Retail sales dropped 1.2% last month on a seasonally adjusted basis, the Census Bureau reported today. That’s the biggest monthly decline since last September’s 2.2% fall and the first retreat since December’s mild 0.2% loss. The latest drop in retail expenditures, coming at a time of rising deflationary worries, suggests that the worst fears about the economic recovery are confirmed. But while it’s too soon to dismiss such concerns, today’s retail sales update for May isn’t the smoking gun it appears to be.

Indeed, monthly retail sales figures bounce around a lot and so we should be cautious in reading too much into any one number. Consider a bit of perspective. Over the past five years, monthly percentage changes in this series has ranged from roughly a 3% rise down to a 3% fall. Meanwhile, the first four months of this year logged consecutive gains. As a string of non-stop monthly advances go in retail sales, that’s about as good as it gets. In other words, we were due for a pullback. That doesn’t mean all’s well, but at the moment it’s hard to determine if the broad economic trend is getting worse simply by looking at retail sales for May.
Consider the 12-month rolling percentage change in retail sales, a superior gauge of the underlying trend vs. the monthly numbers. Like many economic statistics over the past year, the annual pace of retail sales has rebounded sharply, as the chart below shows. In April, retail sales were higher by more than 8% over the past 12 months. But that rate of improvement is unsustainable, even under the best of economic conditions. A downshift was always inevitable, and more of the same is surely coming. As of last month, the annual pace slowed to a gain of less than 7%. That’s still high by historical standards, which implies that we’ll see a further slowdown.

If this was a “normal” economic recovery we might leave it there and move on to the next topic. But the business cycle is far from normal at this point. We’re referring, of course, to the labor market, the last great unknown in an otherwise encouraging economic recovery, at least in terms of the shift in trend over the past year.
The marginal change in retail sales relies on the general trend in the labor market over time. And much of the news on the change of trend in the job market has been positive over the past year. Nonfarm payrolls have gone from shedding hundreds of thousands of jobs every month to eking out small gains. An impressive rebound. From the depths of hell to the subpar normality in a year. As employment recoveries go, the change has been striking, particularly since it’s come over a relatively short span. As such, the improvement in retail sales over the past year is more or less tracking the change in the labor market and other economic metrics. No big surprise there.
But as we’ve discussed many times over the past year, the big challenge was less about rebounding off of depression lows. Rather, the critical question: How will the economy fare this time once the danger of outright economic implosion had passed? It’s passed, and we’re now knee-deep with the tougher task of keeping the positive momentum going and avoiding a double-dip recession.
The risk of slipping back into outright economic contraction still looks low, but much depends on how the numbers play out over the summer. Are we concerned that retail sales are headed for a prolonged slowdown? Yes, or at least we’re a bit more anxious today after reading the latest numbers. But it’s important to point out that last month’s retreat was led by a record 9.3% tumble for spending in the building materials and garden equipment industry. It’s probably no coincidence that a homebuyer tax credit recently ended, and so sales for this group were negatively affected with a one-time demand reversal tied to the end of a government stimulus effort.
The downturn in private-sector job creation in May is more worrisome. Clearly, May was a tough month, as the markets recognized via a sharp round of selling. It’s becoming clear why May was the worst month for the broad asset classes in more than a year. We still don’t have a full picture of May’s economic numbers, but as the reports in the coming weeks arrive, we’re expecting the numbers to look soft.
The bigger mystery is whether the trend in June, July and August will confirm or deny the events of May. Over time, government stimulus will wind down. Will private sector demand be able to fill the gap, or at least keep the trend from turning negative? No one has a crystal ball and so the best we can do is guess. For what it’s worth, we’re still modestly optimistic that the economy will muddle through. Today’s retail sales numbers don’t materially change this view. But that’s cold comfort. There are other demons lurking that could pose trouble in the weeks and months ahead. Yes, it’s going to be a long summer.