Early presents Early presents http://www.georgiaprime.com/ga/static/images/ga/ga-logo-amp.png http://www.georgiaprime.com/ga/daf\images\insights\article\christmas-presents-boxes-ornament-small.jpg December 14 2023 December 15 2023

Early presents

Inflation grinds lower, the Fed throws in the towel and holiday spending slows.

Published December 15 2023

Bottom line 

In the penultimate week before Santa’s visit, financial markets got a bevy of gifts. On Tuesday, we learned that inflation in general—and the Consumer Price Index (CPI) in particular—continue to retreat. Wednesday, the Federal Reserve announced the start of its pivot party from rates at the 22-year high of 5.5%. The central bank is likely done hiking and expects to cut rates as much as 0.75% next year. And Thursday, the Commerce Dept. reported better-than-expected retail sales for November, suggesting  consumers are spending just enough to keep the economy out of recession.

Irrational exuberance? The S&P 500 has surged 15.5% over the past seven weeks, from an oversold 4,100 in late October to an overbought 4,738 yesterday—eclipsing our year-end target of 4,600—as investors discount this good news. This rally should continue to 5,000 in the first half of 2024. Benchmark 10-year Treasury yields have plunged from an oversold 5.00% over the past two months to an overbought 3.90% yesterday, eclipsing our 4.00% year-end target. 

Inflation grinding lower Inflation clearly peaked last year, and is making solid progress towards achieving the Fed’s 2% target: 

  • Consumer Price Index (CPI) Headline retail inflation peaked at a 41-year high of 9.1% year-over-year (y/y) in June 2022 and has declined to 3.1% in November 2023. Core inflation (ex food and energy) peaked at a 40-year high of 6.6% y/y in September 2022 and has fallen to 4.0% in November 2023. 
  • Personal Consumption Expenditure (PCE) index The Fed’s preferred measure of inflation peaked at a nominal 41-year high of 7.1% y/y in June 2022 and has declined to 3.0% in October 2023. Core inflation (ex food and energy) peaked at a 39-year high of 5.6% y/y in February 2022 and has fallen to 3.5% in October 2023. At this pace, core PCE could fall near the 2% target by the end of 2024. But in its December Summary of Economic Projections released at the FOMC meeting Wednesday, the Fed maintained its year-end 2026 forecast for this key metric, which seems overly conservative.

Lower energy prices fueling the bus? Crude oil (West Texas Intermediate, or WTI) prices plunged nearly 30% from $95 per barrel in late September to $68 in mid-December, though they’ve rebounded to $72 recently. Amid concerns about slowing economic growth over the next year, domestic U.S. oil and gas production has hit a record 13.25 million barrels per day, while recent OPEC+ cuts of another 1 million barrels per day were deemed “voluntary.” Lagging retail gasoline prices at the pump have declined 20% over the past two months, from $3.88 per gallon in mid-September to $3.10 today. Retail sales at gasoline stations plunged 2.9% m/m in November, on the heels of a 1.2% m/m decline in October. Lower energy prices leave dry powder for consumers to spend for gifts. 

November retail sales better than expected, against a lowered bar in October Nominal retail sales in November rose by a better-than-expected 0.3% m/m, versus October results that were revised down a tick to a decline of 0.2%. In September (the last month of the important Back-to-School (BTS) season) they rose a solid 0.8% m/m.

“Control” results (which strip out autos, gasoline, building materials and food service, and feed directly into the quarterly GDP report) rose 0.4% m/m in November—double consensus expectations. The government revised breakeven control results in October down from a preliminary gain of 0.2% m/m. Control results in September rose a solid 0.6% m/m

Muted holiday spending With the first two months of the critically important four-month (October through January) holiday shopping season in the bank, spending in October and November rose a combined by 3.2% y/y, less than half of the solid 7.1% y/y gain registered during the 2022 season. That’s roughly in line with the forecast from the National Retail Federation, a key industry trade group, which expects 3-4% sales growth during November and December. The accounting firm Deloitte projects 3.5-4.6% sales growth from November through January. Adobe is forecasting online sales growth of 4.8% y/y, but they also project a surge of nearly 17% in “Buy Now, Pay Later” sales, which alludes to the pressure faced by low-income consumers.

