Thursday, August 1, 2019

High Consumer Confidence Is A Notable Stock Market Warning

Summary:  In July, the Consumer Confidence Index (CCI) jumped to its highest level since last September, right before stocks started a 20% correction. Sometimes a high in the CCI coincides closely with a 5% or greater fall in stocks, but at other times the lag has been many months. In general, however, the risk/reward for investors over the next 6 months has not be favorable.

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In July, the Conference Board's Consumer Confidence Index (CCI) jumped to the highest level since last September. According to the Conference Board: “Consumers are once again optimistic about current and prospective business and labor market conditions. In addition, their expectations regarding their financial outlook also improved."

The CCI was created in 1967, based on a monthly survey of 5,000 households. The report gives details about consumer attitudes (how would you rate the current business and employment situation; do you think your income will be higher or lower in 6 months) and buying intentions.

Increasing confidence is generally good for the economy as it drives consumption, which is 70% of the US economy.

But excessive confidence is not good, especially for the stock market. The timing is far from perfect but risk/reward and forward returns are often poor.

The current CCI is now 136. It has been higher in only 3 other periods: the late 1960s, the late 1990s and last year (the next 4 charts are from Sentimentrader; to become a subscriber and support the Fat Pitch, click here). Enlarge any chart by clicking on it.

The CCI was 135 last September (lower than now) before SPX started a 20% fall that ended on Christmas Eve. There was virtually no lag between the high in CCI and the start of the fall in SPX.

That's not always the case. See the annotations in the chart above. The CCI reached current levels in January 1998 and SPX rose another 20% over the next 6 months before giving all of those gains back. SPX rose another month after a high CCI in May 1999 and another 8 months after a high CCI in November 1999 before the big bear market of 2000-02.

That was also the pattern in 1968-69: SPX rose another 5% a month after the high CCI before the 1969-70 bear market started. On the other hand, two highs in CCI in 1967 and 1968 coincided closely with 5% and 7% falls in SPX, respectively.

In general, risk/reward has been unfavorable over the next 6 months following a high in the CCI. In half of the instances listed below, SPX fell more than 4% during the next month. The median fall in the next 3 months was more than 5%, jumping to 9% in the next 6 months. Only 2 of the 17 instances (12%) avoided any serious trouble (in green). The odds strongly favor trouble.

Mark Hulbert reaches a similar conclusion: SPX tends to underperform following a high CCI (his article is here).

While the outlook for US equities suffers after a high CCI, it's hard to make the case that the economy is necessarily in immediate trouble. It took more than 3 years for the next recession after the CCI hit a similar level in 1997, and recessions have started from lower levels four other times in the past 40 years. There are not enough instances or consistency to draw a firm conclusion (from Doug Short).

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