It’s very difficult to maintain conviction in the stock market as an investment vehicle when the economy is so rotten. (Frankly, it’s never very easy!) The market was rattled a little bit this week when it was reported that one of the consumer confidence indexes was down again. The bears aggressively took to the airwaves, discussing how the economy could not recover unless and until consumers felt better about things.
This made me curious. What actually happens to the stock market when consumer sentiment is poor? J.P. dug up all of the data from the University of Michigan’s Consumer Sentiment Index, which runs back to 1978. He broke all of the monthly observations into deciles and examined stock market returns over the subsequent five years.
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Interesting, isn’t it? When consumer sentiment was low-in the bottom three deciles-subsequent five-year returns in the S&P 500 were over 12% per year, significantly higher than the 9.3% average over the entire sample period. When consumers felt absolutely fantastic about things and sentiment was in the top decile, subsequent five-year returns were actually negative! Confident consumers engage in reckless behaviors that sow the seeds for the next downturn. Fearful consumers engage in behaviors that build the foundation for the next upturn.
Right now, consumer sentiment resides in the second decile. Based on historical precedent, subsequent five-year returns are likely to be above average from here.
It is well-known that advisory sentiment indexes can be interpreted in a contrary fashion, and it seems that consumer sentiment may fall into the same category, at least over the longer term. This is one of the many reasons investing is difficult-it is an uphill climb against human nature to be bullish when conditions are poor. To buy when the outlook is dim takes a real leap of faith-and a steadfast optimism that things will improve over time. When things seem like they can’t get any worse, it just might be because they really can’t get any worse-and are about to get better.
[...] human nature to be bullish when conditions are poor,” the Dorsey Wright Money Management blog says. “To buy when the outlook is dim takes a real leap of faith — and a steadfast optimism [...]
Five years is too long term for me. How would the numbers look if future six month performance was used?
I’m not sure. We didn’t look at a 6-month period. Most indicators have more accurate results over longer time periods, probably because investing itself is a longer term endeavor. There is always a lot of randomness in the short term.
Obvious. Consumer sentiment ebbs & flows with stock prices w/ a slight lag. If stocks are down, sentiment is down; but also when stocks are down, subsequent returns good.
[...] Bad consumer sentiment? Good returns - Systematic Relative Strength [...]
[...] Ned Davis Research on Consumer Confidence John Dorfman’s article on Bloomberg discusses research done by Ned Davis on the Conference Board’s Consumer Confidence Index. The results are in line with what we found when looking at the University of Michigan survey data. [...]
Perhaps a good strategy is to go with this contrarian indicator. But hedge it by A) Buying solid dividend paying companies well off their highs, and B) selling at-the-money calls against them.
[...] didn’t stop there. Last time this was a big issue, J.P. got going on a research project. And guess what we found? What actually happens to the stock market when consumer sentiment is [...]
build your self confidence…
[...]Consumer Confidence « Systematic Relative Strength[...]…