Stocks initially extended their losses this morning, following another set of disappointing data points from the Institute of Supply Management, this time it was lower than expected growth in the services sector.

Unlike yesterday’s manufacturing data, which fell below 50 indicating a contraction, today’s non-manufacturing index came in at 52, suggesting it’s still expanding. But, the number was below 55 expectations and included some disturbing trends such as new orders dropping six percentage points to 51 — the largest month-to-month decline in over four years.

Once again the most cited concern of those polled were tariffs which now seem to be working their way into consumer goods. And this is even before the tariffs with China are scheduled to ratchet up on Oct 16 and Trump’s surprising decision to slap an additional 7.5 billion of taxes on European goods.

The move is mostly a retaliation for what is cited as illegal government aid to Airbus, the main competitor to Boeing (BA) and will put a 10% tariff on aircraft made by Airbus. But, it will also slap 25% levies on a range of other items including Irish and Scotch whiskeys, wine, olives and cheese, as well as certain pork products, butter and yogurt from various European nations.

This couldn’t come at a worse time as we head into the crucial holiday spending season. For the past few months, it had become clear that it was the consumer, which accounts for some 70% of the U.S. economy, was all that was keeping the U.S. from slipping into a recession.

From a stock market perspective, the retail sector had already been lagging the broader market since the beginning of the year as shown in this comparison of the SPDR Retail ETF (XRT) the broader S&P 500 Index by nearly 20% YTD.

(Source:Freestockchart.com)

But the weakness in the XRT, which includes companies such as Macy’s (M) and Gamestop (GME), speaks more to the struggles of legacy and mall-based operators than the true state of consumer spending which has been marching steadily higher for the past few years and increased to $1.32 trillion in the second quarter of 2019.

(Source:Tradingeconomics.com)

Indeed, if you compare the performance of top retailers in terms of both market share and market capitalization such as Wal-mart (WMT), Costco (COST) Amazon (AMZN) and Home Depot (HD) you can see those stocks have far outpaced the XRT and the S&P 500 Index.

(Source:Stockcharts.com)

This morning’s ISM report, which showed a sharp drop in new orders, indicates businesses are becoming less confident in future demand. If this proves accurate and consumer spending does slow, due to higher prices resulting from tariffs or a weakening job market.

Two key items to keep an eye on are Costco (COST) earnings, which will be reported after the close Thursday and the monthly jobs data due Friday morning.

If these numbers are disappointing it would indicate we are losing the lynchpin of strong consumer spending which could increase the odds of a recession, in turn, leading to a true bear market, not just the modest pullback we’ve seen over the past few days.

BA shares were trading at $370.53 per share on Thursday afternoon, up $3.17 (+0.86%). Year-to-date, BA has gained 16.86%, versus a 17.32% rise in the benchmark S&P 500 index during the same period.

About the Author: Option Sensei

Steve has more than 30 years of investment experience with an expertise in options trading. He’s written for TheStreet.com, Minyanville and currently for Option Sensei. Learn more about Steve’s background, along with links to his most recent articles. More...

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