Heads Up: Retail Spending Momentum Turns Negative
(Note: The Vice Index is lagged: recent vice spending pullbacks are reflected in the chart above starting June.)
Consumer Spending Slowing Down
Regular readers know the Vice Index is the real way to measure the breadth of the US consumer. It factors in many disposable spending habits like alcohol, marijuana, prostitution, and gambling.
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Everyone knows consumer spending (including disposable spending) is the lifeblood of the US economy. There are different but related measurements:
- Disposable Income is personal income minus taxes.
- Personal Consumption Expenditures (PCE) is disposable income minus savings, interest payments, and transfer payments. (It runs ~91.5% of Disposable Income)
- Discretionary Income is PCE minus basic essentials
In other words, discretionary spending is the spending on wants after the needs get covered: taxes, interest, savings, and basic needs. It includes luxuries like apparel, cars, TVs, vacations and so on.
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Discretionary Incomes are directly impacted by changes in incomes and inflation. But the spending of that income is most influenced by the state of the economy and expectations about the future, which affects consumer confidence and the willingness to spend or not.
Retail spending is an incomplete measure of consumer spending because it only follows spending at stores and virtual stores. By definition, it excludes major luxury spending like recreation (vacations, sporting events, gambling, air fares, and so on). That’s a significant gap: US gambling is a 0 billion (B) industry.
An Even Higher View of the Vice Index
Vice spending is broadly representative of the US consumer:
- Broad-based: Every socioeconomic and demographic group participates
- High-volume transactions: Over 100 million discrete events per year
And vice spending is highly sensitive to near-term economic conditions:
- Cash based: depends on free cash flow
- Luxury spending: wants not needs
- Significant dollar amount: not pricey but not cheap
That’s why analysts spend so much time crunching the data and spitting out projections and expectations.
Guess what? Moneyball’s Vice Index nailed it again.
Where Consensus expected a solid month in retail expectations, the Vice Index was flashing warning signs.
| Retail | Retail ex Autos & Gas | |
| Consensus Expectations | 0.1% | 0.4% |
| Andrew Zatlin | -0.1% | 0.1% |
| Actual | -0.2% | -0.1% |
More concerning is that the Vice Index is flashing rapid deceleration in spending momentum. It’s worth showing the Vice Index chart again.
Spending has clearly downshifted.
Last month I predicted an inflection point – a downshift in retail spending trend. Specifically, I forecasted a drop from the 4%~5% range to a more moderate 3%~4% range. That’s now happened.
Spending growth slowing down is no longer a one-off problem. It is now a trend.
Discretionary Spending: Leading Indicator for Bond & Equity Markets
The impact on the bond and equity markets is both immediate and direct.
Increased demand for consumer discretionary goods and services is inflationary and boosts the likelihood of interest rate hikes.
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It also leads to higher corporate revenues which in turn boosts the stock market. The opposite is true as well: reduced demand will lead to lower production and services, which means weaker performance by companies in the affected sectors and lower inflation and falling interest rates.
Tracking Consumer Spending: Personal Consumption Expenditures & Retail Spending
The main conventional data points that track consumer spending are Personal Consumption Expenditures (PCE) and Retail Spending. PCE tracks the ability to spend and Retail tracks the actual spending.
If PCE measures the ability to spend (after-tax money left over after covering essentials). And Retail measures a portion of the spending… Luxury spending measures the willingness to spend.
As the quintessential non-essential, luxury spending is highly elastic with incomes and that makes it the canary-in-the-coal-mine for consumer spending.
Track luxury spending and you gain leading visibility to consumer spending.
Luxury Spending: The Missing Piece of the Puzzle
Traditional definitions of luxury are quite narrow: costly goods purchased by the wealthy to demonstrate affluence.
As such, measurements are limited in scope and scale: diamond purchases, Tiffany’s and Sotheby’s revenues, and yacht sales, to name the most widely used.
We want to know whether consumers feel that they have more or less money in their pockets and, therefore, will spend accordingly.
For that reason, the price is irrelevant. A normal good purchased by a rich person may be a luxury good to a lower income person.
A more useful definition of luxury spending is anything that is (1) truly non-essential, (2) not an ordinary day-to-day purchase, and (3) enjoyed on relatively rare occasions. In addition, there is a psychological element of satisfaction: the consequence of buying luxury goods and services is that the consumer feels
Vice Spending to the Rescue
Remember, Vice spending tracks US consumer spending on alcohol, marijuana, prostitution, and gambling.
As a result of this sensitivity, Vice Spending carries a distinct advantage: it leads by 4 months.
Over time, the vice spending correlation to retail spending and Personal Consumption Expenditures has improved significantly. I think that comes from changes that expanded the reach of vice spending and its consequent representation of overall spending.
- Gambling became more accessible: In the early 1990s, only 2 states had legalized gambling. Today 48 states have legalized gambling.
- Prostitution became more accessible: the internet reduced barriers to participation and created marketplaces that connected clients and providers
- Marijuana consumption expanded: Boomers and Millenials smoke pot. For example, (per the CDC) in 2002, 1% of adults aged 45-54 surveyed said that they smoked marijuana in the previous month. In 2014, 6% said they did. For those aged 26-34, the figure went from 8% to 13%
In other words, the end of the 90s saw an accelerating ease of access (and an accompanying reduction in social stigma) that led to significantly higher participation by the general population.
A Reason for Spending Slowdown
Simply put, spending is slowing because income growth is slowing
Compensation received has slipped from 4.5% last year to barely 3% this year. And the trend is down. That limits growth in spending: PCE has rolled over again.
KEY TAKEAWAY: There’s nothing signaling a recession. But slower spending is not going to help the stock market.
And if the Vice Index is correct about a major spending slowdown in 4Q, that’s a problem as we head into 2018.
