Why Retail Sales and Consumption Is Staying Strong

Summary

Recessions and crises change behavior. Government stimulus checks mailed during the pandemic told consumers they don’t need to save as much. This is driving strong consumption and retail sales, keeping economic growth above potential. Such an economy does not need rate cuts.

Comment

In the tweet above, Gross says retail sales are pumping the economy. The following chart shows the retail sales control group, which includes only the retail sales items in the GDP calculation.

The bottom panel shows the actual release has only missed estimates in seven of the last 31 months. Twenty beat expectations (green bars), and four met expectations (zero bar).

A surge in U.S. consumption is driving the retail sales beats above. The following chart shows Bloomberg’s economist survey of the median forecast for 2024 consumption.

U.S. consumption (black) is vastly outdistancing most of the developed world (colored lines).

This surge in consumption is driving 2024 U.S. GDP forecasts (black) far ahead of the developed world (various colored lines).

So why is consumption surging, driving retail sales beats and strong GDP forecasts (relative to the rest of the world)?

Change

We have argued that financial crises and recessions change an economy. We had both in 2020. We also emphasize that change does not mean worse or dystopian. It simply means different.

The following chart shows the U.S. personal saving rate, which is calculated by taking total personal income (wages plus government transfer payments) less disposable spending. In other words, how much of your monthly paycheck do you have left over after all your spending?

Also noted on the chart:

• Green arrow, the decline in the saving rate from 1991 to 2007
• Blue line, the post-financial crisis period of 2010 to 2020
• Red line, the post-pandemic period started in 2022 once the economy was fully reopened after the Omnicom variant passed

Note that the savings rate calculation does not include gains in asset prices like stock portfolios and housing prices. These gains drove the savings rate from nearly 10% in 1991 to a record low of around 2% in 2007.

Why did consumers go from spending 90% of their paychecks in 1991 to 98% in 2007? Asset markets had two major bubbles: technology stocks into 2000 and housing into 2006.

During this period, gains in asset markets were the savings tool, so consumers could spend nearly all their paychecks while watching their brokerage statements and home prices drive their savings goals.

This all came crashing down with the financial crisis in 2007/2008, which changed behavior. After this stressful period, consumers decided they needed to save more. As the blue line above shows, from 2010 to 2020, the savings rate averaged 6.1%. This high saving rate caused the post-crisis economy to struggle, as spending was weaker than expected.

When the pandemic hit, many consumers were initially happy they exercised spending discipline and saved. But, in our opinion, they were made to feel foolish once the government started sending out massive stimulus checks to most citizens. See the April 2020 and March 2021 savings rate spikes above to understand how massive the transfer payments were. And, to make matters worse, those who responsibly saved did not qualify for stimulus checks.

So, coming out of this crisis, behavior changed again. Once the economy fully reopened in late 2021, after the Omnicom variant passed, consumers decided that savings were unnecessary. The government established that “savings” would be mailed during a crisis. So, the savings rate dropped to just 3.9%, as shown in red above.

The following chart shows pre-pandemic consumption (blue) averaged 67.6% of GDP. Since the 2022 full reopening (red), consumption has averaged 69.2% of GDP. The lower savings rate drove more consumption and higher retail sales.

This measure is “chain-weighted,” meaning it is after inflation. So, this spending is not due to higher prices from more inflation. Instead, consumers have been buying more units of goods and services.

This behavior change has driven a strong economy.

The following chart shows real quarterly GDP growth back to 2020. The gray band is what economists call potential growth. This is their estimate of the economy’s growth if it is neither stimulated nor restrained. It is estimated to be between 2% and 2.5%.

The blue bar is the Q3 estimate from the Atlanta Fed GDPnow calculation.

Combining the brown bars (before 2022) and the green bars (starting in Q3 2022), 10 of these 13 quarters saw growth above the potential of 2.5%. This period also saw two negative quarters in Q1 and Q2 2022 (red bars). This happened when the Fed aggressively hiked rates by hundreds of basis points, and the stock market corrected by 25%. But the NBER cycle dating committee, the arbitrator of when the economy is in recession, has said this was not a recession. But even with this “non-recession” contraction, the economy has grown by an average of 3.0% over this period (dashed horizontal line).

This cycle has had solid GDP growth, driven by strong consumption and low savings rates.

Conclusion

Recessions and crises change behavior. This was certainly the case with 2020, which was highlighted by the move to remote work. This period also changed consumers’ attitudes about saving, as it was not seen as necessary, given that the government mailed thousands of dollars to everyone who did not save. Market-driven wealth effects certainly help, but this is also about a change in consumers’ attitudes.

How long will this last? Until the next recession/crisis. Then, behavior will change again. How will it change? It depends on what happens. Does the government mail even more money? If so, maybe the savings rate might approach zero. Why save if “savings” are mailed to you when you really need them (a crisis/recession)? Does the government mail no money in the next crisis? If so, the consumers will stop spending to raise savings to protect themselves from the next crisis.

This behavior change is why we believe the economy is stronger than most think. The Fed apparently does not see it this way and is set to cut rates at its meeting next month. Our fear is that they are stimulating an economy that does not need it and will create more inflation.