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.
i agree with you , some times to go against crowd is also beneficial.
Makes perfect sense to me. Every time consumer confidence is low the government has put a stimulus to stimulate consumer demand that brings the markets back. Unfortunately it is not so clear right now whether governments are in shape enough to continue doing this. They seem to be running out of options. They have already brought interest rates to almost nothing, making consumer borrowing more available, and they already borrowed and spent more money to stimulate the economy then they could afford. The next step they need to do is wealth redistribution, which would take away some income from the wealthy in higher taxes and redistribute it to the poor to increase consumer demand, but this particuar step is not so great for stock markets in the short run, because the wealthy would end up with less money to buy stocks, which is good because they seem to be overvalued in the medium-run.
That’s why the contrary trader is the most challenging yet most gaining stocks trader. As you said, for contrary trader, consumer lower trader is a good news since offer the good opportunity.