Broad Outlook Unchanged Since Last Commentary. As discussed in Commentary No. 250, the worst is still ahead for the economic and systemic-solvency crises. Economic reporting has shown no meaningful signs of business recovery, with the current depression likely to evolve into a great depression, in conjunction with the collapse of the value in the U.S. dollar and a hyperinflation. Risks are high for these crises to explode in the year ahead. The general outlook is not changed.

With revisions considered, this week’s economic reporting was in line with expectations, yet it added some information to the big picture. Annual CPI-U inflation for example, increasingly appears to have bottomed out in July. Against oil-price-collapse driven massive drops in the CPI in during the fourth quarter, today’s spiking oil prices promise positive inflation no later than November, with year-end inflation likely to push above three-percent.

Typical of the patterns seen in housing starts, industrial production and new orders for durable goods, the September retail sales report showed ongoing bottom-bouncing at an extremely low-level plateau of business activity. Adjusted for inflation, there are no signs of recovery, just monthly swings that stay within a narrow range.

The reported monthly decline in retail sales followed a downward revision to the previously reported clunkers-related sales gains in August. With clunkers gone, and with the tax credit for first-time home buyers effectively expired, bottom-bouncing seen recently in both retail sales and housing data likely will turn into renewed monthly declines in the quarter ahead.

Shown in the accompanying graph is the "recovery" in retail sales. The monthly volatility is smoothed using a six-month moving average, but the pattern generally is the same using just raw monthly data. The inflation-adjusted dollar reading for September was the lowest since June and below average for the last eight months. As seen in the graph, and in the numbers at any level of smoothing, the current level of activity is about the same as it was 10 years ago. Virtually 10 years worth of real retail sales growth has been destroyed in the still unfolding depression.

September CPI Restrained by Falling Food Prices? September’s CPI picked up some new-car inflation that had been masked in the prior month by the Bureau of Labor Statistics (BLS) not counting clunker rebates as part of new-car pricing. Such was offset in today’s reporting with an extremely suspect decline in food inflation. The CPI-U reflected both month-to-month and year-to-year declines in food prices, yet, seasonally-adjusted retail sales showed higher grocery store sales both month-to-month and year-to-year.  

A note on the different CPI measures: The CPI-U is the monthly headline inflation number and is the broadest in its coverage, representing the buying patterns of all urban consumers.   The CPI-W covers the more-narrow universe of urban wage earners and clerical workers and is used in determining cost of living adjustments in government programs such as Social Security. The C-CPI-U is an experimental measure, where the weighting of components is fully substitution based, and generally shows lower annual inflation than the CPI-U and CPI-W. The two latter measures once had fixed weightings — so as to measure the cost of living of maintaining a constant standard of living — but now are quasi-substitution-based. The SGS alternative measures are attempts at adjusting the reported CPI-U inflation for the impact of methodological change of recent decades designed to move the concept of the CPI away from being a measure of the cost of living needed to maintain a constant standard of living. 

CPI-U.  The BLS reported this morning (October 15th) that the seasonally-adjusted September CPI-U (Consumer Price Index for All Urban Consumers) rose by 0.17% (up by 0.06% unadjusted) +/- 0.12% (95% confidence interval not seasonally adjusted) for the month, after rising by 0.45% (up by 0.22% unadjusted) in August. Seasonally-adjusted, the annualized rate of inflation for the third-quarter average CPI-U versus the second-quarter (same way the GDP price deflator inflation is calculated) was 3.60% versus 1.33%.

Unadjusted, year-to-year inflation was less negative (formal deflation), again, down by 1.29% +/- 0.20% (95% confidence interval) in September, versus a 1.48% annual contraction in August. With the negative annual inflation having bottomed in July, year-to-year inflation should turn positive again in November, perhaps even as early as in October’s reporting. Annual CPI-U inflation could break above the positive two-to-three percent range by year-end 2009.

Recent annual declines in CPI-U inflation have been the biggest since 1950. I estimate, however, that CPI reporting methods used in 1950 would generate a reported current inflation rate of roughly 6% (see Alternative Consumer Inflation Measures below). The brief and shallow formal deflation that now is coming to an end — based on official CPI-U reporting — appears to have been about half the depth and half the length of the negative inflation bout in the 1950 circumstance.

Annual inflation would increase or decrease in October 2009 reporting, dependent on the seasonally-adjusted monthly change, versus the 0.82% adjusted monthly decline seen in October 2008.  I use the adjusted change here, since that is how consensus expectations are expressed. The difference in growth would directly add to or subtract from September’s annual inflation rate of negative 1.29%.

For those interested in exploring the various facets of official CPI-U reporting, I continue to refer you to CPIwatch.com, a site prepared by one of my SGS colleagues.

CPI-W.  The BLS reported that the narrower, seasonally-adjusted September CPI-W (CPI for Urban Wage Earners and Clerical Workers) rose by 0.18% (up by 0.08% unadjusted), following an increase of 0.55% (up by 0.30% unadjusted) in August.  Year-to-year, CPI-W inflation declined by 1.68% in September, following a 1.90% drop in August.

C-CPI-U.  Year-to-year or annual inflation for the Chain Weighted CPI-U — the fully substitution-based series that gets touted by CPI opponents and inflation apologists as the replacement for the CPI-U — fell by 1.37% in September, versus a 1.48% drop in August. The deeper decline in the C-CPI-U annual inflation rate versus the CPI-U is the normal relationship for the two series.  

