Watch Retail Sales Data As A Predictor Of S&P 500 Returns

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by: The Investment Strategist

Summary

Some economic indicators can be good predictors of future returns in the stock market.

If consumption is 70% of the US economy, then retail sales should be a good indicator of future S&P returns.

Additional analysis may still be necessary to confirm the initial thesis on market direction.

As retail sales go, so does the S&P 500. It's often mentioned in the press that consumption makes up about 65%-70% of the US economy, so it shouldn't come as a surprise that retail sales growth and the S&P 500 would move in tandem. The chart below is a good visual of that relationship.

So I asked myself, is there a way to determine what the market performance might be in the next year based on retail sales growth from month to month?

According to the data, there is. Now keep in mind there are other factors to consider and making investment decisions based solely on retail sales data, or any other individual variable, would not be a good investment approach. But, it could be a harbinger of market direction that could be verified with additional analysis.

We analyzed monthly retail sales changes going back to March 2007 and compared it to the subsequent 1, 3, 6, and 12 month returns of the S&P 500. We were looking for patterns where positive retail sales growth might indicate a rising market over subsequent periods, as well periods when retail sales contracted and the market declined over subsequent periods.

The market reactions to changes in retail sales were not too surprising considering consumption makes up 2/3rds of the economy. But the consistency of predictability was interesting.

In the table below, we divided the periods in which retails sales increased from month to month on the top portion of the table, with the periods in which retail sales declined from month to month on the bottom portion of the table. The relationship between retail sales and subsequent market movements is evidently stronger when retail sales rise. For example, when retail sales increased from month to month, the market was up no less than 69% of the time over the following 12 months. That is a good sign considering we just had a positive reading on retail sales.

Source: Orenda, fred.stlouis.org

On the other hand, when retail sales decline from one month to the next, the 6 month market return is positive only 36% of the time and 38% of the time if we go out 12 months. Subsequent periods any shorter than that did not seem to have much of a relationship with retail sales changes, as evidenced by the almost 50/50 results for the 1 month and 3 month subsequent returns.

With retail sales still in an uptrend, we might find comfort in this data and decide to remain invested in the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) for a little while longer. At least until retail sales decline, and then we might still have a few months before we must seriously consider paring back our exposure.

As I mentioned earlier, however, making investment decisions on one driving factor can be quite risky, as is investing in general, and particularly with the increased level of uncertainty and unpredictability of US policies. But the data above is interesting to note even in isolation and gives us a bit of comfort - comfort we will confirm with additional research - that the market may still have more upside.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.