Consumer sentiment is usually considered an economic leading indicator. When confidence is at rock bottom levels, it’s a sign that the economy and stocks markets are heading lower. This isn’t true. I’ve published for years that consumer confidence is one of the best contrarian indicators. In other words, when consumer confidence hits all time lows, stock markets are about to go up.
On the other hand, when consumer sentiment is at lofty levels, the economy and stock markets are about to plunge. At such times, bond markets are the place to be. It may not provide perfect (i.e. to the day) timing, but its been very reliable for me over many years. The below chart illustrates that subsequent to high readings of consumer confidence, the S&P 500 (bottom half of chart) suffers a significant decline.
The Conference Board’s consumer confidence index rose to 131.6 this month (January) from 126.5 in December. Economists polled by Dow Jones expected consumer confidence to rise to 128. (CNBC PUBLISHED TUE, JAN 28 2020)
Despite the consensus belief that the economy and employment are at historically strong levels, there continue to be layoffs and weakness in many sectors of the global economy.
As I mentioned in an earlier post, we may very well already be in the earliest stages of the next recession. This bodes well for longer bonds as the yield curve continues to invert. At these low interest rates, the duration of bonds is quite sensitive to even small decreases – meaning the prices of the bonds will increase disproportionately (i.e. up and away) to any modest fall in rates.
Despite coronavirus and other early warning signals (inverting yield curve) the University of Chicago Consumer Sentiment Index (see graph below) is at the high water mark again – the highest level in 8 months. Sentiment will only decline after we begin to see signs of trouble in corporate earnings and slowing economic growth (weeks and perhaps months from now, but coming).