Market Thoughts
Links | Sitemap | Search:   
  Home  > Commentary  > Archive  > Market Commentary  

Retail Sector Watch

(June 7, 2004)

Please read our terms and conditions before reading the following information.  Be sure to utilize a hard stop in each trade that you make!

Dear Readers:

The Retail Sector: As my readers may remember, we ended our discussion of the bank sector last week with the conclusion that while bank stocks look overvalued (absolutely and relative to the overall market) it is still too early to conclude that they have topped out - the major reason being that despite higher rates, the average American can still choose to borrow more money if he or she has the capacity to do so.  Whether the average American has this capacity is a difficult thing to gauge.  I also did not like the fact that every financial writer and the next door neighbor was calling for a top in bank, mortgage, and homebuilding stocks.  If the Fed chooses to let short-term rates remain low, then these financial institutions will ultimately even have a larger profit margin.

In this commentary, I will attempt to measure this capacity of the average American to borrow or spend more money, and hopefully, I will be able to do it in a simplistic but convincing way.  Please note that this analysis is all the more important since consumer spending makes up approximately two-thirds of GDP, and a significant stock market top rarely comes without at least a temporary exhaustion in consumer/retail spending.

Following is a two-year chart of the Retail Sector - which represents an objective gauge of how tapped out the stock market thinks the average American is:


It is still too premature to be calling for a top in the retail sector - even though the market has been quite unsure of itself in recent months.  The fact that the Retail HOLDRS (RTH) is still above both its 50-day (91.50) and 200-day (90.97) moving averages is an encouraging sign.  A resumption in its uptrend would be confirmed with a close above 95.75 - its recent closing high made on March 1.

Now, let's look at relative strength.  The following is a weekly chart of the Retail HOLDRS vs. the S&P 500:

Relative Strength (Weekly Chart) of the Retail HOLDRS vs. the S&P 500 (May 2001 to Present)

Based on the above relative strength chart, it is also too premature to call a top in the retail sector.  Again, please keep in mind that since consumer spending makes up two-thirds of the GDP, there will most probably be no broad market rally unless the retail sector participates as well.  An encouraging sign of a sustainable market uptrend will be for relative strength to break out above its March 22nd high.

Finally, in terms of sentiment, I believe the following is a very powerful chart - a chart that spells a thousand words and which I believe probably overrides the two charts that I mentioned earlier.  I got the idea of creating the following chart after attending a talk by Mr. Richard McCabe, Chief Market Strategist at Merrill Lynch earlier this year.

Monthly Chart of the Consumer Confidence vs. DJIA (January 1981 to May 2004)

The above is a monthly chart of U.S. Consumer Confidence vs. the level of the Dow Jones Industrials from January 1981 to May 2004.  Please note that I (like Mr. McCabe) am using the level of Consumer Confidence as a contrarian indicator - which historically has been a very reliable thing to do.  The argument goes something like this: If consumer confidence is high, then the outlook of retail investors on the U.S. economy is also high - resulting in more purchases of stocks by retail investors.  A consumer confidence level that is overextended should also translate into an overextended condition in the stock market - thus resulting in a top.  While a high level of consumer confidence does not necessarily mean a top in the stock market, please note that every stock market top in the last 20 years has been accompanied by a high reading in the level of consumer confidence.  It is also interesting to note that even at the top of the bear market rally during March to May of 2002, the level of consumer confidence was over 110 - far higher than today's reading of 93.2 (and January's 97.7). 

The author's opinion: Despite high debt levels, the average American is most probably not tapped out yet.  Also, despite a huge run-up in stock prices in 2003 and high valuations, a top in the stock market will probably not materialize until the level of consumer confidence is over 110.  Since the author believes that we are in a very strong cyclical bull market (within a secular bear market), the author will not start thinking about a potential top (and not do any shorting -- except for hedging purposes) until consumer confidence has hit a higher level - probably at 115 or so (where it was in October 1987 and very close to the June 2001 level).

Henry K. To, CFA

Article Tools

Subscribe to this FREE commentary

Discuss this page

E-mail this page to your friends

Printer-friendly version of this page

  Copyright © 2010 MarketThoughts LLC. | Privacy Policy | Terms & Conditions