Consumer confidence is often mistaken as a leading indicator. My experience over many years is that the measure is used at times to rationalize irrational bullishness – when the brain says sell and take some profits, but the urge to splurge is the more compelling. If consumer confidence is robust, then everything must be fine and the future bright for the economy and markets – so go for it. A great excuse (cognitive dissonance) to stay in the market or top up despite one’s better judgement.
On the flip side, when the markets are behaving badly, and emotionally the investor wants to run for the trenches, a drop in consumer sentiment is interpreted as foretelling there’s more misery to come – down markets and a deteriorating economy.
from an update by Jennifer Lee, Senior Economist at BMO Capital Markets, Economic Research:
“U.S. consumer confidence tanked in August. The Conference Board’s latest survey showed that American confidence levels sank 14.7 pts to 44.5 in August, the lowest level since April 2009 and the largest monthly plunge since October 2008. Although the view of the ‘present situation’ slipped 2.4 pts to a 7-month low of 33.3, the perception of what lies ahead darkened. The ‘expectations’ component took a 23.0 pt dive (again, the largest since the Great Recession’s heyday) to 51.9, which does not bode well for the economy.”
Sounds awful, but in reality markets are usually bottoming out at the same time consumer sentiment hits lows. The actual level of the index is pretty meaningless, but the direction and amplitude of the change is significant. For instance I’ve found that even small corrections in stock markets can coincide with large drops in consumer sentiment. The following picture is my attempt to illustrate the point.
Longer term graphs tend to make historic crashes look tiny, but rest assured the damage (like 1987) was serious enough. What’s important, is that optimism concerning stock markets is far more warranted when consumer confidence is low because expectations (and valuations) are low – and when at its lowest levels the only sensible prediction is that things might get better. The stock market is a leading indicator and will turn upward before there’s any economic (or sentiment) data evident.