What Insights Can We Glean From Retail Sales Numbers?

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

Equities continued their determined march higher last week, with the S&P 500 and Dow Jones Industrial Average each notching new record highs. The gains came during a light week of economic data; investors focused instead on earnings season, which so far has been relatively strong. Solid earnings reports and an absence of bad news on the economic front gave investors little reason to question the consensus view that the economy is on its way to a soft landing. Indeed, the widely followed retail sales report out last week from the Census Bureau showed that consumer spending in September came in above Wall Street estimates. Given that consumer spending has been a source of strength for the economy during the past few years, the report was encouraging. However, we note that, like many of the economic reports we study, the headline spending data comes with an asterisk.

To be sure, the growth trajectory of inflation-adjusted retail sales has been consistent in data going back to 2015. However, buyer behavior by income level has significantly diverged since the arrival of COVID. Prior to the early 2020 pandemic, average retail spending growth was mostly consistent regardless of income level. Since 2020, however, income has played a much larger role in determining consumer behavior.

According to a recently released study done by economists with the Federal Reserve, spending by low-income households spiked after the onset of COVID, growing at a faster pace than that of middle- and high-income households. Notably, the jump in spending coincided with stimulus payments in 2020 and 2021. Since then, however, spending by low-income households has tumbled, while spending by high earners has steadily increased. Indeed, since January 2018, average monthly spending by households with incomes of $60,000 or less has grown 7.9 percent, while those earning $100,000 or more have increased their monthly spending by a total of 16.9 percent. For further context, during the same period, total monthly household spending for all income groups has risen 14.7 percent. Put simply, spending by upper-income households is what has been driving much of the economic resilience of late.

One possible driver of the divergences is that higher-income households are enjoying a “wealth effect” from gains in housing and stock markets and, as the study notes, also “receive more interest and investment income during periods of higher interest rates, all providing a stimulus for sustained level of spending.”

The reason we highlight the changes in buyer behavior are twofold. First, it is consistent with trends we’ve seen in many parts of the economy when solid headline readings mask widely divergent pockets of strength and weakness in the economy and markets. As we detailed in our most recent Quarterly Market Commentary, economic strength is relatively narrow, with a few areas propping up overall growth while other pockets struggle under the weight of high interest rates. Second, the spending data highlights the risk to the seemingly solid economic growth we’ve seen. If elevated interest rates begin to seep deeper into the economy and start to impact higher-earning households, economic weakness could quickly gain momentum.

This brings us back to the question that we have long viewed as the key to whether we will see a recession. Will the Federal Reserve be able to cut rates fast enough to resuscitate weak areas of the economy so that growth can continue? Or will it have to take a gradual approach in reducing rates because of lingering inflationary pressures (the result being the cumulative toll of borrowing costs eventually kicks out the last remaining strong leg propping up the economic stool)? While it may be months before we know the answer to these questions, the bifurcated nature of the economy brings with it  risk. Put simply, there is less room for error when only a fraction of the economy is healthy. As such, we believe investors would be well served by balancing current risks against potential upside performance.

The group of winners that have been driving market returns higher are in those pockets of the bifurcated economy that are growing. When the economy eventually regains balance—whether through a soft landing or recession—the overlooked areas of the market, we believe, will gain traction and possess strong upside potential over the intermediate and longer term. As we have noted over the past several months, there are ample opportunities in the market—such as small and mid-cap equities—that are trading at relatively attractive valuations and should be well positioned to perform over the next 12 to 18 months whether the economy slips into a recession or a soft landing occurs and the equity market advance broadens. We continue to believe investors will be well served by following an investment plan for which an unexpected twist or turn doesn’t have an outsized impact on the long-term success of achieving their financial goals.

Wall Street wrap

Solid retail sales growth: The latest retail sales numbers from the U.S. Census Bureau show that overall retail and food service sales grew 0.4 percent in September, up from August’s rise of 0.1 percent. Sales strength was broad, with 10 of 13 categories measured showing gains, up from just five of 13 last month. Grocery stores and food service and drinking places each saw a 1 percent rise in sales for the month. Combined, the two accounted for just more than half (0.22 percent) of the overall increase. Other areas that saw strong gains were clothing (up 1.5 percent) and health and personal care stores (up 1.1 percent).

