Alright, so you already know that I’m not much on paying attention to economic data, at least when it comes to the idea that there’s any cause and effect relationship between the performance of the US economy and the stock market. Sure they correlate for long periods of time. But stocks virtually always start turning at major inflection points well ahead of the first signs of change in the economy.
At market tops, stock prices are usually well below the highs and on their way down before anyone realizes that the economy is in a recession. In fact, markets always top out when the news is good because that’s when the Fed starts tapping the brakes. And markets respond to that tapping virtually instantly.
So the fact that economic data is going gangbusters is not good news. The Fed is tightening and it will continue to apply the pressure until the economy weakens, and weakens a LOT!
But economic data can tell us about the state of the economy, obviously. As economic observers and actors, we’re always interested in that. Many of us have businesses or work in businesses that depend on the broader performance of the US economy. And economic data can tell us something about the difference between the Street media narrative and reality. Finally it can tell us whether we should be worried about the really big picture, as in, “Will our grandchildren be able to do as well as we did here in the US, or should we tell them to think about seeking their fortunes elsewhere?”
Retail sales data is a treasure trove of such information.
While the top line again showed boffo growth in April, when we peel back the layers we are once again confronted with my theme of the Tale of Two Economies. Those of us at the high end of the spectrum are doing so well that we skew the totals nicely positive. But the majority of American consumers are barely treading water. The base of the economic pyramid is being hollowed out, and that should concern those of us fortunate enough to live near the top. The fruits of our labors are at stake.
Wall Street’s Adjusted Numbers Hide Grim Spending Data
So, last week, the Wall Street Journal ran with the headline and lede:
|Climbing Gas Prices Didn’t Keep Consumers From Spring SpendingApril retail spending still rose 0.3% from March when excluding gasoline and auto activity. Despite rising gas prices, Americans ramped up their spending at the start of spring, signaling modest wage gains and the recent tax overhaul helped buoy spending.
They were, of course, referring to seasonally adjusted data, which is a number made up by government statisticians to smooth out a bumpy trend. They use a statistical method called X-12 ARIMA. It’s really little more than a fancy moving average.
It’s always subject to huge revisions, month after month, year after year, because it’s based on an average of the last 5 years and the next 5 years in the future. Obviously, that’s not known yet, so the number gets revised to fit the actual numbers for the next 2 months, and then every year for the next 5 years, until the seasonally adjusted graph perfectly fits today’s data 5 years from now. But right now? Not so much. Sometimes it’s close to the mark, sometimes not so close.
To be fair, they report the revisions, but nobody cares. The media, and the Wall Street crowd only care about that first number, which, as often as not, is wrong.
As a technical analyst, I’m comfortable with actual, not seasonally finagled data. What can be better than reality? OK, we know that economists can’t handle the truth, but we technicians like it. Plot the data, draw a straight line connecting the lows and voila! You can see the trend.
So here’s what the not seasonally adjusted reality looks like.
Now, that’s a helluva trend. Year to year, nominal retail sales rose 3.8%. But wait! That’s the second slowest annual growth rate in the past 12 months. Month to month was down 5.2%. Now, April always declines versus March, so a month to month change of -5.2% isn’t surprising in that regard. But that’s worse than any March-April dip of the past 10 years.
Wait a minute! Weren’t the tax cuts supposed to stimulate spending? Apparently that’s not working. Retail sales growth is actually slightly below trend. But let’s give the above graph its due. If this month is below trend, it’s not visible in the big picture. And you can see on the lower graph, that the 12 month moving average of the growth rate continues to inch higher.
Now let’s dig a little deeper. This trend includes an inflation component. So let’s back out inflation using the measure that I like better than CPI for this purpose. It’s the PPI for core finished consumer goods. The resulting chart of real retail sales, representing the unit volume of sales versus the dollar value suddenly doesn’t look so hot. By the same token it doesn’t look much different from recent years. Nothing has changed, the tax cut notwithstanding.
Real retail sales rose just 1.8% year over year and were down 5.4% month to month. That performance was close to trend, with the average growth rate gradually accelerating from near zero at the end of 2015 to nearly 2.5% now. It’s not spectacular but it’s solid. There’s absolutely nothing here that would deter the Fed from continuing to tighten.
It’s when we peel the onion a little more that the internal rot begins to show up. We know for example that US population has grown over the past decade. So part of the rise in total sales is due to population growth. How does the graph look if we normalize not just for inflation, but for population? It gets flatter and flatter. Apparently most people are not spending more. In fact, real retail sales per capita aren’t even back to where they were during the 2008 recession!
Finally, gasoline accounts for about 10% of retail sales. Gas prices have been rising sharply over the past year. That is contributing to the overall rise in retail sales. So let’s ex that out and see how the sales of everything else are doing after inflation, and on a per capita basis.
That’s just ugly. The year to year rate of change of retail sales ex-gas per capita fell 0.4%. The March-April decline of 6.2% was bigger than any March-April drop in the past 10 years. April had the worst year to year momentum showing since an anomaly in February 2016. Only this month’s drop isn’t an anomaly. The growth rate has been declining for 5 months.
Not only that, but current spending is below the April 2016 level as well. And current spending is no better than the levels reached in 2004, 2005, and 2006.
Where to Put Your Money As The Economy Gets Hollower And Hollower
This number is an average. Top income earners skew that average to the upside. Even with that, the average is flat. This highlights the fact that most people can’t even maintain recent spending levels, and have only recovered back to where they were in 2004, 2005, and 2006. The majority of consumers in the US haven’t been able to increase spending back to where they were 13 years ago. And whatever recovery they had experienced since the recession, stalled in 2016.
This is an example of the hollowing out of the US economy. The top line looks great, thanks to big spending high earners like many of us. But we should be worried, because the bulk of people can’t keep up, and US businesses need them as customers if they are to grow at all. At the same time, the US economy is burdened with record and growing debt.
Now this is fundamental stuff that has no bearing on the stock market in the short to intermediate term. Over that time, however, the Fed will keep tightening-removing money from the system. That will steadily erode demand for financial assets. And the US Treasury will keep pounding the market with more and more supply.
All the while, the US economy is being hollowed out. You don’t want to sell, take your money home, and let it hug you under those conditions? Hey, be my guest!
But if this logic resonates with you, continue to use all rallies as an opportunity to liquidate your portfolio. Cash will be king.
And if you’re adventurous and want to profit from the decline that I believe lies ahead over the next 2 years, use rallies to key resistance levels as opportunities to sell short the SPY. One of those levels is 2742 on the S&P 500. I’d have a mental stop a little above that. Then if the market does go through our mental stop, I’d look for the next sign that the market is beginning to roll over between there and the next resistance level of 2800 as another logical entry point for shorting the market.
As always, if you’re interested in making profits on the downside of the market, in addition to our ideas here, you can check out Shah Gilani’s put play recommendations in Zenith Trading Circle.