Economists Can’t Forecast Retail Sales, But You Have an Edge Because You Can

I had to chuckle when I saw how surprised the Wall Street media crowd was by Thursday’s monthly retail sales report for December. The consensus of economists guesses for the month was for a 0.2% increase. Instead, they got smacked with a drop of 1.2% in the seasonally adjusted headline number. How could they have been so wrong?

The funny thing is that if they had been paying attention all these years, they would know that, retail sales track the stock market with a slight lag. No surprise there. Most economic indicators track the direction of the stock market with a slight lag. That’s because the market is one of the primary signaling mechanisms for consumer behavior.

House prices are another, but stock prices are far more visible, particularly to the big spenders who are the ones who move this number around at the margin. They own stocks. When stocks go up, we feel richer and we spend more. When they go down, we pull in our belts. Most people who don’t own stocks are spending to subsist. They typically don’t have much discretionary income so their spending patterns don’t change much. They’re the stable base of retail sales. Stock owners are the swingers who spend more when the market is up, and vice versa.

I guess it boils down to this. The stock market is the economy. So why bother following economic data when the stock market tells us all we need to know? Mainly because the Fed watches both. The Fed cowers when the market declines, and it cowers when economic data shows up with a negative “surprise” that shouldn’t have been a surprise.

Here’s how you can gain an edge by knowing this information.

Knowing What the Fed will See Before It Sees It Gives You An Edge

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There may be some value to us if we see what the Fed will see before the Fed sees it. For trading purposes at least, there lately seems to be some value in anticipating what the Fed will say before it actually does anything. The stock market has had an enormous move in a very short time simply on the basis of traders anticipating what the Fed might do, when it has actually done nothing.

And probably won’t do anything.

Look at this chart of the headline number for retail sales along with stock prices. The upper half is the totals for each. The lower half shows the annual rate of change. Study that chart for a moment. It speaks for itself. Stock prices lead. Retail sales follow.


The stock market tanked from October through late September. The only surprise is that economists pay so little attention to the real world that they didn’t see this coming. Most of them never see anything coming. There are a few that do, but the Wall Street media tends to marginalize them. Wall Street likes to focus on what “everybody” is saying.

Meanwhile, even the Fed may have been mildly stunned by this report. Yesterday, Fed Governor Lael Brainard was crying in her beer, opining that the number was a “mess.” She’s worried about “downside risks” to the economy. She wants normalization to end by later this year. It seems that the Fed will move gingerly toward reducing its balance sheet normalization schedule, ending it before it returns to a normal tight reserve position, which would be some time in 2020.

However, as I’ve pointed out several times, I do not think that reducing the rate of draining money from the system, or even stopping it, will help the outlook for stocks. The market will still need help in absorbing the massive flow of Treasury supply that will be pounding away for years to come.

The Fed would need to actually print and pump to do that, and it’s nowhere near that decision. That would mean a return to QE, and such a dramatic move would seem to require that a financial or economic accident come first.

Here’s How We Know That January Sales Will Rebound

Given that retail sales follow the stock market, and given the strong wage inflation numbers in recent months, January retail sales should show a sharp rebound. While the Fed is very nervous right now, the February numbers should encourage the FOMC to stay the course with its balance sheet shrinkage.

That of course will ultimately lead to a bearish market reaction. It would be the very accident the Fed would need as an excuse to reverse policy and restart QE. In my view, the accident must precede the action.

The issue, as always is timing. We rely on technical analysis for that. So far, the indicators and projection techniques that I use are not yet pointing to the next decline being imminent. But they also suggest that there isn’t much upside left in this rally (check out my Liquidity Trader).

We need to be vigilant. In my Technical Trader reports, I had been recommending holding SPY calls since early January, but I think that game is played out. There’s a SPY put trade on the way, but not yet.

Meanwhile, both the Fed and consumers and business decision makers are watching the stock market for clues to what to do next. At the same time, investors and traders are watching and anticipating the Fed’s next move. The Fed is in turn watching them, as expressed in the direction of the stock market. It’s like a dog chasing its tail. Or a circular firing squad.

All the while this is going on, available market liquidity is being stretched to the hilt as dealers, traders, and investors buy stocks and Treasuries on credit. The Primary Dealers in particular have entered into uncharted waters with the astronomically rising size of their Treasury long positions. Without the constant flow of new Fed cash to their accounts, the dealers must finance these purchases with leverage.

While The Fed Dallies, Leverage Is Running Wild

There’s another sign of the increased use of debt financing and leverage driving these rallies. Weekly Fed data on the issuance of loans to non-bank financial institutions is a proxy for the Fed’s old line-item, loans for securities financing. Issuance of these loans has exploded since November, rising from an already rapid growth rate of 9-10% to 15%. With central bank provided liquidity falling, the rallies in stocks and bonds have been driven by increased leverage.


The risks in the financial markets increase as leverage increases. But there are ways to profit from the market while limiting your risk by keeping most of your assets in short term T-bills, and setting aside a small percentage of your portfolio for options trading, where potential profits are available regardless of the market’s overall direction. In fact, some of the biggest and fastest options trading profits often come on the downside.

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