Crushing The "Lower Gas Price = More Spending" Fiction

Excerpted from Sterne Agee's Chief Economist Lindsey Piegaz report,

Caveats to the equation: lower gas prices = more spending

Aside from the long-standing issues of minimal income growth and lackluster job creation, consumers have become accustomed to an end-of-the-year price reprieve at the pump, and in some cases are simply using the increased funds to offset rising utilities and health care costs. We explore the various facets of this in further detail below:

1) Consumers have become accustomed to extreme volatility in energy prices. Particularly around this time of year, consumers are increasingly familiar with energy price reprieve from summer gas prices and no longer adjust their long-term spending habits as much, or at all, based on short-term price fluctuations.

Since reaching a high of $3.69 in June, average gas prices have fallen more than fifty cents a gallon, to a monthly average of $3.17 as of October, and have continued to fall throughout the early weeks of November. While impressive, this four-month decline is hardly unusual. In 2011, retail gasoline prices fell from an average monthly high of $3.91 in May to $3.27 by year-end, a decline of nearly sixty-five cents over seven months.

Then again in 2012, after ratcheting up to $3.85 at the end of September, gasoline prices tumbled more than fifty cents a gallon in just three months, down to $3.31 before turning the corner to 2013. And finally, last year told a similar story of lower energy prices before the holidays, dropping nearly thirty-five cents by the end of the year to $3.28 a gallon.

In each case, retail spending was hardly robust with an average monthly sales pace of 0.4% over the past four years. In fact, the largest monthly increase was in September 2012, up over 1%, thanks to a hefty increase in electronics purchases corresponding to the release of the iPhone 5. This September, retail sales saw a similar boost from the release of the iPhone 6.

As consumers increasingly anticipate sub-$3 gas prices to be more common in the coming year, however, according to the NACS, consumers say they are more willing to increase spending in the near term. In other words, as consumers anticipate permanency in price cuts at the pump, they are more inclined to adjust and increase consumption. According to the latest survey of consumer optimism, 21% of shoppers interviewed say they are looking forward to spending more in the coming months, up from just 15% in October. Although, the survey also found that 65% of Americans plan to spend the same this holiday season, with only 14% pointing to gas prices as a catalyst to potentially spending more.

2) Energy prices are going down, perhaps temporarily, but other costs are going up, some permanently.

While gas prices are aggressively retreating, cost savings at the pump are simply helping to offset price increases in other areas of household spending, particularly utilities and healthcare services. Service expenditures typically account for two-thirds of consumer spending, with the remaining one-third comprised of goods consumption. The largest component of service expenditure is housing and utilities, and as winter ensues, heating bills rise, diverting even more spending power to household energy consumption. While some conditions appear to have the consumer on better footing relative to last year’s harsh polar vortex, with winter storms already making their way across the Northeast and Southwest, and temperatures dropping in some areas to the single digits, consumers are already spending their savings from the pump on heating the family house.

In 2013, consumers ramped up service spending at the end of the year at the expense of goods spending, as Americans enrolled in Obamacare. The average family shelled out an extra $600 over the winter season to combat one of the coldest and snowiest winters in years. Of course, rising natural gas prices only exacerbated the situation in early 2014, with a high of $6/MMBtu by February. This year, again, consumers may not escape unscathed. Already natural gas prices have far exceeded levels this time last year, and according to the Farmer’s Almanac, this winter will be colder than normal, “with the coldest periods in late December, throughout January, and in early February.” Furthermore, snowfall is expected to be above normal in most regions with the snowiest periods in mid-December, and mid-January. In other words, lower prices at the pump may have translated into an extra $100 for the average family, but many Americans bracing for another terrible winter are hoping for further gas price reprieve, enough to cover higher winter heating bills.

Behind only housing and utilities, healthcare is the largest component of consumer service spending at 26%, accounting for nearly 18% of total household spending. In part driven by the availability of excellent treatment and the latest technology, and in part by the Affordable Care Act, both healthcare costs and total expenditures are rapidly rising. According to a national online private insurance exchange, health insurance premiums have increased between 39-56% since early 2013. For an average family, that means paying $663 a month, an increase of $230 a month or nearly $3,000 annually. Over the past three months, a price decline of more than $0.50 a gallon has left consumers with a modest increase of cash in their pocket, ranging between $80-100 assuming the average two-car household fills up each 20-gallon tank at least four times a month. And while a savings of $100 is hardly something to sneeze at, relative to rising healthcare costs 30 times greater, such savings is hardly momentum to ramp up spending when other bills need to be paid.


3) Consumer confidence reflects a relatively better holiday season.

Thinking back to the winter of 2013, it’s hard to argue consumers are not relatively better off this time around. After all, last year’s holiday season was dominated by a government shutdown and an extremely harsh winter weather which, based on personal opinion entirely, was the worst winter in history. This year, while consumers were inundated with negative ads surrounding the mid-term elections, most consumer surveys show consumer sentiment was more widely affected by overall economic concerns such as improvement in the labor market, international risks including the threat of the deadly Ebola virus, and pocketbook issues such as falling gas prices and rising healthcare costs. Still, as retailers count on just these last few months of the year for up to 40% of their annual revenues, a relatively more confident consumer may not be enough to ensure more “merry” this holiday season. After rising 0.6% in August, an above trend rise, consumer spending has been flat with October’s rise simply offsetting the decline the month prior.

While consumers may feel on stronger footing relative to the quicksand in Nov/Dec 2013, enough to continue to drive expectations higher, consumers’ assessment of current conditions remains little changed over the past three months following an initial pop in August as gas prices began their descent. In other words, the limited boost in sales in August as a result of increased consumer confidence may have been the extent of the ramp up in spending resulting from a decline in gas prices.


4) The labor market remains suboptimal, leading to increased savings.

Some consumers are increasingly willing to spend now in anticipation of increased spending power down the road. For many Americans, however, unemployment and underemployment have dampened the outlook for future earnings. Despite being more than five years into the recovery, wages remains stagnant, undermining optimism for an increased ability to finance today’s spending with tomorrow’s wages. In the October Employment report, while headline job creation rose 214k and the unemployment rate fell further to 5.8%, average hourly earnings rose 0.1% in October, maintaining a stagnant 2% annual pace. In fact, average wage increases have remained stubbornly low at a 1.9% annual pace since 2010.

With uncertainty lingering and patience wearing thin after five+ years of still lackluster wage growth, consumers are increasing saving for the future, hedging against a continuation of “more of the same.” Thus, for many, extra savings at the pump as a result of lower gas prices are simply being stored away to help supplement spending needs in the future, ramping up savings, not spending. As of September, consumers increased savings from 5.4% to a 5.6% pace, up from a recent low of 4.3% in November of last year.


Against the backdrop of three consecutive months of aggressive energy price reprieve, retail sales have fallen short. With more than a $0.50 drop in the average cost of a gallon of gasoline, anything less than a minimal 0.5% increase in monthly retail sales highlights just how fragile the U.S. economy remains, particularly the consumer sector. While the weakness in October was dominated by a few categories, there was insufficient demand elsewhere to compensate. Consumers continue to spend, but at a modest level with no sign of further momentum in sight with income growth stubbornly limited, and consumers opting to use savings from lower gas prices to offset rising healthcare and utilities costs. We are, after all, a consumer based economy, and if the consumer is struggling to go out and spend on goods and services, or if Americans are simply hesitant to ramp up spending, it could be a very un-merry holiday season for retailers. From the Fed’s perspective, if consumer spending continues to disappoint, headline activity is likely to significantly underperform monetary policy officials’ optimistic forecast of +2% in 2014 and circa 3% in 2015.