American consumers are letting the good times roll again

Never Underestimate the American Consumer

Another day, another item of evidence that the US economy isn't slowing down anything like as much as many had thought. US retail sales in January rose the most in almost two years, reinforcing the narrative that consumer demand remains strong. This is despite fears from Wall Street pundits that cash in the system is waning as money doled out for the two-year pandemic stimulus dries up. Consumers' appetite to keep buying may bolster the Federal Reserve's resolve to maintain its aggressive monetary tightening campaign.

It is hard to explain the positive figures away. All 13 retail categories showed growth both on a month-on-month and a year-on-year basis. They're led by motor vehicles, furniture and restaurants, which should all benefit from post-pandemic reopening. Sales at restaurants and bars — the only service-sector category in the report — increased 7.2% in January to the most since March 2021, suggesting that the rotation from goods to services continues in full force. (Given the difficulty reserving a restaurant in Manhattan over the last few weeks, this isn't surprising.) 

The 3.0% total retail sales growth for the month matched the highest estimate in a Bloomberg survey of economists, which had a median forecast of 2%. Further evidence that the economy was hotter than thought helped bond yields to rise, but the stock market remained largely impervious, with the S&P 500 registering a slight rise.

The main takeaway? That consumers are off to a good start in 2023 despite various pundits calling for a tough year for the US economy. Appetite to spend, it seems, remain solidly intact. Here's Eliza Winger, economist at Bloomberg Economics:

With the disinflation process stalling and the economy showing only limited signs of softening, the strong retail-sales data suggest the Fed will need to keep rates high for longer — with a growing risk of a higher peak fed funds rate.

The report came on the heels of a slightly hotter-than-forecast inflation print, adding to the evidence that the Fed's rate-hiking efforts have not had their intended effects just yet. For Barclays economists including Jonathan Millar, the recent data amplifies risks that the target range for the funds rate could surpass its current assumption of a 5.25% to 5.50% peak after the June meeting. Traders continue to see about a 50-50 chance of a quarter-point rate hike in June (not not long ago, there were hopes that this month's hike would be the last) and expect interest rates to peak around 5.3% in July. Or, to use the latest analogy of choice, this contributes to a "no-landing" scenario, rather than the previous debate between soft and hard landings. Torsten Slok, chief US economist at Apollo Management, defines as follows:

There are more and more signs of the market pricing the no-landing scenario where the economy remains strong, and inflation remains sticky and persistent. Not only are short rates increasing, but one-year breakeven inflation expectations are rising and approaching 3%… In other words, the market is saying that inflation will be significantly higher in a year's time than the Fed's 2% inflation target. Put differently, instead of expecting a recession and lower inflation, short-term inflation expectations are rising and becoming unanchored. In response to this, the Fed will have to be more hawkish to ensure that inflation expectations do not drift too far away from the FOMC's 2% inflation target.

While the idea of not having to bring the plane in to land at all sounds positive at first blush, it isn't. As Slok points out, it would mean higher rates that would endanger equities and the credit market. Is a "no landing" really possible?

Some Long-Term Context

Viewed in longer context, the numbers add grist to the notion that the pandemic at last jolted consumers out of a slump that had lasted ever since the Global Finance Crisis. Viewed on a log scale, it's clear that the dive in retail buying after that recession was never followed by a return to the prior trend. Now, that's changed. After the lockdown's lurch downward, American retail sales are back roughly where they might have been expected to be by now when Lehman fell.

Evidently inflation has much to do with this. Higher prices will tend to increase the nominal value of retail sales. But if we look at retail sales in real terms (by dividing through by the Consumer Price Index), we find that the narrative of a jolt back above the depressed post-GFC trend remains intact, even if sales aren't back above their momentum from before the crisis, shown in the upper dotted line:

If consumers really have returned to a pre-Lehman normal, this has much to do with their access to money. Over time, growth in the money supply tends to be closely correlated with consumer consumption. Money growth in the US, as measured by the Fed's M2 aggregate, has been startlingly consistent. The desperate efforts to print money in the crisis and its aftermath had little impact as all of it went toward allowing banks to recognize losses on the bad loans on their books. The pandemic stimulus went into people's wallets, and even though money supply growth has actually been negative over the last 12 months, much of it still hasn't been spent:

In the long term then, it's possible to make the case that this is the end of the weird post-pandemic period, which can be called "the financial repression bubble" in the words of Longview Economics' Chris Watling; in other words, a policy of forcing consumers to lend to the government at very low rates (known as financial repression) is now over, and it's natural to see a snap back in retail sales. The return of inflation is another symptom of this. 

Some Short-Term Context

If that is a reasonable long-term explanation, can the retail sales be explained just by some short-term quirks? Like other recent data, the numbers may be noisier than usual. Bank of America economists including Michael Gapen said part of their strength in January is payback for the seasonal distortions that weighed on the December data — distortions that had in fact been there since October:

To get a clean read on the trend in retail sales, we compare the January data to last September. Ex-auto and core control retail sales are up 4.6% and 2.6% respectively on a four-month annualized basis. Given that retail sales represent nominal spending, the data point to solid, but not surging, goods demand.

