Consumer Spending As A Market Indicator

Using various individual retail sales figures may be one of the best indicators available for how to predict the coming months of retail economic activity. But where do we start? Let’s take a look.

Before getting into individual metrics, the single commonality that is defined among analysts and investors in the retail space is same store sales. It is simply a measure of the change in sales over a defined period, usually year-over-year for all stores open for more than a year.

As with most stocks, earnings per share and revenue matter, and should be a point of focus, but it is just as vital to watch the important retail metric of same store sales. Retailers that produce strong and steady same store sales are often those that offer the best performance, so the metric is a key one for analyzing retail stocks.

The holiday onslaught is not just confined to the shopping malls of America, but finds itself on Wall Street with the torrid release of same store sales data. It usually starts after the first week of December and continues through to late January, as retailers have differing release dates.

In the 1990s, before online shopping and gift cards, this time frame was late December to mid-January. But online sales growth and the proliferation of Christmas gift cards has since widened out the holiday shopping season, making the opportunity to capitalize on seasonal effects less possible.

Retail chains have also standardized their release of same store sales within a few days of each other for consistency, which typically occurs on the first trading Wednesday evening and Thursday of January. After the release of this holiday sales data, the investment community usually tries to make its assumptions for the next five to nine months. The reason that analysts wait for one month's data to forecast five to nine months in the future, is because the holiday season is the most critical quarter for retailers.

For a forward fiscal year, retail analysts usually make their largest fiscal forecast estimate changes in mid-January to early February of each year, right after most companies report earnings and all of the major holiday misses or surprises are apparent. Generally, they do not make any additional major changes until the summer, when the "back to school" effect can be seen. There are exceptions, such as a firm-specific changes or a major market event, but this pertains to the group as a whole.

Upon the release of fourth quarter earnings reports — which encompasses the holiday season — companies tend to offer their year-ahead guidance. Analysts will also shore up their previous forecasts and will often change their ratings on retailers, especially if large forecast changes need to be made.

This helps to provide additional clarity in the projected strength of a company's sales, looking forward, along with the overall retail climate. If several major retailers start to issue weak guidance, it is usually a sign of large-scale retail weakness and should be a warning sign to retail investors.

There are a wide number of (very) different retailers in the market. To gain an overall understanding of the retail market, along with distinguishing strengths and weaknesses within retail segments, it is wise to group similar retailers. For broader-based retail chains, consistent leaders such as Walmart (WMT), Target (TGT) and Costco Wholesale (COST), might be the key players to consider. Of course, the companies that top this list will vary and the list itself will change over time. While these are just a small segment of the wide retail sector, due to their size, the retail sales data of these companies are some of the most important to watch, to be able to gauge spending health in the economy.

To gain an understanding of whether or not consumers are buying bigger ticket items, check out consumer electronics, mainly brick-and-mortar companies like Best Buy. You can also look to online retailers, such as Amazon.com (AMZN), to gauge the health of consumer internet spending.

To gauge how often people are going out for dinner, which is often a sign of consumer health, look to mega-chain restaurants like Brinker International and Darden Restaurants. However, chains such as McDonald's, Yum! Brands and other fast food or fast casual food chains should not be in the equation, because their products fall more into the range of consumer staples than discretionary goods.

The list can grow longer by the minute if you want to be very specific in your segmentation, but breaking down the retail space into just a few segments can still give you insight into how consumers are spending. The following chart provides an example of how your retail spreadsheet might look:

Not all retailers will shed light on the spending health of consumers, typically these are the companies that sell life staples, which are purchased regardless of the economic conditions. Examples of these companies include basic-level food chains and drugstores.

Also, autos and other transportation-related sectors aren't a good gauge, as U.S. auto manufacturing and sales for decades has been steadily less correlated to overall economic spending. This is partly because of foreign auto sales forging ahead into the U.S., and partly because of recent woes of the Big Three, plus the incentives they use to lure new car buyers. As this has grown to be more and more of a problem each year, it is not likely that any sizable change would be expected there.

Housing product sellers, such as Home Depot and Lowe's also aren't the best indicator of consumer health either, because of the inherent ties to housing and the drastic swings that the housing sector tends to experience.

If the retail consumer's spending is going to slow down for five to nine months, the rest of the economy has to operate on different assumptions. Housing is volatile, autos are volatile and durable goods are volatile; the swings are often temporary, but systematic retail change can be longer-lasting.

A severe positive or negative global shock event can impact discretionary retail spending overnight. A drastic decision out of the Federal Reserve on its monetary policy or a rapid and unexpected interest rate cycle shift, can change this scenario, as well. Critical changes are rare, but when they unexpectedly occur, it changes the game.

Severe commodity or energy price changes can also drastically alter the cost structure of this scenario, although this is often well publicized. A severe bull or bear market must also be taken into consideration.

General consumer discretionary spending, and the related parts of retail, are what define a good or bad economy and catching this trend can be invaluable. Picking a year's high-flier or a severe laggard in each group does not usually help, because of overall index misrepresentation. Therefore, using the traditional, steady choices of stocks in each retail group can provide savvy investors with a wealth of information.