15% Year-over-Year Percent Change: 5.6% 3-Month Annualized Rate: 8.9% 12% -6% -9% -12% -15%

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1 Economics Group Special Commentary Eugenio J. Alemán, Senior Economist (704) Shannon Seery, Economic Analyst (704) What Sectors of Retail Were Trending Late in 2017 Executive Summary Nominal retail sales figures surged through the final months of the year, suggesting 2017 sales ended on a solid note for the fourth quarter. Similarly, increased spending around the holidays, as well as significant improvement in control group sales since September, point to increased real retail sales for the final month of the year. Despite not yet having real (inflation-adjusted) data for December, in considering the nominal measurements it appears even more encouraging that real sales will register elevated gains in December, as inflationary pressures remained muted. Such underlying details point to strong personal consumption expenditures (PCE) and overall GDP growth in the final quarter of the year. In this special report, we examine both real and nominal retail trends throughout 2017, specifically analyzing those toward the end of the year. In analyzing the different sectors of the retail industry, we consider how the final months of the year compare to the trends of the prior year and explain how individual sectors have led to strong consumption. Finally, throughout this report, we emphasize why we expect such strength to be evident in the upcoming fourth quarter GDP release. Strong Retail Holiday Season a Primer for Solid Q4 GDP The strong end-of-year for nominal retail sales, specifically seen in holiday retail and control group sales, presages a good end-of-year for real personal consumption expenditures (PCE) as well as overall GDP growth. 1 Strength behind the nominal figures is especially evident given inflationary pressures, which, although steadily increasing, remain low compared to historical standards. This past holiday season s retail sales number outshines recent end-of-year sales performances. Similarly, control group sales registered exceptional gains, further suggesting increased strength in retail sales to finish the year. Figure 1 Figure 2 1 8% Holiday Retail Sales 1 8% 12% 9% Retail Sales Ex-Food, Autos, Gas & Building Materials "Control Group" Retail Sales : 5. 3-Month Annualized Rate: 8.9% 12% 9% The strong endof-year for nominal retail sales presages a good end-of year for real personal consumption expenditures. 4% 4% 2% 2% 3% -3% 3% -3% -2% -2% -4% -4% -9% -9% Holiday Retail Sales: 6.1% -8% -8% % -12% Holiday retail sales are defined as November and December retail sales while control group sales are retail sales excluding food, autos, gasoline and building materials. This report is available on wellsfargo.com/economics and on Bloomberg WFRE.

2 The strongest sector within the retail and food services sales sector was the sales of alcoholic beverages at drinking places. As Figure 1 shows, the 6.1 percent year-over-year growth rate of holiday retail sales was the strongest print since the 2005 holiday season and is likely a major contributing factor to sales strength through the final quarter of the year. Similarly, in Figure 2 we see that control group sales, which are utilized in the calculation of overall GDP, had a pretty good performance toward the end of the year, growing 5.6 percent in December, year over year. Such strength is even more apparent when analyzing the three-month annualized rate of control group sales, which, at 8.9 percent in December, registered its highest rate since This pace of growth surrounding holiday spending reflects why we expect a solid fourth quarter for both PCE as well as GDP. Small but Trending Higher in 2017 Within the retail and food services sales sector, alcoholic beverages at drinking places experienced the strongest growth rate for most of 2017 and certainly for the end of the year. This sector is reported on the services side rather than the goods side of the retail and food services sales report. Broadening economic growth coupled with surging consumer confidence could have in part contributed to the impressive strength in this sector, perhaps a reflection of good moods among Americans. This sector also includes full-service restaurants, limited-service eating places (or fast food restaurants), as well as special food services. However, of all the sectors, the only one that stood out this past year was drinking places, alcoholic beverages (Figure 3). While we do not have nominal nor real December data for this series, we could infer that as the sector was robust throughout 2017, even some softening from current levels would still suggest a sturdy trend overall. During the 12-month period that ended in November 2017, the drinking places sector s sales increased an impressive 15.4 percent in nominal terms, and by an even more impressive 12.2 percent in real terms. Figure 3 Figure 4 2 Real Retail Sales - Drinking Places Drinking Places: 12.2% 2 Real Retail Sales - Specialty Food Stores Specialty Food Stores: 8.2% Although drinking places comprises a small share of overall retail sales, it is still noteworthy as it held the strongest growth rate this past year. Despite the solid performance of the drinking places sector during 2017, it is clear that this segment was not the source of overall strength in the retail sales and food services sector. While drinking places represents 4.2 percent of total sales of food services and drinking places, it represents a mere 0.4 percent of overall retail sales and food services. That is, this sector was not the one moving the needle for retail sales during the final quarter of the year; however, the sectors strength is still noteworthy as it was the segment that grew at the strongest rate this past year. Another sector that was booming into the final quarter of the year was specialty food store purchases (Figure 4). This segment is part of the goods sector of the retail and food services report rather than the services sector. Real retail sales in this sector grew 8.2 percent in November on a year-earlier basis, and by 7.2 percent compared to the previous 12-months. Unfortunately, we cannot assess the nominal figures; we do not have the nominal sales historical data for this sector because the Bureau of Economic Analysis (BEA) generates this sectors sales with unpublished data from the Census Bureau. As was the case with the drinking places sector, this segment represents a small portion of total retail sales and food services. The sector represented only 2

