Looking for upside surprise from the consumer

| June 19, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

Consumer spending is central to the US economy as it represents roughly two-thirds of GDP.  In recent months, the consumer has become even more pivotal. Lockdowns led to a drastic drop in consumer activity in March and April and the gradual reopening has already led to a dramatic improvement in retail sales for May.  Further gains are likely in June, though the quarterly decline in the second quarter will still be catastrophic.  Beyond June, the consumer looks likely to continue delivering upside surprises.

May retail sales

 The recently-released May retail sales report showed a much stronger-than-expected rebound in May after April’s record drop (Exhibit 1).  The figures backed up anecdotal reports and high-frequency data on credit card swipes and mobility that pointed to a robust pickup in consumer activity after April’s lockdown-imposed doldrums.

Exhibit 1: May Retail Sales

Source: Census Bureau

 The breakdown by category shows that nonessential stores, the ones predominantly closed in late March and April, saw the biggest rebounds in May.  Apparel outlets offer the most extreme example.  This category suffered through a nearly 90% drop in sales in March and April.  In that context, the 188% rebound in May, as impressive as it sounds, still left the May level of sales down over 63% from the February reading.  Furniture and electronics and appliance stores also saw big gains in percent change terms, but sales remain far below normal.  On the other side of the spectrum, sales at grocery stores, nonstore retailers, and building materials outlets were higher in May than in February.

Auto dealers fall in between the two extremes.  Relative to expectations, auto sales have held up much better than feared back in March and April.  The May retail sales tally for motor vehicle dealers was only 6% below the February level, though unit sales still have much further to go, down by more than 25% from February with part of that gap reflecting a collapse in fleet sales mainly by rental car companies.

Retail sales only measure goods purchases with one exception: restaurants.  Restaurants have only been able to open on a limited basis due to social distancing.  Thus, the category enjoyed a sizable bounce in May but remained over 40% below the pre-COVID pace of sales.  This offers a window into how some services components may perform in May.

May consumer spending

Retail sales figures point the way to a detailed forecast for overall May consumer spending.  The contours of the goods pieces largely reflect the retail sales figures, with autos rebounding sharply, gasoline lagging due to price drops—which will reverse to a degree in June—and other goods posting a double-digit advance.

Within the services sector, the restaurant figures from the retail sales report and high-frequency data on other types of service providers offer insights into the May performance.  Services categories illustrate that there were divergent impacts from the lockdown across sectors.  Housing services, utilities, and communications were essentially unaffected, and financial services, education, and professional and business services only saw modest declines due to the lockdowns.  In contrast, restaurants and hotels, transportation (air travel), personal care (hair and nail salons), and recreation were crushed.  Ironically, health care services also dipped sharply, as doctors’ and dentists’ offices were closed and many hospitals sat empty in parts of the country not hit hard by COVID early on.

May should be a mixed bag.  Restaurants rebounded substantially and health care outlays also likely bounced sharply, as people addressed pent-up medical needs.  In contrast, many states have been slow to reopen some types of activity, and spending for personal care services, transportation, and recreation may only rise modestly from depressed levels.

Look for a 5.2% increase in services outlays in May, which would restore about 20% of the losses recorded in March and April.  Such a result for the services sector would likely lead to a gain for overall consumer spending of about 7.5% in May, retracing about half of the April plunge and just over 30% of the combined March-April drop.

June consumer spending

Looking ahead to the current month, motor vehicle sales probably continued to recover, approaching pre-COVID levels.  Gasoline station receipts undoubtedly surged, reflecting both an increase in driving and a rebound in pump prices.  The rest of the goods sector likely increased but at a much slower pace than in May.  Still, the advance ought to be substantial, as June is the first month when nonessential stores would have been open for a full month in most states.

On the services side, some of the sectors that were slow to recover in May should see a more substantial bounceback, including hotels and personal services.  Restaurants also likely enjoyed another sharp rise.  Other sectors, such as air travel and recreation, may have remained depressed.

Look for consumer spending to rise by another 5% in June.  That would put the level of outlays still far below the pre-COVID pace.  In fact, it would mean that the May-June rebound retraced just over half of the March-April drop.

Quarterly readings

These projections for May and June would yield a quarterly drop of almost 38% annualized for real consumer spending in the second quarter despite the sizable bounce back in May and June.  Nonetheless, the fact that the June level would be well above the quarterly average sets the stage for a powerful increase in the third quarter.  Assuming further but decelerating gains over the summer, real consumer outlays in the third quarter look set to bounce by an annualized 45%.

These estimates seem reasonable, not overly aggressive.  Nonetheless, it likely lands on the sunny side of the consensus, particularly for the third quarter. The second quarter projection is actually not very far from consensus.  Prior to the May retail sales report, the median forecasts in the Bloomberg monthly survey called for a 40% annualized drop in real consumer spending.  However, the median forecast for the third quarter was a 25% annualized gain.

On its face, a 25% annualized rebound seems plenty aggressive.  However, when you do the arithmetic, up 25% is actually extremely conservative.  The projections here for May and June would put the June level so far ahead of the second quarter average that flat monthly readings for July, August, and September would yield nearly a 24% annualized third gain.  Flat monthly performances in the summer strike me as exceedingly pessimistic, as air travel and several other categories will be slowly but surely ramping back up.

This arithmetic constitutes a key underpinning of an outcome likely since the early days of the pandemic lockdowns – that the consensus was too conservative about the third quarter rebound in GDP growth.  Consensus forecasts have risen somewhat but remain substantially too gloomy for the third quarter.  To be sure, consumer spending by the end of the summer will still be substantially below pre-COVID levels, but upside surprises from the consumer relative to the consensus will likely continue beyond the May retail sales report.

john.killian@santander.us 1 (646) 776-7714

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