‘Marpril’ and Back to School (BTS) sales portend softer holiday spending Over the past 30 years, holiday, BTS and “Marpril” sales periods have been 73% positively correlated, and personal consumption accounts for about 70% of GDP. “Marpril” 2023 rose 1.7% y/y versus 8.6% in 2022, while BTS rose 2.8% y/y in 2023 versus 9.7% in 2022.

Sector results mixed Despite decent foot traffic from Thanksgiving through Cyber Monday, department store sales plunged 2.5% m/m in November. But e-commerce results rose by a strong 1.0%, as consumers clicked away to buy sporting goods (up 1.3% m/m) and clothing (up 0.6% m/m). Auto purchases rose 0.5% m/m in the aftermath of the 6-week UAW strike, but electronics dropped 1.1%.

Mortgage rates have nearly tripled over the past two years, from 3% to 8%, continuing to pressure housing-related retail categories. Building materials fell for the third consecutive month (down 0.4% m/m), but furniture rose for the first time in five months, up 0.9%. The consumer shift from goods to services continues, energized by ongoing demand for revenge travel, as retail sales at restaurants and bars soared 1.6% m/m in November. 

Social Security bump drove last January’s retail sales Thanks to the worst inflation in four decades, Social Security benefit payments soared 8.7% in January 2023, the largest increase in 42 years. That helped to drive a powerful 7.4% y/y increase in retail sales last January, which clearly goosed spending trends for the entire 2022 Christmas season. But in January 2024, Social Security benefit payments will increase by a more pedestrian 3.2%, which is likely to drive much more muted retail sales overall for the 2023 holidays. 

Sales, inventories and profit margins under siege In addition, luxury stores are reporting a growing pile of unsold inventory, which they are loathe to mark down to clear for fear of damaging their brand’s aura. That suggests either nominal sales or profit margins are likely to come under pressure this season, as the top 20% of American consumers disproportionately account for 40% of retail sales. Toy and board game behemoth Hasbro announced it will cut 20% of its workforce two weeks before Christmas due to weak sales trends.

Low-end consumer is stressed The personal savings rate, which plummeted from 26.1% in March 2021 to a 17-year low of 2.7% in June 2022, has now risen to 3.8% in October 2023, as some consumers are reducing spending and amassing dry powder ahead of a slowing economy. Excess savings have fallen by 80% over the last two years, from $2.2 trillion to $450 billion in October 2023, while credit card delinquencies have doubled to 3%. 

Strong wealth effect should help Evercore ISI notes that over the past 25 years, there’s a 78% correlation between the S&P 500’s fourth-quarter performance and holiday sales. The S&P is up about 10% so far in the fourth quarter on a price-only basis, which may help to mitigate some of the organic weakness in retail sales that we envision.

Poor Christmas tree sales Starting in 2003, Evercore ISI has been gathering data from 24 regional Christmas tree associations, farmers and retailers in the U.S. and Canada during each of the four or five weeks in between Thanksgiving and Christmas, to gauge the relative strength or weakness of the sale of trees, wreaths and garlands. If consumer confidence is high and the economy is strong, people usually spend more money on holiday decorations, in addition to gifts, food, beverages and travel. We’re now three weeks into the current 5-week holiday season, and ISI’s annual Christmas tree unit sales survey has posted a relatively weak 4.1% y/y sales gain. That’s 43% below the average 7.2% gain recorded in the first three weeks of the survey over the past two decades, confirming a disappointing holiday season. 

Connect with Phil on LinkedIn

Tags Markets/Economy . Equity .

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Consumer Price Index (CPI): A measure of inflation at the retail level.

Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.

Personal Consumption Expenditures Price Index (PCE): A measure of inflation at the consumer level.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

Issued and approved by Federated Advisory Services Company