shows, with the exception of the first few years following the Financial Crisis, American consumers have been rapidly growing their outstanding debt loads since the year 2000. This is the same period over which the real median household income has been steadily declining, as already shown. The conclusion that we are forced to draw from this is that consumers, faced with declining real incomes, have been borrowing money to maintain the lifestyles that they have become accustomed to. What is more, this growing amount of leverage, along with inflation, has been the driving force behind much of the growth that the retail sector and economy as a whole has seen over the past several years.
For further proof of this, we can look to an obscure economic metric known as the velocity of money. The velocity of money is defined as the frequency at which one unit of currency is used to purchase goods and services over a given time period. In other words, if the velocity of money is increasing, then more tables, chairs, or walnuts were sold in the current period than in the previous one. Here is a chart, also from the Federal Reserve Bank of St. Louis, which shows the velocity of the M2 money supply:
As this chart shows, the overall trend in the velocity of money since the year 2000 has been unequivocally negative. This means that, as a whole, progressively less and less money is trading hands every year.
There is only one way to grow an economy with a declining velocity of money, as Mike Shedlock notes. That is to increase the size of the money supply. This is because GDP is equal to the size of the money supply times the velocity of money. Relatively simple math then tells us that the money supply must be increase in order to grow the nation's GDP when velocity is decreasing.
There are two ways to increase the size of the money supply. Either the government can coin it or banks can create it. In the case of the United States, the Federal Reserve Act of 1913 saw the Federal Government give up its authority to create money, transferring all power to do this to the banking system. Banks create money by making loans to people which is clearly the creation of debt. Therefore, given the declining velocity of money, debt must increase in order to produce GDP growth. This is exactly what we have seen in the United States over the past decade.
With all of this said, I must admit that I am uncertain what to make of this over the short-term. Over the long-term, these economic fundamentals are unsustainable but that does not mean that we will see a market collapse or another recession or anything like that in the near future. The market could certainly see new highs and we may even see some retailers show improvements in their second quarter results should consumers prove to be willing to take on even more debt. However, unless some progress is made in reversing these trends, the average consumer will likely reach a point where necessities and debt payments are taking up the vast majority of the family's income and thus will be unable to make discretionary purchases at stores. It is, however, unclear whether this has happened already or will happen at some point in the future.
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