That caveat aside, why are people still spending? The firm's economists blame it on the disposable income that likely surged in January due to robust job growth and inflation indexation of various components of income in the new year

Stephen Stanley, chief US economist at Santander US Capital Markets, suggests that the seasonal adjustment was a key issue. Consumers mostly did their Christmas shopping earlier in 2022. Expenditures were strong in September and October and softened in November and December on a seasonally adjusted basis, leading to "an element of smoke and mirrors behind the huge January rise in sales."

Similarly, Barclays reminds investors these data are backward-looking and may still be revised downward:

But even if this is true, it requires careful interpretation ... If January's effects are providing too much of a boost, this likely means that the effects in November and December attributed too much of a seasonal penalty — implying that the "true" seasonally-adjusted retail sales series would show less weakening late last year. 

As with several recent reports, some have been prompted to change their views, while others on Wall Street see the numbers as a mirage. We should only need to wait a few months to find out who is right. One recent trend, however, is very believeable. Among all the breakdowns of the report, this chart highlighted by Will Compernolle, senior economist at FHN Financial, stood out. 

It shows the widest-ever gap between spending for food and drink away from home compared to food and drink prepared at home. It could be that people are tired of their home-cooked meals or that they feel the ingredients needed to prepare their own dishes could cost as much as eating out. Tricky to tell, but the trend upward is pretty clear. It also suggests that this could be a great time to open a restaurant — assuming that you can pay enough to recruit the staff. The opportunity is there. People have felt for years that they should get out more. Now at last they're putting it into action.  

A London Landmark
The FTSE-100, the most widely followed index of the UK stock market, has topped 8,000 for the first time. Landmarks and round numbers shouldn't matter much, and this one has been greeted not with excitement so much as relief. 

A Landmark in London
Eight years after reaching 7,000, the FTSE-100 has at last topped 8,000

The FTSE reached 7,000 as long ago as early 2015. Since then, in price terms, it has compounded at 1.7%, with the Brexit referendum and the political turmoil that followed it, then the pandemic, and last year the blink-and-you'll-miss-it premiership of Liz Truss all inflicting setbacks. 

To give a more representative version of just how dreadful the performance has been, we can view it in dollar terms. This accounts for the serious decline of the pound over this time. Remarkably, the FTSE's landmark only brings it back to a point that it first reached in dollar terms 25 years ago, in 1998. 

Britannia Behind
In 25 years, the FTSE-100 is flat; the rest of the world's stocks have trebled

However, this isn't (primarily) a reflection of the bad performance of the British economy, or of Corporate UK. Despite the awful returns, London has enjoyed great success over becoming the venue of choice for global resources companies to list, even if their operations in the UK are minimal. That has left the FTSE exposed to the vagaries of the commodities market. Most notoriously, Glencore PLC opted to go public in May 2011, picking the top in the global metals market within weeks. Great market timing for Glencore didn't work out so well for its new shareholders. The dragging bear market in commodities since 2011 has thus weighed on London for most of the time since the GFC — and the rally to the landmark in the last few weeks can be taken as a signal of confidence in a broader revival for the global economy:

The Lead Weight Around London
The bear market in commodities has dented FTSE-100 performance

The listings of many multinationals have helped the London Stock Exchange itself, which has enjoyed the highest percentage gain of any FTSE-100 stock since the market bottom of 2009, rising 2,500% in that time. London's standing as a financial center has remained remarkably durable, despite everything that has  been thrown at it. Maybe, just maybe, London-quoted assets now look so cheap that they will attract more buyers. It's something to hope for. Meanwhile, the 8,000 landmark does at least show that confidence in a global recovery, possibly driven by reopening in China, is rising. So that's also a cause for restrained British celebration.

Survival Tips
As Raquel Welch has very sadly passed away, I'd like to pay tribute to her by linking to this classic video of her performing with another global sex symbol, Miss Piggy. Rest in peace, Raquel.

Meanwhile, for something a tad more serious and uplifting, I'd like to share a story I read today about Benjamin Graham, the father of value investing, Warren Buffett's mentor and the author of The Intelligent Investor. He retired when he was 60 after a spectacularly successful investment career. Fernando del Pino of Myway Investments in Madrid told the story to Stray Reflections of what happened after that: 

He spent the remaining 20 years of his life doing different things (apart from merely making money), alternating between his homes in California and in the south of France, writing, reading and savoring, in his own words, "the world of the mind, from things of beauty and culture in literature and in art." 

In these final years, a journalist asked him why he had quit investing in the stock market. I leave you with his response in the hope that it might teach you something you won't learn listening to today's society. Graham smiled warmly and said: "Why should I try to get any richer?"

That, says del Pino, "is what I'd call wisdom." I'd agree. Generally, the reason many very rich people don't stop and give themselves a comfortable retirement is precisely because it was their competitive and workaholic nature that made them so rich in the first place. They just don't want to stop. People with the commitment and talent to get rich, and the self-knowledge and grasp of priorities to use their money to have a good life, are rare indeed. We should all aspire to such wisdom.

John Authers is a senior editor for markets and Bloomberg Opinion columnist. A former chief markets commentator and editor of the Lex column at the Financial Times, he is author of "The Fearful Rise of Markets." @johnauthers

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.