The latest report shows retail sales are up 1.7 percent year over year. Sales figures are adjusted for seasonal variation and holidays but not for price changes. That means that year-over-year sales have risen more slowly than inflation. However, the third quarter appears to have been strong, with the Control Group (which is a proxy for the spending measure found in Gross Domestic Product [GDP] growth) up about 6.4 percent in the third quarter, suggesting GDP growth for the quarter will be strong. As a result, our recession worries proved premature as third quarter economic growth continued to surprise to the upside.

Homebuilders’ confidence improves for a second month: Gradually cooling inflation and expectations for lower mortgage rates in the coming quarter led to improved homebuilder confidence in October. The latest sentiment reading from the National Association of Home Builders came in at 43, up two points from September. The latest reading is still very low by historical standards and comes as builders continue to have headwinds of high interest rates and elevated prices. The modest uptick in outlook is based on hopes that interest rates will begin to fall as the Fed cuts rates. However, interest rates on mortgage loans have actually risen since the Fed’s recent 50 basis-point cut. The national average for a 30-year fixed-rate mortgage is up nearly 0.4 percent since the cut, as the yield on the 10-year Treasury is up by about the same amount (mortgage rates are heavily influenced by the yield of the 10-year Treasury). It’s also important to note that the markets have already priced in a total of 1.25 percent in rate cuts through June 2025. This means that yield on the 10-year Treasury already reflects expectations of those cuts. Although optimism rose, the number of builders offering price cuts to buyers held steady at 32 percent. However, the average price reduction rose one point from September to 6 percent.

Housing starts decline: The latest housing starts data from the U.S. Census Bureau shows residential starts fell 0.5 percent in September to a seasonally adjusted annualized rate of 1.354 million. On a year-over-year basis, starts were down 0.7 percent. Single-family housing starts rose by 2.7 percent from August’s revised pace to a seasonally adjusted annualized rate of 1.03 million units. September’s seasonally adjusted pace is the highest since April of this year (4.5 percent at September’s revised pace) but down 15.7 percent year over year.

Total building permits decreased in September by 2.9 percent to 1.428 million. Single-family permits were up 0.3 percent from the prior month to 970,000. Multifamily permits came in at 398,000, a decline of 10.8 percent.

Continuing jobless claims move higher: Initial jobless claims were 241,000, down 19,000 from last week’s level. The four-week rolling average of new jobless claims came in at 236,250, an increase of 4,750 from the previous week’s average.

Continuing claims (those people remaining on unemployment benefits) stand at 1.867 million, up 9,000 from the previous week’s revised total. The four-week moving average of continuing claims came in at 1.842 million, an increase of 11,500 from last week’s revised number. We view continuing claims as a more reliable indicator of the labor market, as they measure workers who are facing long-term challenges in finding a job and, as such, filter out some of the temporary noise that can be found in initial claims data.

The week ahead

Monday: The Conference Board’s latest Leading Economic Index Survey for August will be out mid-morning. Recent reports have shown modest improvement but still point to weak economic growth ahead for the U.S. economy. We will be scrutinizing the data for any indications of a change in the pace of the slowdown.

Wednesday: The Federal Reserve will release data from its Beige Book. The book provides anecdotal insights into the nation’s economy and has shown economic weakness in many parts of the country as of late and some easing in the employment market. We will be watching to see if these trends continue.

We’ll get a look at existing home sales mid-morning from the National Association of Realtors. This report, along with the new homes data released this week, should give a clearer picture of whether the housing market remains stalled due to high interest rates.

Thursday: We’ll get an update on the health of manufacturing and services in the U.S. when S&P Global releases its Flash Purchasing Manufacturers Index reports for September. Activity rose last month in services, while manufacturing continued to struggle. We will be watching for signs to determine whether both sides of the economy continue to face higher input costs as well as any changes in demand for each.

The Chicago Federal Reserve Bank will release its national activity index. The report looks at economic activity across the country and related inflationary pressures. Last month showed an uptick in progress, although the three-month trend moved lower. We’ll be paying close attention to indications of whether the recent improvement was statistical noise or a sign of improvement for business conditions.

The U.S. Census Bureau will release data on new home sales for August. We’ll be looking at this data to assess the impact that fluctuations in mortgage rates have had on demand for newly built homes.

Friday: Data on durable goods orders for August will be released to start the day. We’ll be watching for signs of the direction of business spending in light of signs of slowing economic growth.

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