3 3.6 percent of sales at food and beverage stores in November 2017, and just 0.4 percent of overall retail sales and food services sales. Housing Related Sectors Took the Lead in 2017 An examination of the important sectors of retail (in terms of overall size) that were relatively strong in 2017 leads to almost all of the sectors linked to the housing market. Such findings reflect the strength in the housing sector for the U.S. economy. Sectors such as furniture, home furnishing stores, appliances stores, building materials, and lawn and garden equipment and supplies dealers, were among some of the strongest retail sectors at the end of the year. Although some segments were more subdued at the start of 2017, they picked up steam as the year progressed and ended 2017 at a relatively strong pace. The strongest sector related to the housing market in 2017 was the smallest of them (about 1.1 percent of total retail sales and food services), that is, lawn and garden equipment and supplies dealers sales. This sector grew 12.0 percent in real terms during the period from December 2016 to November Real sales for this sector in 2016 grew only 2.5 percent compared to 2015, so the pick-up in growth this past year was notable. In fact, real sales for this sector were up 16.1 percent on a year-earlier basis in November 2017, the latest month available, which means that the sector continued to strengthen as the year was coming to a close (Figure 5). The second sector in terms of strength in 2017 was home furnishings stores sales. Real sales for this sector were up 9.3 percent during the period December 2016 to November On a year-earlier basis, this sector was up 12.6 percent in November 2017 (Figure 6). In 2016, the sector had grown 5.9 percent compared to 2015 in real terms. That is, this sector performed solidly in 2016 but improved considerably in Sectors linked to the housing market were particularly strong in 2017; a reflection of the strength in the housing sector of the U.S. economy. Figure 5 Figure 6 5 Real Retail Sales - Building Material & Equipment 5 2 Real Retail Sales - Furniture & Home Stores Building Materials & Supply Dealers: 8.3% -3 Lawn & Garden Equipment: 16.2% Furniture Stores: 7.4% Home Furnishing Stores: Meanwhile, real sales at electronics and appliance stores were also solid in 2017, growing 6.7 percent compared to the previous 12 months ending in November The sector grew 4.6 percent in real terms in 2016 compared to That is, sales at electronics and appliance stores also strengthened further from an already strong performance in In November 2017, this sector s real sales were up 9.8 percent on a year-earlier basis, which further points to its strength as the year was coming to a close. Real sales at building materials and supplies dealers were up 6.4 percent from December 2016 to November 2017 versus a 7.3 percent rate for the whole of 2016 versus That is, even though sales over 2017 were a bit slower than during the whole of 2016, the sector s real sales remained solid. In fact, the sector improved its performance during the second part of last year to finish the year at a relatively strong pace. On a year-earlier basis, real sales for the sector increased 8.3 percent in November (Figure 5). 3

