The Summer Slowdown Will Weigh On Stocks

May retail sales declined 0.9%, exceeding expectations and marking the largest drop since November 2023, driven primarily by a 3.5% decrease in auto sales. This decline, coupled with downward revisions to April's figures, signals a potential deceleration in economic growth led by consumer spending, further pressured by anticipated price increases from tariffs. The slowdown is reflected in a sharp deceleration of personal consumption expenditure growth, suggesting downward revisions to GDP estimates and corporate earnings expectations, potentially leading to a 3-5% market pullback.

Analysis

The U.S. economy is exhibiting initial signs of a significant deceleration, predominantly driven by weakening consumer spending, as highlighted by the May retail sales report. Sales fell 0.9% month-over-month, marking the largest decline since November 2023 and surpassing expectations, while April's figures were revised downwards from a 0.1% increase to a 0.1% decrease. This downturn was principally led by a 3.5% drop in auto sales, alongside contractions in building materials and gasoline sales. Although year-over-year retail sales increased by 3.3%, the inflation-adjusted figure is a more modest 0.9%, signaling a clear slowdown. Projections indicate a continued decline in sales over the subsequent months, attributed to anticipated price hikes from tariffs and a softening labor market, which is expected to necessitate downward revisions to GDP estimates and corporate revenue and earnings growth forecasts. The weakness was broad-based, with seven of the thirteen retail categories registering declines; notably, sales at bars and restaurants fell 0.9% in May, the largest drop since early 2023 and a critical indicator of discretionary spending, suggesting a slowdown in the broader service sector, a trend corroborated by recent PMI reports from ISM and S&P Global. While the Atlanta Fed’s Q2 GDP estimate is 3.5%, over 2 percentage points of this growth stem from a reversal of the Q1 trade deficit. Personal Consumption Expenditure (PCE), which constitutes over two-thirds of economic growth, decelerated sharply from 4% in Q4 2023 to 1.2% in Q1 2024, and after a brief tariff-driven acceleration at the start of Q2, its growth rate has again moderated to 1.9%. This deceleration in consumer activity, combined with geopolitical concerns such as escalating tensions in the Middle East which also pressured stock markets, supports an outlook for annual economic growth nearing 1%. Such a subdued growth environment would make it challenging to achieve Wall Street's consensus S&P 500 revenue growth of 5% and earnings growth of 9%, potentially exerting pressure on the current forward 12-month earnings multiple of 21.6 and possibly leading to a market pullback of 3-5%.

Key Decisions for Investors

• Investors should closely monitor upcoming consumer spending indicators, particularly Personal Consumption Expenditure data and retail sales reports, for further confirmation of the forecasted economic deceleration.
• Consider exercising caution with investments in sectors highly reliant on discretionary consumer spending and those particularly exposed to the adverse impacts of tariffs, such as price increases or supply chain disruptions.
• Prepare for potential downward revisions to corporate earnings and revenue guidance, especially for companies sensitive to overall economic growth, and reassess valuations accordingly, particularly for equities with elevated forward multiples.
• It may be prudent to adopt a more defensive investment posture or implement tactical asset allocation adjustments to mitigate risks associated with a potential 3-5% market correction and heightened volatility during the summer months.
• Factor in existing geopolitical risks, such as the Middle East tensions cited, as an additional source of market volatility that could amplify the impact of weakening economic data.