Will holiday sales come up short? Not according to the stock market

When it comes to the holiday selling season and stock market performance, there's a case to be made that retail sales forecasts are putting the shopping cart before the equity horse.

That's the conclusion from Jeffrey Kleintop, chief market strategist at LPL Financial, the Boston-based financial services firm. According to his research, the market's a remarkably good predictor of holiday sales -- and what Mr. Market is saying is that the holiday shopping season will turn out much better than feared.
The National Retail Federation, for example, predicts a 1% decline in holiday sales versus last year. Market researcher Retail Forward, for its part, believes sales will be flat. But if you go by recent market performance, holiday sales should actually post a very salutary mid-single-digit percent gain over 2008, according to Kleintop, who wasn't immediately available to talk.

True, a good Black Friday for retailers doesn't necessarily mean a green holiday season for investors, the strategist wrote in his weekly market commentary. After all, there have been years where positive fourth-quarter retail sales didn't help the stock market at all.

Using the Dow as a Compass

But then that's looking at the connection the wrong way, Kleintop argues. "[This] question has the relationship backwards; it is instead the gain in the stock market that bodes well for retail sales this holiday season," he says.

Consumer spending, of course, accounts for the great majority of economic activity, hence the breathless attention given to Black Friday, the annual kickoff to the holiday shopping season. And make no mistake, it's called Black Friday for a very good reason. No, it's not because it's a dark and terrifying experience fighting the throngs at Wal-Mart (WMT). Rather, the moniker stems from the fact that holiday business allows so many retailers to report an annual profit -- marked in black on an income statement -- rather than a bright red loss.

That's why we're deluged with so many noisy reports about the early shopping returns and what they bode for share prices. Too bad these annual predictions are usually totally wrong. Like exit polls on election day, the basis for making these forecasts just isn't all that rigorous, writes Barry Ritholtz, CEO and director of equity research at FusionIQ, as well as author of The Big Picture blog.

"We ask shoppers what they spent last year, and what they plan on spending this year," Ritholtz says. "From that 'data,' we then draw a big conclusion as to what sales will be this year. The issue with this methodology is we humans are 1) bad at recalling what we spent last year and b) worse at forecasting what we are likely to spend this year."

Stock Performance Linked to Consumer Confidence

As they say in data analysis: garbage in; garbage out. That's what makes Kleintop's conclusions so interesting. Stocks, of course, are supposed to be forward looking. Sure, they get the future wrong -- in the short term, anyway -- depressingly often. (Two bubbles in less than a decade, anyone?) But Kleintop has found that there is a very consistent relationship between stock market performance in the months of October and November leading into the holiday season and the gain in retail sales in the fourth quarter.

"This makes sense since the stock market is one of the best barometers of consumer confidence and, if it is rising, it stands to reason that consumers are feeling a bit more confident and willing to spend," he says. In fact, measured statistically, the performance of the S&P 500 ($INX) in the months going into the holiday season and holiday spending (excluding food and autos) have a correlation of 0.75. That's high.

Kleintop's bottom line? If you're going to try to forecast holiday spending, it's easy to make the case that there is only one thing you need to watch -- the stock market.
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