Reality Hits Traders Hard As US Retail Sales Shows Consumers Spending Less Than Expected

Reality hit traders hard on Wednesday following the release of the U.S. Retail Sales Report which showed that consumers are spending less than expected. It’s obvious that high unemployment and concerns over job security are forcing consumers to spend less and save more.

The report also demonstrated how interconnected the markets are as almost every futures sectors reacted in some way to the news that the U.S. economy may recover at a much slower pace than anticipated by speculators.

As I mentioned yesterday, the best sector to focus on is the financials because Treasury yields are the best indicator of economic growth. The recent multi-month break in the June Bonds and June Notes reflected the huge amount of supply that came into the market to finance the growing deficit created to fund the bailout of the economy. Yields slowly rose while the Treasury was issuing massive amounts of debt however the Fed eased the pace of the rise by implementing its government asset buy-back program.

The decline in the Treasuries was also fueled by thoughts of a rapid economic recovery. Investors sold Treasury futures and invested in the equity markets as they became more optimistic that the U.S. would pull out of its economic funk a lot faster than analysts and the Fed were predicting. Speculators went on stock and commodity buying sprees even though many of the economic reports were showing declines in the economy because they were “better than expected.”

All of this thinking came to a crashing halt yesterday as traders began to realize that it is going to take real improvement in the economy to sustain the current gains in both the equity and raw materials markets rather than just bad guesses by analysts.

The rally in the June Treasury Bonds yesterday and overnight is already showing signs that traders believe the economy is still in a weak position. Yesterday the main trend on the daily chart turned up in this market as yields fell. Some of this drop is being caused by the fact that we are in a dull period because the Treasury Department is taking a break from raising cash by issuing debt. Another reason for the decline in yields is the Fed’s active buyback program, but the main reason is investors are realizing that consumers are controlling the economy.

Not only are equity traders realizing the economy is still weak, but many are beginning to discover how overpriced stocks are given the forecast for future earnings. In addition, the sudden increase in the amount of banks seeking capital through secondary offerings is sucking money away from other sectors. This could cause liquidity issues that could trigger a sharp correction in the market.

Rather than speculate too much at this time while the economy goes through the bottoming process, investors may want to shift their focus toward commodity markets that are rallying due to real supply and demand fundamentals. These include soybeans, corn and cotton.

July Soybeans are on the brink of a bonafide bull market because supply is at a five-year low. Low production in South America and high demand from China has created this condition which may only get worse if adverse weather conditions develop.

July Corn is also in a position to rally sharply higher as wet weather in the Midwest has caused delays in planting which could lead to fewer acres being planted. This year’s production may drop further if drought conditions develop later in the growing season.

Finally, farmers shifted acres normally used for cotton to soybeans this spring. Any weather problems including drought or hurricanes later in the growing season could put upside pressure on cotton.

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