In 2011, the S&P 500 fell in five consecutive months from May to September before rebounding sharply (up more than 10%) in October. Consumer confidence followed suit, with Gallup’s Economic Confidence index collapsing from -22 to -56 from May to September before rising along with the stock market in October and the following months. On the other hand, in 2013 the stock market was very strong overall (up more than 30% for the year), but consumer confidence plummeted during the year as the pending government shutdown weighed on consumer sentiment.
It is impossible to know how much the stock markets control consumer confidence and spending behavior. Confounding this difficulty is the likely effect of strong long-term market returns overriding short-term volatility in the stock market or even sharp declines. However, if it is true that the behavior of media, politicians, investors, the Federal Reserve and consumers is increasingly influenced by the stock market, then we might see that consumer confidence tends to follow the stock market in both the short and long-term.
In the chart below I graphed the 2015 monthly performance of the S&P 500, a proxy for the U.S. stock market, along with Gallup’s U.S. Economic Confidence Index. Gallup provides this survey periodically, usually three or four times a month, and I’ve used an average of the data provided for each month. In addition, I added a line showing the average monthly return for the S&P 500 during the years 2012-2014. The average return for those three years was about 20% per year, or about 1.7% per month.
My intention with the graph is to see how strong a correlation there might be between the market’s return and consumer economic confidence. By comparing the stock market’s monthly return to its average monthly return during the prior three years we can determine whether the market was “strong” (above average) or “weak” (below average). We see that generally the Gallup economic confidence measure has fallen through 2015, reaching a low in late August and recovering somewhat since then.
This economic confidence index hit a yearly low of -21 when individuals were surveyed by Gallup in the period of August 24-26. On August 25, the stock market hit its low point for the year, on the path to its worst month of the year, down about 6%. Thus consumer confidence and the stock market both hit their respective lows of the year on essentially the same day. It is also interesting to note that this economic confidence index fell 5 points from just a week earlier, a substantial decline. During the same week leading to the yearly low for the confidence index, the stock market declined by 10% amid high volatility.
It seems nearly impossible that the stock market’s volatility did not have a significant impact on this decline in consumer confidence. In general, it appears that the decline in consumer confidence this year mirrors, at least in part, the generally weak stock market. In only three months of the year – February, July and October (though October is not over yet) – did the stock market do better than its average over the last three years. So generally, at least compared to recent years, stocks have been “weak”. And at least this year, consumer economic confidence has generally been falling.
To be sure, looking back at the last several years, consumer confidence is still rather high, which bodes well for the economy, at least in the short term. The current Gallup economic confidence level of -11 is below the peak of +7 that was reached in January of 2015, but far above the levels below -50 seen in 2009 and 2011. That January peak was the highest level of Gallup economic confidence in the past 8 years. Perhaps not coincidentally though, in January the stock market had reached a record high the previous month, after three strong years for the stock market. With a generally flat stock market this year, consumer confidence has pulled back from those January highs.
When looking beyond the stock market, at economic growth, it’s more difficult to follow how consumer sentiment follows the economy. For example, if we just look at 2015, economic growth in the U.S. was reported to be weak in the first quarter, just 0.6%, but quite strong the second quarter, at 3.9%. Consumer spending was estimated to have grown 1.8% in the first quarter and up 3.6% in the second quarter. Despite the difference in economic growth, and consumer spending, between the first and second quarter, there was a steady fall in consumer confidence. One might think that higher economic growth would result in higher economic confidence but that doesn’t seem to be the case. Similarly, the economy was said to have grown more than 4% in the second and third quarters of 2014 yet economic confidence was not strong, no stronger than the first quarter of 2014, which was said to be negative.
The unemployment rate is currently the lowest it has been in 8 years, but recent economic confidence has been comparable to levels seen in 2012 and 2013, when the unemployment rate was 2% or 3% higher.
Still, the economy has generally been motoring along this year. The unemployment rate (faulty as it may be) has fallen during the year, from 5.7% to 5.1%, and Gallup’s measure of the percentage of individuals working at least 30 hours a week is high, compared to the last 5 years. (Though that percentage is still quite low, as I discussed in an article I posted here in February of this year.) Gallup’s measure of job creation is also at 7-year highs, steadily gaining since 2009.
The question though, is how much the stock market’s past strong gains have led to gains in the economy, and whether further strengthening of the economy, and consumer confidence, will happen without strong stock market gains. Despite the flat stock market for the last 9 months, investors, consumers and businesses are still digesting and profiting from the windfall market gains of 14%, 32% and 16% over the past three years. It seems reasonable that those gains have translated into much of the economic growth, jobs and confidence that have filtered through the economy.
If there is artificial economic levitation occurring from oversized past market gains, we need to be watchful of how a flat stock market may impact economic growth in the future. Or worse, a stock market decline. The Schiller P/E ratio, which averages 10-year corporate earnings and profit margins, is currently at 25, more than 50% higher than its average for the past 100 years. The only times this index has been higher was at the peak of the 1920s stock market bubble, the late 1990s dot.com bubble, and during the mid-2000s real estate and financial bubble. At best, this index suggests we cannot expect future long-term returns of 20% to propel the economy. The last year the U.S. stock market was flat (a 1.9% gain, in 2011) consumer confidence was very weak and economic growth was poor. The years of 2008 and 2009 saw the stock market fall by about 20% over those two years and economic growth for those two years was negative, while economic confidence was extremely low.
The stock market, consumer confidence and the broader economy are now tightly linked. A past Federal Reserve Chairman, Alan Greenspan, often spoke of the “wealth effect”, how gains in the stock market translate into gains in the economy. For a variety of reasons, politicians and Fed officials want strong economic growth in the here and now, regardless of fundamentals, economic cycles and market distortions.
For seven years the Fed has kept interest rates at nearly 0%, because of a lack of confidence that the economy can sustain itself with normal interest rates. This has had the effect of discouraging saving while encouraging stock and bond market speculation and misallocating capital to the wrong areas of the marketplace. P/E ratios have expanded while debt levels have exploded. More than $8 trillion in federal debt has been added since just 2008, while state and local debt has increased by more than 150% since the year 2000 to over $5 trillion. Much of that spending and debt has filtered into the economy and the stock market, artificially boosting both.
My belief is that the economy cannot survive, in its current form, without the stock market to boost it, and governments to overspend enough to prop up the economy. If the market loses one or both of these supports, we will see what kind of economic fundamentals truly exist in the U.S. economy.