Recession Odds Rising As Retail Sales Slump

by: Ian Bezek

Summary

Retail sales have been flat or down every quarter to start 2016.

Auto sales have gone from a big growth driver to a slow spot.

How will this dynamic effect stocks and earnings into the rest of the year?

Retail sales is among the most important of the indicators for judging the strength of the economy. While it isn't watched as closely as GDP or inflation, retail sales is one of those benchmarks that really strike at the core of an economy's fundamental strength. If people have both the income and confidence to buy, times can't be too bad. If sales are persistently weak, it's a big red light for the broader economy.

During this bull market, retail sales have been fine. They haven't been as strong as you saw in some past recoveries, but the consumer hasn't been that weak. In fact, given the overall slow growth rate of GDP in recent years, consumer spending has been among the bright spots helping the overall pace of economic activity.

However, that trend may be coming to a close. Retail sales have put in three duds in a row to start 2016. Retail sales were down 0.4% in January, flat in February, and down another 0.3% in March on a year over year basis.

In 2015, severe weather caused a sales slump to start the year, followed by a spring burst of activity to make up for the lost time. There appears to be no similar catalyst for a turnaround in the offing this year. The 2016 retail sales slump appears to be driven by one of the economy's hottest sectors, autos, running out of gas.

The previous record high sales year for the automotive industry was 2000; just before that cycle's stock boom went bust leaving so-called paper millionaires out of the new car market. In 2015, 2000's peak level was finally topped, with sales coming in at 17.5 million, just above the old record.

From the 17.5 million blowout in 2015, most analysts were expecting further gains in 2016, with levels between 17.75 and 18 million being widely forecast. If you've seen the spate of recent articles urging investors to buy Ford (NYSE:F) and General Motors (NYSE:GM), yes, there is extremely positive sentiment surrounding the sector.

Actual sales data has been much less exhilarating. The most recent tally would put 2016 on pace for a total of 16.5 million light vehicles, down a million from last year and far from analyst expectations. This is very bad for the overall retail sales figure, since autos play a big role in the calculation. It's also bad news for the commodity companies that produce inputs for the industry.

Some market commentators have discussed auto loans as the potential next bubble or big short. The market has in fact exploded in size, as the graphic below demonstrates:

The overall size of the market isn't the only thing to watch. The credit scores involved are a good indicator. Subprime borrowers are getting a fair bit of the action, though the credit spread doesn't appear to be skewing toward subprime nearly to the extent that the market moved toward subprime prior to the housing bust. One note that supports the auto loans as a big problem point of view; duration on auto loans has been rising. That's risky, given the rapid depreciation of the underlying asset involved.

However, given the overall immaturity of the auto finance market, it's unlikely this will cause a huge bust, at least not yet. The market mechanisms such as indices of loans that made it easy to create subprime loan derivatives and shorts hasn't made it to the auto market yet. Simply put, the next Hollywood-story big short probably isn't found here.

That said, the talk of bubbles overshadows the more important point. Auto sales may well have peaked; the upside momentum is certainly gone. These sales account for a large portion of overall consumer spending and also represent a large number of jobs for the United States and its closest trading partners.

Auto sales surged from a recession low below 10 million up to 17.5 million last year. That was responsible for a sizable portion of the overall economic lift since 2009. With autos having pulled more than their fair share during this economic upturn, a sudden weakening in the market will require significant help from other sectors to be offset. Otherwise, the threat of a recession will loom larger.

What's Driving The Broader Shift?

On the positive side, there are some factors that should be supportive for retail sales farther out into 2016. The economy has added more than 600,000 jobs since the turn of the year. And average hourly wages are up a respectable 0.7% to start the year. The minimum wage hike, in particular, has a large effect in driving consumer spending, since those with the lowest wages tend to spend most of their incomes and do so quickly, raising the economy's monetary velocity.

Beyond that, most signs are negative. The middle class has seen little economic improvement in recent years. The populist movements dominating the current political scene are at odds with the happy confident consumer culture that has frequently powered American economic growth.

This earnings season, as my article warned, has been a rough one. So far, a large number of important Dow and S&P 500 (NYSEARCA:SPY) components have been missing earnings expectations. Companies like Starbucks (NASDAQ:SBUX) and Visa (NYSE:V), the sorts of core building blocks of a strong consumer economy, haven't been performing as well as had been hoped.

The equity market has been fairly strong as of late, but signs of volatility are again presenting themselves. Carden's sophisticated Smart Hedge indicator remains cautious. If the S&P 500 cannot make new highs, even with oil this strong, it sets the stage for a big correction as earnings season progresses. The weakness in retail sales is another element pointing toward slowing GDP growth and soft corporate outlooks for 2016 that will keep a lid on stocks.

If you're looking for a more conservative approach that reduces risk while retaining reasonable upside, this is a good time to think about the Carden Smart Wealth portfolios. With the stock market near all-time highs, and with mounting signs of trouble arising, focus on risk management is crucial.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.