Weak Retail Sales May Trigger Rate Cut This Month: 5 Picks

The U.S. economy suffered a setback as retail sales for the month of September declined unexpectedly for the first time in seven months. Although contraction of retail sales in one month may be a discrete phenomenon, continuation of this trend is likely to raise recessionary concerns especially since the manufacturing sector contracted in the previous two months.

Meanwhile, market participants and industry researchers are busy assessing whether tepid retail sales will call for another rate cut by the Fed this month. Possibility of a third rate cut in October intensified on the back of prolonged uncertainty about the U.S.-China trade tussle, global economic slowdown and weak U.S. economic data.

Retail Sales Contract in September

On Oct 16, the Department of Commerce reported that retail sales in September declined 0.3% against the consensus estimate of growth of 0.3%. This happened for the first time since February. August’s data was revised upward from an increase of 0.4% to 0.6%. U.S. consumers reduced spending mainly on automobiles, building materials, and online purchases. However, year over year, retail sales increased 4.1%.

Core retail sales in September (excluding automobiles, gasoline, building materials and food service) declined 0.1% compared with a gain of 0.2% in August. Consensus estimate was also of a gain of 0.2%. Core retail sales data is highly correlated to the consumer spending component of the U.S. GDP.

Importance of Retail Sales Contraction

U.S. consumer spending constitutes 66-70% of the country’s GDP. Notably, personal consumption is the primary driver of U.S. economic growth in the first half of 2019. U.S. GDP grew 2% in the second quarter while personal consumption increased 4.6% on an annualized rate, the highest in one and a half years.

The importance of consumer spending has increased significantly in third quarter since U.S. manufacturing, which constitutes 12% of its GDP, contracted in the last two months. Lingering tariff war with China raised input costs for high-end U.S. products, resulting in slowing business investment. Moreover, labor market, which remained robust despite trade jitters also witnessed lower job growth in September.

Meanwhile, trade-related conflict with China continues despite President Trump’s assurance about substantial progress of a partial deal. The Wall Street Journal reported that China wants U.S. tariffs to be rolled back before increasing imports of U.S. agricultural products. Further, diplomatic relations may aggravate between the two countries owing to political unrest in Hong Kong.

At this juncture, reduction in consumer spending (the main driver of the economy) along with manufacturing contraction and slow job growth will have significant negative impact on the U.S. economy.

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Will Fed Opt for Third Rate Cut in October?

On Oct 8, Jerome Powell gave signals of a possible third rate cut this month. The FOMC is scheduled to meet on Oct 29-30. Powell cited a slowdown in the job growth rate and muted inflation along with global economic slowdown, due to the U.S.-China trade war, as the primary reasons for a likely third rate cut this year.

Notably, the central bank has already reduced the benchmark lending interest rate by 50 basis points in two equal tranches in July and September. The Fed lowered the benchmark interest rate for the first time in more than 11 years.

Moreover, disappointing retail sales data for September increased the vulnerability of the largest component of the U.S. GDP. These negatives are likely to compel the central bank for a third rate cut this month in order to honor its pledge to do the needful to sustain U.S. economic expansion. President Trump is also a vocal supporter of further reduction in interest rate in order to realize the full effect of fiscal measures taken by his administration.

Notably, as of Oct 17, the CME FedWatch assigned more than 88% probability of a 25 basis point rate cut in October while nearly 12% expects status quo to be maintained.

Our Top Picks

Under these circumstances, rate-sensitive investments like utilities, REITs and telecom which offer attractive dividends will be prudent. We narrowed down our search to five such stocks which gained impressively in the past three months and still have upside left. Each of these stocks carries a Zacks Rank #1 (Strong Buy). You can see Zacks Investment Research