What is record low consumer confidence telling investors?

The relationship between consumers’ attitudes (particularly their confidence or otherwise about their current economic circumstances and prospects) and stocks’ returns is complex, intermittent and indirect. It’s indirect in the sense that these attitudes can influence major macroeconomic indicators such as GDP growth, consumer price inflation and unemployment; these indicators, in turn, can affect re-turns. The relationship is complex in two senses: firstly, its nature and strength vary over time; secondly, confidence can reflect as well as affect major macroeconomic indicators.

Consequently, the impact of consumer confidence upon stocks is usually indeterminate or minor. Occasionally, however, its influence can clearly be significant – and these circumstances may exist today.

It’s not merely a huge puzzle to academics; it’s potentially a major warning signal to investors. This year in the U.S., confidence hasn’t merely plumbed historic depths: it’s reached new all-time lows. Yet GDP continues to grow (indeed, Federal Reserve Chairman Kevin Warsh opened a press conference on 28 October by stating that it’s expanding “at a strong pace”) and unemployment is relatively low.

Donald Trump goes much further. He’s repeatedly described the U.S. economy in glowing terms, calling it “the greatest economy we've ever had by far.” At the recent mid-term elections, most Americans disagreed.

In this article, I analyse America’s – indeed, the world’s – oldest and closely-watched measures of consumer confidence: the Michigan Consumer Sentiment Index (MCSI) and associated data. Several of my conclusions are hardly contentious:

1. Americans aren’t just miserable regarding their present circumstances: pessimism about their short- and medium-term prospects has also reached all-time lows.
2. This deep gloom isn’t an artifact of the country’s partisan divide: non-partisans (“Independents”) are almost as morose as the general population.
3. Why have Americans become so despondent? One set of reasons is well-known: for the past several years a large minority has been facing a severe (probably the worst since the 1970s) cost-of-living crisis.

I also emphasise two sets of points which most people are either ignoring or denying.

Firstly, the U.S. Government is broke. Politicians have legislated promises which it can’t honour – and has begun to disavow. Secondly, the market value of American households’ most valuable financial asset, the family home, is decelerating sharply (according to objective data) and falling (according to subjective assessments).

The implications of extremely low consumer sentiment aren’t clear-cut. On its own, it certainly doesn’t cause recession; nor does it guarantee that a bear market – never mind a crash – is nigh. Indeed, more than once it’s been a contrarian indicator: today’s extremely low confidence could thus portend higher returns from stocks.

Hence today’s gigantic conundrum: does plummeting sentiment portend a recession in the economy (which would almost certainly impact equities adversely) or a boom on the stock market?

Developments currently unfolding in residential real estate markets may resolve this puzzle: when households’ general pessimism coincides with souring assessments of their homes’ values, as is occurring now, the implications are almost always negative. Specifically, under these conditions consumers usually retrench their spending – and, albeit indirectly, adversely impact business activity and eventually stocks’ returns.

I therefore conclude that today’s extremely low levels of confidence in the U.S. – and, not incidentally, Australia – are less likely to rebound anytime soon, and more likely to signal a recession which clobbers many stocks.

If you want to read the full version of this article (27pp), which describes the data I analyse, presents the results of my analysis and outlines its implications, download the pdf file at the bottom of this wire.

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