Consumer Confidence and Equity Returns

Businessweek details:

Confidence among U.S. consumers increased more than forecast in January, reaching its highest level in eight months on signs the labor market is improving.

The Thomson Reuters/University of Michigan preliminary index of consumer sentiment climbed to 74 from 69.9 at the end of December. The median estimate in a Bloomberg News survey called for 71.5. The measure has increased 9.9 points in the last two months, the biggest such gain since April-May 2009.

The Interloper and I have had some discussion regarding consumer confidence and the impact (if any) on forward equity returns. Looking at the data, it became clear that on average consumer confidence is a lagging, rather than leading, indicator for equity returns (great chart here and can be seen in the table below in the average columns).

There does however appear to be pockets of opportunity at extremes.

The table below outlines the average three month forward S&P return against the three-month change in the Michigan Confidence index and the absolute value of the index since 1979. While the data is limited for each "box" (and in some cases, there were no data points), it does show that the S&P 500 has performed very well on a going forward basis when:

• Confidence Levels are low (less than 70) and stabilizing (between -5% and 5%)
• Confidence Levels are high (greater than 85) and slightly falling (-10% to 0%), indicating potential "buying the dips" opportunities

On the other hand, returns were much more volatile at low confidence levels and when confidence fell abruptly.

Note we are currently up 22% in three months to that 74 level, which would indicate stability in equity returns going forward if the table is to be trusted.

Source: Bloomberg