Tuesday, March 20, 2012

Consumer Confidence as a Stock Market Indicator

With consumer confidence on the rise, one might wonder what that might mean for the stock market.

Over the last 45 years, the Conference Board’s index of consumer confidence has been quite reliable at providing buy or sell signals for the stock market—though not how you might think.

On the surface, it might seem that high levels of consumer confidence would be good for the stock market.  Consumers are confident when the economy is growing, unemployment is down and incomes are rising, and corporate profits are booming.  But that historically is when stocks should be sold, not bought.  At such times, stocks already have risen sharply and amply reflect the favorable conditions.  Instead, stock market bottoms typically occur when the reverse is true—consumer confidence is low.  At such times, usually the economy is struggling, unemployment is high and incomes are stagnant, and corporate profits are weak.  Stocks then are cheap and already reflect the bad news. 

The key in the stock market is always what will change.   Peak conditions can’t get much better, while poor conditions can—and often do--get much better.

The Conference Board Index of consumer confidence has an excellent long-term record as a contrary indicator for the stock market.  Periods of unusually low levels of consumer confidence have occurred at major troughs in the stock market, while periods of unusually high levels of confidence have occurred at major peaks in the stock market.  The following table contains major market troughs and peaks over the past 43 years:

                                  High Consumer                     Low Consumer
                                      Confidence                           Confidence
                            (stock market peaks)              (stock market troughs)
                                  October, 2007                         October, 2011
                                  January, 2000                          March, 2009                                          
                                  September, 1987                     March, 2003
                                  December, 1972                      January, 1991
                                  October, 1968                          October, 1982
                                                                                     December, 1974
How does this indicator look now?  Though consumer confidence has risen recently, it is still at historically low levels, which bodes well for gains in stock prices.

Despite the historical reliability of this single indicator, it should be just one input to one’s asset allocation decisions.  With major stock indexes in the U.S. up more than 25% since last October and measures of investor sentiment showing high levels of optimism among investors, I would not increase allocations to stocks at current levels.  Instead, I would raise cash and try to tune out the various good news items, such as the new highs set by Apple stock, and patiently wait for better purchase opportunities.

Steve Lehman

S & P 500:  1400

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