Summary
- Intuition would suggest that falling gas prices would increase consumers' disposable income, and in turn increase spending at retail stores
- The data shows some moments in which this occurs, but more often the opposite happens - gas price declines coinciding with declining retail sales (and vice versa)
- While the data suggests the link between lower gas prices and higher sales is tenuous, lower gas prices could help lower retailer transportation costs, which would benefit retailer earnings
The Details
Gas prices have plummeted over the last several months, and the stock market has fluctuated sharply in how to interpret the recent decline. Since the peak of the summer, the national average price of a gallon of gas has declined by 31% from $3.64 to $2.50. Initially, the market reacted positively, noting that the decline would bode well for consumer spending during the holidays. However, as the decline continued, market participants began to worry that the declining price was a sign of weak global demand.
Intuitively, a negative correlation between gas prices and retail sales makes sense. As gas prices decline, retail sales are boosted by consumers now having $20 - $40 more in their wallet. Low-income consumers benefit even more because $20 - $40 is a greater percentage of their total disposable income. This appeared to be the thinking behind the market's initial response.
Alternatively, one might suspect a positive correlation (with both gas prices and retail sales increasing or decreasing together) when taking a more holistic view of the market. Prices are a measure of the relative levels of supply and demand. A decline in prices could be due to higher supply relative to the demand or due to lower demand relative to the supply. If it's the former (the high supply), then the issue is specific to the oil-industry, and is not a sign of economic weakness. However, if it's the latter (the low demand), then the demand slowdown could potentially be a global issue that would hurt many companies. This appears to be the thinking behind the market's more recent sell-off.
Given my lack of in-depth knowledge on commodity markets and the health of global economies, I'm hesitant to take a stance on what the current oil price declines could mean for retail sales. However, data from the last two decades suggest that gas price movements are more often positively correlated with retail sales. As I show below, gas price declines coincide with a retail sales decline (and vice versa) quite frequently. This was especially true in the 90's when they appeared to move together in lockstep. There were a few divergences though, namely in 2002-2003 and in 2007.
One other way in which lower gas prices might theoretically help retailers is through lower transportation costs. Retailers, especially those with bulky items (like furniture or appliances), spend a lot of money transporting items back and forth from the manufacturer to their distribution centers, and from the distribution centers to their stores. Lower gas prices would likely lower these costs, which could in turn benefit their expenses and earnings. The impact wouldn't be as significant as a sales boost, but it is another impact to consider.
Expense benefits aside, I would argue that investors should be hesitant to purchase retailer stocks specifically on the bet that lower gas prices will help their sales. While it certainly makes sense intuitively, there is a long track record in which the relationship plays out differently.