Retail sales suggest higher stock prices

Key points:

• The October retail sales data showed healthy results that were also above expectations
• The S&P 1500 retail industry group closed up 1.28% and outperformed the S&P 500
• When retailers outperform on a retail sales report day, this signal has a 100% win rate

Using the message from the market to identify a potential edge

One of my favorite market quotes is from a gentleman by the name of George Chestnutt. It says the following.

"The most reliable forecaster of market action is the action of the market itself." 

Let's conduct a study to assess the outlook for the S&P 1500 retail industry group when the index closes up 1% or more and outperforms the S&P 500 index by 0.50% or more on a retail sales report day. The equal-weighted retail ETF (XRT) was up 1.06% on Tuesday, which means participation was broad-based even though Amazon was down on the day.

Similar signals show gains and consistency

This signal has triggered 30 other times over the past 21 years. After the others, future returns and win rates were above historical averages across almost every time frame. The 2-month window shows 10 consecutive winning trades over the last decade.

Adding seasonality to the signal increased the win rate

With retail seasonality about to turn positive, let's assess the outlook for the retail sales study when the signal triggers in November or December.

This signal has occurred 7 other times over the past 24 years. After the others, future returns and win rates were solid across all time frames except the first week. If we look at returns for all periods less than a year, we see drawdowns were minimal, with a worst-case scenario of -4.0% over the next 2 months. The 1-year results had two unfortunate instances that occurred in and around bear market periods.

What the research tells us...

When retail stocks outperform on a day when retail sales are reported, future returns and consistency are above historical averages. When this happened in November or December, retailers showed a 100% win rate 3 and 6 months later.