Retail sales hit air pocket

Retail sales literally collapsed from August through December, falling at an annualized 24% rate. A good portion of this was due to falling gasoline prices, but there's no avoiding the fact that we've never seen anything like this in modern times in this country.

If this were to continue we'd be in a depression before too long. But it's important to remember that there is a lot of psychology in these numbers. People cut back on their spending because the financial markets were in free-fall and our leaders were warning that the situation was dire and massive government intervention was necessary to avoid catastrophe. My wife and I cut back on our spending, just to be prudent. Everyone I know has cut back; it's no wonder that the line on this chart has turned down with a vengeance. Our political leaders couldn't have done a better job of eroding confidence.

Like jobs, which are a lagging indicator, I see retail sales as also a lagging indicator. That's why I pay much more attention to what's happening on the margin in real-time markets: e.g., swap spreads, implied volatility, the TED spread, credit spreads, commodity prices, shipping rates, currencies, gold, etc. All of these things have registered significant improvement in recent weeks and months. I continue to think we've seen the worst of the news, and that the economic and financial fundamentals are on the mend. Sooner or later this will bubble up to the level of newspaper headlines, and consumers' fears will be assuaged. Spending has the potential to bounce back almost as fast as it declined.

It's also important to track changes in the likely direction of policy: for example, the risk of higher taxes has fallen significantly in recent months, and it's now increasingly likely that some taxes will be cut. Obama seems to be backing off on his pledge to unilaterally renegotiate NAFTA. He even had dinner last night with George Will and a host of leading conservatives—imagine that!