With all the excitement about the cut in the Fed Funds Rate and the positive response in the stock market one may wonder how the market was valuing the retailer market. After all, if the stock market was up but the retail component is lagging the market clearly does not think the retail sector will do that well in the near term. If the retail sector is a surrogate for consumer spending, maybe the market is not really that confident about the strong economic growth in the near term. Just maybe all recent increases in stock prices are caused by the euphoria of a rate cut and have nothing to do underlying fundamental strength of the economy.
To test this idea I created a simple index, using June 1, 2007 as a base, so the S&P 500 index could be compared to the S&P Retail Index.
The first graph below clearly shows that although the S&P 500 has had its ups and downs since May, the index is only slightly off the highs sustained through May, June and July. The S&P Retail Index is, however, a different story. The Retail Index also had its ups and downs in May, June, and most of July, but beginning in late July the index began to decline from the base period. More importantly, although the index has recovered from its lows in mid-August it has not recovered as much as the S&P 500 index over the same period. As a matter of fact if the difference between the two indices is calculated it clearly indicates that the S&P 500 is recovering much more quickly than the Retail Index (graph two).
What does all this mean? As stated above if the larger market is up but the retail component is lagging the market clearly does not think the retail sector will do that well in the near term. With consumer spending accounting for 70% of real GDP it appears that the market ultimately is saying that economic growth will be weak in the near term. Does this mean we will have a recession within the next 6 to 9 months. It is difficult to say, but clearly things are lining up that way.