Saturday, November 22, 2014

Lower Gas Prices Alone Do Not Equate To Higher Retail Spending

The pump price of a gallon of gasoline continues to drop in the U.S. This decline in gas prices is believed to result in a pickup in consumer spending since the consumer will be spending less on gasoline. Specifically, the spending increase is expected to flow through to an increase in retail sales. Guggenheim Partners wrote a comment, Falling Gas Prices Fuel Holiday Cheer, that noted an increase in discretionary spending as one's gasoline consumption as a percentage of disposable income declined. The chart below graphically depicts this relationship.

From The Blog of HORAN Capital Advisors

On the other hand, as the following chart indicates, if one compares the simple decline in a gallon of gas to retail sales (excluding sales at gasoline stations), declining gas prices do not seem to equate to an increase in retail sales. As the below chart shows, it actually appears as gas prices decline retail sales decline as well. So what is the broader implication then?

From The Blog of HORAN Capital Advisors

Certainly, a number of factors impact the price of oil and the resultant price of gasoline. A large factor influencing energy prices is of course supply. With the positive supply impact of fracking's success, this pushes gas prices lower. The primary contributor to retail sales growth is an increase in a consumer's disposable income. Disposable income certainly increases if consumers are spending less on gasoline. However, in our view, a greater impact on retail sales growth is the overall health of the economy which translates into job growth and wage growth.

On the wage front, employees have been experiencing real wage growth since the end of 2012 as noted in the below chart created by Doug Short at Advisor Perspectives. In a New York Times article from earlier this year, it was noted that some economists do believe the slowing in wage growth is behind us in this economic recovery.

From The Blog of HORAN Capital Advisors

From an employment perspective though, the economy and job market have not recovered at a rate commensurate with prior recoveries. The below chart looks at the trend in the unemployment rate and currently the rate equals 5.8%. However, the yellow line in the below chart displays the unemployment rate using the participation rate in March 2008. Using the 2008 participation rate results in an unemployment rate that turns out to equal a much higher 10.4%. There is debate about the cause of the declining participation rate. Some believe it is due to baby boomer retirements while others believe it is the result of individuals dropping out of the labor force. Bill McBride at Calculated Risk does a nice job providing analysis around the participation rate.

From The Blog of HORAN Capital Advisors

Lastly, given the decline in gasoline prices, one might expect individuals to travel more in a strengthening economy. Again, Doug Short has assembled a lot of good information on vehicle miles driven and one particular chart below shows a steady decline in miles driven.

From The Blog of HORAN Capital Advisors

Doug Short summarizes the above chart with the following comment,
"As is readily apparent, the correlation is fairly weak over the entire timeframe. And, despite the volatility in gasoline prices since the onset of the Great Recession, the correlation since December 2007 has been even weaker. There are profound behavioral issues apart from gasoline prices that are influencing miles traveled. These would include the demographics of an aging population in which older people drive less, continuing high unemployment, the ever-growing ability to work remote in the era of the Internet and the use of ever-growing communication technologies as a partial substitute for face-to-face interaction."
In conclusion, a decline in gasoline prices alone will not simply result in higher retail sales. Of primary importance is a strong economy where GDP growth is in the 4-5% range; thus, creating an environment where job and wage growth are strong. We believe the current economic environment is one where growth remains below the economy's full potential and results in under employment. The impact on the retail sector is one where investors will need to be selective. A rising economic tide currently being experienced is not likely to result in across the board strength in retailers. Recent earnings reports do reflect this situation, with some retailers exceeding expectations and others falling short of expectations. As an example, last week, Urban Outfitters (URBN) fell over 6.5% after missing earnings before recovering at week's end. Gap (GPS) exceeded 3Q estimates but was cautious on Q4 guidance. The stock fell over 4%. I could list a number of other retail reports, but suffice it to say, lower gasoline prices are not benefiting all retailers. In fact, a move higher in pump prices might be more of a sign of a stronger economy and have a greater positive influence on retail sales.

Updated (11/22, 3:14pm): Thomson Reuter's AlphaNow site provides a summary of Q3 retail reports in an article titled, Q3 Retail Same Store Sales Report: 50% Beat Estimates, 47% Fall Short.

Disclosure: No position in GPS or URBN.

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