[“3 Things” is a weekly publication of ideas, usually contrarian, to provoke thoughtful discussions and decision-making processes. As a portfolio strategist, I am sharing things that I am considering with respect to current investment models and portfolio allocations. Please feel free to email or tweet me with your comments and ideas.]
Retail Sales Flop
Last month, when the retail sales figures for May were released showing a sharp rebound in consumer spending by jumping 1.2%, analysts were quick to jump on the “economic strength” bandwagon. The jump in spending was also stated to be a sure sign that low oil prices had finally worked their way into the pockets of consumers.
“While the pickup in retail sales was certainly welcome, singular data points, particularly following several months particularly weak data, rarely point to a return of a more sustainable trend. This is particularly the case given that retail sales are currently near levels that have normally denoted very weak, or recessionary, economic environments.”
Notwithstanding that both April and May retail sales gains were revised substantially lower, the recent report on June retail sales confirmed ongoing weakness. As reported by Econoday:
“The second-quarter suddenly doesn’t look very strong as retail sales for June, showing broad weakness, came in way below expectations, at minus 0.3 percent. Motor vehicles were part of the reason, excluding which sales came in at only minus 0.1 percent. But excluding both autos and gasoline, core sales fell 0.2 percent.”
As stated, singular data points rarely provide any meaningful analysis other than what happened at a specific point in time. To understand the “economic story” being told data must be analyzed within the context of its current trend. If the economy is indeed improving, then retail sales should be improving as the economy improves. Conversely, a weakening economic environment will be revealed by a declining trend in retail sales. This is particularly the case in the U.S. economy where consumption comprises nearly 70% of the overall economy.
As shown, the economy, when viewed through the lens of retail “control purchases,” is currently operating at levels that have only previously been witnessed during recessionary periods.
While I certainly understand the desire for stronger economic growth, the reality is the economy continues to operate at extraordinarily weak levels. Even employment growth, which has been a major hold out for the “bull camp” has been more of a reflection of population growth rather than stronger economic growth.
The ongoing weakness in retail sale suggests that there is more to this story than just a “cold winter.”
The most recent survey from the National Federation of Independent Business (NFIB) also showed much of the same weakness as reported in retail sales. After a strong surge over the last couple of months, driven primarily by “hopes” of economic expansion following the “cold winter,” reality came home to roost as activity failed to emerge. For the month of June not only did the headline survey fall to 94.1 but it wiped all the gains in the survey back to January of 2014.
Furthermore, all of the primary measures of economic activity, along with future expectations, reversed sharply in June. Chief Economist Bill Dunkleberg summed the results of the report up well:
“June terminated a promising string of improvements in owner optimism during the first months of the year. While it is not a disaster or a signal of a looming recession, it is a disappointing sign that economic growth on Main Street is not set for a strong second half of growth. The weakness was substantial across the board, showing no signs of a growth spurt in the near future.“
The majority of mainstream economists and analysts have been frustrated by the lack of resurgence in economic activity over the last couple of years. At the beginning of each year, expectations for an economic resurgence have been left wanting as real activity failed to appear. However, since economic growth and overall business activity is supported by consumer demand, as discussed with respect to retail sales above, we can look directly into the NFIB survey at actual sales versus expectations.
As shown in recent months expectations of increased sales in coming quarters have crashed as sales have failed to materialize.
The problem with this is that the lack of actual demand from consumers has negatively impacted almost every measure of business activity covered in the survey from hiring plans to capital expenditures.
Bill Dunkleberg was very correct in stating that while this data does not suggest an immediate recessionary state, it does suggest that economic growth is likely far weaker than many of the headline statistics show.
This is an important point to consider given the Janet Yellen is determined to raise interest rates this year. Since a tightening of monetary policy is used to curb economic growth and quell inflationary pressures, there is little evidence that either currently exists to any great degree.
Divergence In The S&P 500
Earlier this week I discussed the technical backdrop of the market and the internal divergences that currently exist. To wit:
“Given the length of the current bull market advance, the deterioration of momentum and a still weak economic environment – the “bulls” definitely have their work cut out for them.”
My friend Walter Murphy also picked up on another divergence that I found very interesting.
“As noted in recent comments, many indicators have deteriorated to a degree not seen since October. By contrast, the indexes have held up relatively well. This prompted us to wonder if we could quantify the significance of this negative divergence. We examined monthly data since the 2000 peak and compared the S&P 500 with its 12-month RSI. We chose the RSI rather than the Coppock Curve because we wanted an indicator that always has a value in excess of zero.
The study calculates the percentage spread between the S&P’s monthly close and its 12-month high as well as the percentage spread between the RSI and its own 12-month high. We then subtracted the RSI spread from the S&P’s spread. This allows us to visualize how close price and momentum were to their respective highs. Readings near zero suggest that the price trend is in gear with momentum.
Extreme negative readings reflect a positive divergence and the likelihood of a potentially important bottom. The two most negative (oversold) values were in early 2009 and early 2003.
Conversely, high positive levels signal a negative divergence and the likelihood of a potentially important top. As it happens, there are only three other periods with higher (overbought) readings than was recorded at the end of June. The prior extremes were associated with the important 2000, 2008, and 2011 market peaks. On each of those, the spread indicator went through a value of “15” before reversing and completing the process. The indicator fell just short of the 15 level in June. But given that it is already in a league with other readings that were a prelude to the three most important corrections over the past 15 years, we should not dismiss the current divergences.”
As with all data, none of these data points suggests that the economy, or the markets, will immediately plunge into a recessionary contraction. However, what is important to consider is that many of these data points are now converging and suggesting that risk is more elevated now than at any point since the financial crisis.
It is at least worth thinking about.