BUNK 22
BE CONFIDENT ON CONSUMER CONFIDENCE
Each month, we get a flurry of headlines on consumer confidence. It’s up—yay! Things will be good ahead! It’s down—oh no! Look out below! The media reports it as if it means something special. It doesn’t. That’s not to say it isn’t nice when people feel better. But—a repeated theme in this book—feelings are not your friends in investing.
Heck, consumer confidence is so popularly followed, it’s even part of the closely watched Leading Economic Index (LEI). And though a bit wonky, LEI does a pretty good (though not infallible) job of predicting where the economy is going. But confidence is just one of 10 components in that index. (Folks also like to think LEI is predictive of stock returns, but one of the components is the S&P 500. So those who believe LEI is predictive of future stock returns must believe in part that rising stocks are predictive of future rising stocks. But if that were the case, bull markets would never end. Bear markets neither. Can’t be true!)

Confidence Is Coincident

A buddy and I co-authored a scholarly research paper in 2003 on consumer confidence—“Consumer Confidence and Stock Returns”—published in the Fall 2003 Journal of Portfolio Management. If you like geek-speak, you can find the paper online. I’ll summarize: Consumer confidence indexes are coincident to the stock market at best—and slightly lagging at worst. And you know from Bunk 21 that coincident indicators are worse than useless—people think they are predictive when they’re not.
There are two major consumer confidence surveys done by the Conference Board and the University of Michigan, though perhaps the Conference Board’s survey is more widely followed these days (and that might change down the road). But they overwhelmingly move together (they’re basically surveying the same population), with the occasional wiggle. Both aim to capture consumers’ feelings about the economy now and as expected over the next 6 to 12 months—that’s the confidence part. There’s also the American Association of Individual Investors (AAII) sentiment survey. Now, you know stocks typically lead the economy—up and down. So an investor sentiment survey should—if it’s any good—lead consumer confidence. But it doesn’t. All three move closely together!
But what do they say about stocks? Figure 22.1 shows S&P 500 total returns and the Conference Board Consumer Confidence Index. They basically move together—coincident. Also note, confidence peaks and troughs are relative. (Like the VIX in Bunk 21! Useless.) You know if there’s a peak or a trough only in retrospect. And what’s high at one point in time may not be so high at another.
Figure 22.1 Consumer Confidence and Stock Returns—Confidence Isn’t Predictive
Source: Thomson Reuters, Conference Board Consumer Confidence Index, S&P 500 total return (monthly) from 12/31/1999 to 12/31/2009.
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The Conference Board itself says the index level is less important than percent moves.
What we wrote about in that 2003 paper was when stocks go up, people feel better and more confident about the future. Surveys pick that up. And when stocks fall, people feel grumpier and less confident. A confidence index is reflective of what just happened—not what will happen. It’s coincident. In fact, it’s even lagging, since the data is released at the end of the following month. And it’s an average of how people felt over the month—so it’s basically reflective of average feelings in the middle of the previous month. Wonky! So, stocks go higher in May. In late June, you find out people were generally more confident on May 15. Why is that useful? You tell me what the stock market did in a month, and I’ll tell you with pretty high precision where the confidence indexes are headed and by about how much. But not the reverse.
You cannot tell what stocks will do based on confidence. You can only tell, somewhat, how people felt recently. Stocks impact that on the one hand and confidence indexes reflect that on the other hand.

Not Contrarian Either. Just Useless.

Now, some folks like to get cute and say consumer confidence is a contra-indicator—that very high confidence means stocks have risen too much and must fall and low confidence means stocks are too low and must rise. And, like any coincident indicator, that can happen. But, again, like the VIX, extreme peaks are evident only after the fact, making it useless in forecasting. But if that approach worked for the index, it would also work for the stock market—and you know that isn’t so. You know that if the market rose for one, three, five, seven, or any given number of months, it tells you nothing about the next however many months.
For example, Figure 22.1 shows confidence hit a low in March 2003 about when the global markets did—and 12 months later stocks boomed 35.1 percent.1 Being a confidence contrarian worked then—if you had somehow used a magical crystal ball to know that was a confidence trough. In July 2007, there was another near-term confidence peak and 12 months later stocks were down -11.1 percent.2 And the absolute lowest point in recent history for consumer confidence was February 2009. Markets bottomed in early March and started their historically massive surge. Twelve months after the February confidence extreme low, US stocks were up 53.6 percent.3 All perfectly matched-up coincident points you couldn’t possibly know about until after they’d passed. Useless!
Then what about that 2003-2007 bull? Though trending generally higher, confidence was mostly choppy and sideways. You basically wanted to be invested that entire time (never forget—stocks can rise and keep rising for a long time, longer than most think), and if you were trying to time confidence peaks and troughs, you weren’t getting much help. Sure, there was a relative low in October 2005—then stocks rose 16.3 percent over the next 12 months. 4 But a true contrarian indicator (if one exists—I’ve never seen a reliably good one that is actually useful) shouldn’t go sideways during a bull market.
Fact is, confidence surveys aim to predict economic direction over the next 6 to 12 months. But what they do is a great job of telling you how people are feeling right now (with a bit of a time lag), which is almost precisely captured by what stocks just did. The only thing you can be confident about is confidence surveys are useless in forecasting the future for stocks.
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