Alternative Consumer Inflation Measures. Adjusted to pre-Clinton (1990) methodology, annual CPI growth held at 2.1% in September, versus 2.1% in August, reflecting the differences in SGS versus BLS handling of clunkers pricing in August, while the SGS-Alternate Consumer Inflation Measure, which reverses gimmicked changes to official CPI reporting methodologies back to 1980, rose to about 6.1% (6.11% for those using the extra digit) in September, versus 6.0% in August.

The SGS alternative estimates for August included a one-time added 0.28 percentage point adjustment to reflect the clunkers program pricing impact. The September SGS estimates reverted back to their regular methodology, where the base BLS CPI-U numbers for September presumably picked up any continuing higher new-car prices that otherwise had been masked in August’s numbers.  

The SGS-Alternate Consumer Inflation Measure adjusts on an additive basis for the cumulative impact on the annual inflation rate of various methodological changes made by the BLS. Over the decades, the BLS has altered the meaning of the CPI from being a measure of the cost of living needed to maintain a constant standard of living, to something that no longer reflects the constant-standard-of-living concept. Roughly five percentage points of the additive SGS adjustment reflect the BLS’s formal estimate of the impact of methodological changes; roughly two percentage points reflect changes by the BLS, where SGS has estimated the impact, not otherwise published by the BLS.

September Retail Sales Declined Following Downside Revision to Clunkers-Induced August Sales Boost. Yesterday’s (October 14th) Census Bureau report showed a statistically-significant monthly decline of 1.49% (1.92% net of revisions) +/- 0.6% (95% confidence interval) in seasonally-adjusted September retail sales. Such followed a downwardly revised 2.16% (previously 2.67%) monthly gain in August, which was dominated by a large boost in auto sales from the cash-for-clunkers program. Indeed, the bulk of the August downside revision was in auto sales. On a year-to-year basis, September retail sales were down by 5.67%, versus a revised 5.77% (previously 5.31%) decline in August. 

The pattern of narrowing declines in year-to-year change here is not a sign of improving economic activity. Rather it is an artifact of the extremely protracted decline in the current economic downturn, where year ago comparisons are against more rapidly declining activity. While the pace of decline in activity generally has slowed, it is not recovering. As discussed in the opening comments, a period of renewed deterioration is likely in the months ahead.

Even with the one-time clunkers spike in August, and removing the effects of inflation, retail sales activity remains one of bottom-bouncing/plateauing at extremely low levels. As noted and graphed earlier, the level of inflation-adjusted sales for September dropped to a level below that seen in September 1999. Effectively, a decade of real retail sales growth has evaporated, so far, in this economic contraction.

Core Retail Sales.  A change in "core retail sales" methodology was introduced last month, where the net relative monthly increases and/or decreases in gasoline station and grocery store sales were subtracted from the full monthly retail sales number, instead of the total of gasoline station and grocery store sales each month. Assuming that the bulk of non-seasonal variability in food and gasoline sales is in pricing, instead of demand, the revamped reported "core" change more closely reflects the actual retail sales experience. This remains a work in progress and eventually will be used in the development of additional SGS alternative economic measures.

For the near-term, the "core" retail sales will be reported in two versions, where Version I uses the original methodology, and Version II version appears to provide a more balanced picture of the impact food and energy inflation in the standard retail sales reporting.

Consistent with the Federal Reserve’s predilection for ignoring food and energy prices when "core" inflation is lower than full inflation, "core" retail sales:

Version I — retail sales net of total grocery store and gasoline station revenues — fell by 2.2% versus the official aggregate decline of 1.5%.    

Version II — retail sales net of the monthly change in grocery store and gasoline station revenues — fell by 1.7% versus the official aggregate decline of 1.5%. 

Real Retail Sales.  Based on September CPI-U reporting, inflation- and seasonally-adjusted September retail sales fell by 1.4% (down 1.5% before inflation adjustment). In contrast, real August retail sales rose by 1.4% for the month (up 2.2% before inflation adjustment). Year-to-year, September real retail sales fell by 4.4% (down by 5.7% before inflation adjustment), while August real retail sales fell by a revised 4.7% (was 4.2%), which was a 5.8% contraction before inflation adjustment.

Smoothed for monthly volatility on a three-month moving-average basis, the September and August real annual declines were 4.5% and 5.9% respectively. As discussed and graphed earlier, the pattern here has shifted to bottom bouncing in terms of the level of inflation-adjusted sales. Again, there is no turnaround in economic activity — no recovery — evident here, just bottom-bouncing.

Week Ahead. Given the underlying reality of a weaker economy and a more serious inflation problem than expected by the financial markets, risks generally remain for higher-than-expected inflation and weaker-than expected economic reporting in the week ahead, especially for economic reporting net of prior-period revisions.

Industrial Production (September). Due for release tomorrow (Friday, October 16th), September industrial production is expected to show a 0.1% monthly gain (Briefing.com). While such is a reasonable swing following a 0.8% clunkers-spiked gain in August, again, reporting risk again is to the downside of expectations.

Housing Starts (September). September housing starts reporting is due for release on October 20th (Tuesday). Expectations appear to be for relatively flat month-to-month change. Indeed, any monthly increase or decrease likely will be statistically insignificant, as this series continues to bounce along an historically low-level plateau of activity.

Producer Price Index (September). Due for release on October 20th (Tuesday), the September PPI is expected to show a 0.1% monthly increase, per Briefing.com. This highly volatile series remains at some risk of upside surprises to monthly reporting for both September and October.