4 Despite some pick-up related to hurricane effects, nominal sales figures suggest slowing within the motor vehicles and parts dealers sector. Perhaps the weakest sector in real sales of all those related to the housing market was furniture stores sales. Real sales at furniture stores grew 3.9 percent from December 2016 to November 2017 compared to a growth rate of 4.6 percent during the whole of However, the sector s growth improved in October and November in real terms, growing 7.2 percent and 7.4 percent on a yearearlier basis, respectively after coming off a weak performance in the third quarter (Figure 6). Thus, we expect this sector to have closed the year at a relatively stronger growth rate than in the prior three quarters. Trends for Motor Vehicles and Non-Store Retailers The motor vehicles and parts dealers retail distribution channel was also fairly strong in 2017 even though we saw some slowdown earlier in the year. This sector picked up some steam in the September to November period due to the effects of the hurricanes on Texas and Florida; however, according to the nominal retail sales release for December, this sector appears to have slowed in the final month of the year. The slowdown was significant in the other motor vehicle dealers segment, a segment that was booming in September By November, the growth rate had slowed to 5.9 percent, from as high as 19.8 percent in June 2017, year over year. In fact, the other motor vehicle dealers sales were up 11.8 percent during the period December 2016 versus November 2017 in real terms, more than double the 4.8 percent rate recorded during all of However, as we mentioned previously, this growth was down to a rate of just 5.9 percent by November 2017 on a year-earlier basis (Figure 7). Sales at traditional automobile dealers were also relatively strong in October and November, but may similarly have seen a slight slowdown during the final month of the year. However, sales for the period December 2016 to November 2017 were up 5.4 percent compared to a 4.9 percent rate for the whole of 2016, in real terms. That is, the improvement in automobile sales immediately after the hurricanes in Texas and Florida may have strengthened overall sales in the sector during the last quarter of the year. Figure 7 Figure 8 3 Retal Retail Sales - Motor Vehicle Real Retail Sales - Non-store Retailers Automobile Dealers: 6.1% Other Motor Vehicle Dealers: 5.92% Non-store Retailers: The non-store retail sector experienced some slowing in 2017, although sales remain elevated. Meanwhile, the non-store retail sector continued to move ahead strongly, as has been the case for this sector since it started to get noticed as a serious competitor early in this century (Figure 8). The overall non-store retail sector, which includes electronic shopping and mail-order houses, vending machine operators, and direct sales establishments, grew at a rate of 11.6 percent from December 2016 to November The sector did, however, slow from the 14.3 percent real growth rate it recorded in 2016 compared to the previous year. Growth in this sector is driven by the electronic shopping and mail-order houses sector, which increased 13.9 percent in real terms during the twelve months ending in November However, this robust rate of growth was down from the 15.5 percent it printed for the whole of Thus, while the non-store retail sectors did not outshine other sectors of retail last year, it still remained very strong and has continued to gain market share of the market versus other retail distribution channels in the U.S. economy. 4

5 Weak Growth from the Service Side of Retail Growth in the food service industry was very weak throughout The only exception, as we discussed earlier, was the drinking places, alcoholic beverages sector. The overall sector (food services and drinking places) increased 0.7 percent in real terms from December 2016 to November 2017, after growing at a stronger 2.8 percent for the whole of The largest two sectors in this category are full-service restaurants and limited-service eating places. Both of these sectors, which account for 87.3 percent of the food services and drinking places segment and represent about 8.8 percent of overall retail sales and food services, were weak in 2017 compared to Sales at full-service restaurants grew 0.6 percent in real terms between December 2016 and November 2017, while the limited-service eating places sector grew only 0.7 percent. This compares to a growth rate of 2.9 percent and 3.0 percent for these sectors for the whole of 2016, respectively. What is interesting about this sector is that this behavior seems to have carried over into the first two months of the final quarter of the year. For December, (real sales numbers are still not available), it seems that the overall food services and drinking places sector improved somewhat but perhaps not enough to overcome the weakness of the prior two months. Conclusion: Strong Consumption, Strong GDP End-of-year trends in retail sales suggest elevated real retail sales figures to close the year. In analyzing individual sector trends through November, it is evident that underlying strength exists within recent consumption habits, and it is likely that such trends continued into the final month of the year. Similarly, an exceptionally high holiday sales season coupled with the end-of-year improvement in control group sales are in line with the high nominal sales figures for December, and further suggest elevated consumption habits to close We expect PCE growth to come in at 3.8 percent in Q Nominal as well as real figures point to elevated sales through the final quarter of the year and warrant such expected gains in consumption. Growth in the overall food services and drinking places sector appears to have slowed in 2017; however, nominal figures suggest slight improvement in December. 5

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