Consumer behaviour in an ideal market without central banks intervening completely drives market trends. Every purchase decision, investment, and the velocity of money flowing through an economy comes through millions of consumers voting every day with their pocketbook.
Following consumer sentiment gives investors a guiding light for market trends. When consumers are spending money, feeling secure about their employment, and saving for the future, the long-term prospects or an economy and stock market are positive. If consumers decide that the employment market risky, and it is time to pull back spending and become cautious, eventually the stock market will begin showing this sentiment in retail sectors.
Outside of government intervention and utility oriented spending, consumers and manufacturing are the entire economy. Services are a by-product of these sectors, not a driver. All of the businesses that fall under retail categories like restaurants, entertainment, clothing, luxury goods, electronics, and even automotive owe their existence to consumer spending primarily. As the consumer goes, so goes the entire retail sector.
While it is possible for the retail segment to improve profit growth while experiencing a declining top line or revenue growth, this is generally not a long-term trend. Revenue and profit margins in a healthy market will trend together. Consumer behaviour alone determines top line growth for the retail sector.
Monitoring the employment picture, savings rates and general consumer activity like credit spending can predict market trends a quarter or two in advance of them showing up on stock markets screens. Central banks monitor consumers actions partially to predict the level of interest rates. Interest rates dramatically swing market indices higher or lower depending on the rate of increase or decrease.
Market liquidity is often driven by what people think and do. When the consumer is retrenching, pulling in the pocketbook, the entire retail sector will suffer relative to the average of the S&P 500. A serious investor is going to monitor consumer behaviour carefully to spot trends that will impact stock market in 3 to 6 months.
Once consumers are cautious over spending money based on confidence in the future economy, the stock market will soon experience a downward trend at least throughout most of the retail sectors.