Reading the New Consumer Numbers

Given high oil prices and election-season gloom, the dip in October's figures isn't alarming, especially with retail sales rising

By Michael Englund

Consumers would appear to be more cautious, if we can believe the Conference Board's U.S. consumer confidence index for October, released Oct. 26. The measure dipped to 92.8, below economists' median forecast of 94.0, from September's reading of 96.7. It appears that the surge in oil prices to new highs and negative election rhetoric have again depressed confidence.

But appearances can be deceiving. The three-month decline in the index from its July peak has not translated to more cautious behavior, as year-over-year retail sales growth has rebounded sharply. Indeed, we at Action Economics expect steady sales growth -- and a low but stable savings rate -- in the months ahead despite oil and election jitters.

The solid round of U.S. retail sales figures in September translated to a powerful rebound in the year-over-year growth rate to 7.5%, which is toward the higher end of the impressive 5.5% to 8.8% rates seen since the explosive third-quarter surge in 2003. Indeed, the third-quarter data this year faced tough comparisons.


  But consumers have held fast, leaving a stellar growth path for retail sales. That's especially noteworthy, as these sales figures generally understate growth in the overall economy because of the ongoing shift in consumer outlays away from these spending categories toward the service sector.

Based on patterns evident through both this expansion and the prior one, spending is now growing at roughly the same robust rate seen through the boom years of the late 1990s, with growth below the peak rates see in the 1999-2000 period, but above the pace of the 1995-98 period. Spending growth now is similar to the rates seen in the 1993-94 period.

This last comparison is interesting, given that this period was also characterized as an expansion that was not "appreciated" by the public at the time, despite robust spending growth. That upturn prompted a sustained Fed tightening cycle that might ultimately prove similar to the current one.

The cyclical retail sales acceleration in 1993-94 and the massive surges in growth seen in 1999-00 and 2003-04 were associated with a downward move in the savings rate, as households shifted income from savings to spending. In the 1993-1994 period, the savings rate posted a "cyclical" drop from the 8% area to near 5%, hence fueling rapid spending growth. But in 1999-00, the savings rate fell from around 4% to about 2%, and spending again soared. Then, in 2002, the savings rate fell from 2% area to about 1%, and spending soared yet again.


  Presumably, economists monitor the consumer-confidence data to receive early indication of when the savings rate will rise or fall, thereby determining the degree of caution that consumers introduce to their savings-and-spending decisions. But this relationship is not particularly instructive, in our view, as broad swings in confidence largely track other observable economic data, and deviations from other data often reflect noneconomic factors that don't necessarily impact actual spending anyway. The relationship has been particularly misleading in this expansion.

The recovery in confidence readings in 2004 occurred well after the drop in the savings rate in 2002-03, and the swings in 2004 are largely decoupled on a monthly basis as well. In particular, the savings rate has fallen to the 0.5% to 0.9% range over the last three months from June's peak of 1.4%, just as the Conference Board's consumer confidence index has fallen from a June peak, while the Michigan figures have moved sideways.

All the confidence figures are gyrating around healthy levels, and this is consistent with both the low savings rate and rapid sales growth rate that have largely been in place for the last year -- with or without confidence wiggles.


  Overall, we do expect year-over-year retail sales growth to gradually moderate toward a sustainable 5% to 6% growth rate in 2005 following the huge rates of the past year, as the savings rate stabilizes below 1%. The recent surge in oil prices will likely provide near-term support for the nominal spending figures at least until November, even if the "real" (adjusted for inflation) figures are depressed by rising prices. Indeed, the rise in oil prices may boost spending while also explaining a drop in confidence.

Once the election rhetoric is behind us, and especially if oil prices ease off their highs, a solid Christmas shopping season will likely emerge and carry us through December, despite the usual skepticism by retailers. In total, the household spending outlook remains solid just as the savings rate trajectory looks lean, and we are not concerned with the recent confidence declines.

Englund is chief economist for Action Economics

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