Signup for our free newsletter:

Cheap Oil Hasn't Helped Anything Yet

Written By Briton Ryle

Posted January 15, 2015

Are falling oil prices causing the economy more harm than good? The latest retail sales report certainly seems to declare so. The sales results from the recent holiday shopping season are in, and they don’t look good. It looks like Santa took a vacation this time.

Retail sales figures for the month of December released yesterday showed not just a drop, but a plunge, falling some 0.9%. December is supposed to be the best month of the year for retailers, but this one turned out to be the worst one in all of 2014, tied with last January as per the graph below.

Retail sales december 2014

All autumn long everyone was calling for a robust holiday shopping season thanks to the dramatic reduction in fuel prices which saw gasoline fall from $3.68 per gallon in June to $2.26 in December, a drop of more than 38%.

“Americans Saved $14 Billion on Gasoline this Year Compared to 2013,” reported the Daily Fuel Gauge Report on the last day of last year.

That extra $14 billion in savings was supposed to help increase the entire year’s retail sales by at least 5% over 2013’s retail sales. But as it turned out, “in 2014, overall retail sales in the U.S. rose just 4% [over 2013], the smallest increase since the recovery began more than five years ago”, Market Watch informed.

So what happened? Why did retail sales shrink last month? Believe it or not, while the drop in energy prices was supposed add lift, it ended up adding drag. In some parts of the country, lower energy prices were not a blessing but a curse.

Energy Shifted the Economy

There are at least three main factors which contributed to December’s drop in retail sales.

First, while America’s oil and gas boom was on the rise, what used to be little dots on the map in the Midwest and southern U.S. rapidly blossomed into boom towns, with jobs available at every site, and businesses flourishing on every street.

It would make sense, then, that the recent decline in oil and gas prices would return all those small townships back to their normal pre-boom economic conditions, with hirings turning into layoffs, dramatically reducing the flow of money circulating through local economies.

“In the Dallas district, several expressed concern about the impact of the decline in oil prices on that regional economy, with oil service firms seeing as much as a 40% decline in their business, and scattered reports of hiring freezes and layoffs,” reports Market Watch.

Second, the drop in fuel prices which was supposed to help retail sales ended up hurting them as sales at the pumps dropped by 6.5% in December, the largest decline in gasoline sales since 2008. And since gasoline sales account for as much as 10% of the retail sales data, part of the blame for the lower overall sales figure can be attributed to the drop of fuel itself.

Yet even when gasoline sales are excluded from the retail sales number, the remaining sales were still down in December by some 0.3% over November. So clearly there was more going on last month than the loss of jobs and wages in the oil patch and less spending at the pumps.

This takes us to the third reason: consumer confidence is still hurting, with many Americans not feeling comfortable enough with their jobs or wages to spend, opting to save for a rainy day instead.

“U.S. households hoarded the money they were saving at the pumps in December rather than spending it,” senior economist at CIBC World Markets, Andrew Grantham told Marketwatch.

As a result, the U.S. stock market plunged yesterday on the disappointing retail report, with the S&P 500 falling as much as 33 points for a drop of 1.6% by mid-afternoon. Is this a sign of more shedding to come? Or did the market overreact?

Concern is Overdone

Although yesterday’s December retail sales report showing a drop of 0.9% was much more disappointing than the drop of 0.2% that analysts were expecting, sending the S&P below its all-important 150-day moving average by mid-day, it didn’t take long for traders to realize that the figures were greatly skewed by the extraordinary plunge in energy prices throughout the second half of the year.

The National Retail Federation shed more light on the numbers when it reported that total holiday sales actually rose in 2014 by 4% for its largest holiday season gain since 2011.

How could total holiday sales have risen when December sales fell? Because the entire holiday season spans from the end of November to January 1st. Some of the biggest days for retailers come at the start of the holiday season during November’s Thanksgiving week.

Overall holiday sales were even better when you exclude the drag from lower gasoline revenues. Without gasoline, retail sales were up 4.8% this past holiday season, its greatest growth ex-gas in three years.

By the end of the trading day, traders finally saw the report as being not so bad after all, and started jumping into the market again as they pounced on oversold prices, reclaiming some 22 points of the 33-point drop – a full two-thirds – which saw the day close with just an 11.76-point decline, or 0.58%.

Better Than We Realize

The net take away is that the economy is indeed stronger than people realize. Of course the drop in energy prices is going to hurt many local and regional economies in and around the oil and gas patches. But keep in mind that these areas have enjoyed a boom in recent years, and are no worse off than they were before the oil drills rolled into town. They are definitely much better off than they were during the Great Recession six years ago.

What is more, the drop in energy prices takes a little time to filter through the economy. After all, it has been only 6.5 months since energy prices started to plunge at the end of June. And even then, it has been only 2 months since energy prices broke below their 3-year low back in November, as per the graph below.

Energy 3 year low november 2014


Really, then, we need to give lower energy prices a chance to work their magic. The benefits have already begun to show in some parts of the retail sector, as Market Watch points out:

“High-end merchandise did well, while many areas saw strong sales of cars and trucks, manufacturing activity continued apace, and the travel and tourism segments appeared to be on good footing. Demand for business and consumer credit rose.”

These are the areas of the economy that cater to the slightly better-off middle class and above. The remainder of the populace may have to wait a little longer before it feels confident enough to start spending some of what they’ve saved. But they’ll get there. And continuing job growth will help all the more. “Economists predict sales will increase in 2015 because of strong job creation,” Market Watch adds.

That the S&P quickly bounced off its 150-day moving average yesterday to close above its 100-day average is a sign that the market really does not want to tumble. Sure, a bad report now and again will cause it to lose its balance for a bit. But as it has done for the past six years, the market quickly regains its footing and quickly moves along another leg up.

Lower energy prices are definitely going to be one of the reasons for continued strength, even if it doesn’t show up in the retail numbers just yet. Stay long.

Joseph Cafariello