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September 4, 2018 | Consumer Confidence: Decidedly Lagging Indicator

Mike 'Mish' Shedlock

Mike Shedlock / Mish is a registered investment advisor representative for SitkaPacific Capital Management. Sitka Pacific is an asset management firm whose goal is strong performance and low volatility, regardless of market direction.

 

Consumers have not been this confident since October 2000. Hooray?

The Conference Board Consumer Confidence Index® increased in August, following a modest increase in July. The Index now stands at 133.4 (1985=100), up from 127.9 in July. The Present Situation Index improved from 166.1 to 172.2, while the Expectations Index increased from 102.4 last month to 107.6 this month.

Consumer confidence increased to its highest level since October 2000 (Index, 135.8), following a modest improvement in July,” said Lynn Franco, Director of Economic Indicators at The Conference Board. “Consumers’ assessment of current business and labor market conditions improved further. Expectations, which had declined in June and July, bounced back in August and continue to suggest solid economic growth for the remainder of 2018. Overall, these historically high confidence levels should continue to support healthy consumer spending in the near-term.”

Hooray?

Not so fast.

Before you jump up and down with high-fives about confidence please note that confidence is a lagging indicator.

Eternal Sunshine of the Spotless Mind

John Hussman discusses confidence in his latest post: Eternal Sunshine of the Spotless Mind.

Last week, consumer confidence pressed to a fresh cyclical high. As Tavi Costa at Crescat Capital observed, similar extremes in consumer confidence have regularly preceded substantial market losses.

Consumer confidence provides a striking illustration of how temporary psychological factors interact with the long-term and full-cycle effects of market valuation. Despite my error in believing that historically well-defined limits to speculation would survive the Federal Reserve’s deranged experiment with quantitative easing and zero interest rates, I’ve argued for decades that valuations drive long-term and full-cycle market outcomes, while shorter term psychology controls outcomes over shorter segments of the market cycle.

Over the past 12 years, as stocks have moved to bubble valuations, the S&P 500 has gained about 4.7% annually in excess of what one would have expected it to gain on the basis of 2006 valuations. That outcome has emerged hand-in-hand with the current, temporary exuberance in sentiment. There’s most likely a feedback here – the strong performance of the market may help to boost consumer confidence, and strong consumer confidence may help to support the market. The feedback may be self-reinforcing over short periods, but mean-reversion clearly dominates over the economic cycle, as investors fluctuate between extremes of optimism and extremes of pessimism.

Stocks, bonds, and the option value of cash

One of the questions we often hear is, “If you had to choose stocks or bonds for a T-year investment horizon, and you couldn’t change your position, which would you choose?” Presumably, the requirement that you can’t change your position implicitly says that the question is about expected return, not potential volatility.

Historically speaking, the answer has generally been “stocks,” particularly when T is greater than 3-5 years. But once valuations move into the top 20%, the answer generally favors bonds, especially in periods where market internals have deteriorated. Moreover, if the yield-curve is rather flat (so you don’t earn much extra return for extending your maturity), cash actually becomes the preferred asset. If one allows for the possibility of changing the investment position in response to market fluctuations, cash becomes even more dominant. That’s because when valuations are high and market internals are unfavorable, the ability to respond to steep market declines by shifting from cash to stocks can be enormously useful.

Confidence vs S&P 500

Hussman posted a chart of confidence vs the S&P 500, from Bloomberg. Here’s a more readable chart from Doug Short at Advisor Perspectives.

Confidence is clearly lagging, but how lagging? There were non-recessionary big confidence dips in 1987, 1998, 2011, and 2015.

Confidence, valuations, earnings, and corporate bond junk issuance have all made warning signs. But they have been making warning signs for years now.

When the bell finally rings, almost no one will hear it. To invest in this market, you have to be deaf.

Mike “Mish” Shedlock

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September 4th, 2018

Posted In: Mish Talk

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