To compute this measure of consumer confidence, more than 50 questions are asked a representative sample of consumers across the U.S. These questions include whether or not the individual feels he or she is in better shape financially compared to one and five years earlier, as well as expectations for one and five years in the future. Similar questions are asked about the current state of and expectations for the economy, the business environment, inflation, unemployment, interest rates and other factors. This survey (which has a more than 50-year track record) is an important one, because it has been found to have a high correlation with future economic activity. That is, the expectations and confidence of consumers is closely related to future economic reality, whether in the areas of auto or home buying, inflation, unemployment and overall economic growth.
Based on these recent surveys there is still general economic confidence held by Americans. This makes sense considering a stock market hovering near record highs, a low unemployment rate and low inflation. However, as mentioned, that confidence is also down significantly from a year ago. This reinforces my opinion, corroborated by other economic data (some of which I’ve commented on in this space), that recent-year U.S. economic growth and activity hit a peak in late 2014 and early 2015. (On a longer scale, I believe that in relation to the population as a whole, U.S. economic activity hit a peak around the year 2000.)
Below I’ve listed this survey’s average levels of Consumer Sentiment for each 5-year period starting with 1980 up until today. (I’ve adjusted the series to reflect an initial value of 100 for January 1978.) The average level of consumer sentiment over the entire period since 1980 was 107.6. So when the consumer sentiment measure was below 107.6, it was below average, when above 107.6 it was above average. By this measure it has generally been a gloomy period since the recession of 2007 arrived. In the last two 5-year periods in fact, consumer sentiment has been below average. Sentiment has only recently reached above-average levels. This index stayed below average for each and every month over more than seven years, from July 2007 to October 2014, by far the longest period of below-average sentiment in this 38-year history.
To measure the U.S. stock market I used monthly initial values of the S&P 500. I also adjusted each month’s close to compensate for the general uptrend in stock prices. Specifically, since over the 38 years the S&P 500 rose an average of 8.7% per year, or about 0.7% per month, compounded monthly. So in order for the stock market to “outperform” (and have a rising blue line), the stock market would need to advance more than 0.7% per month. A falling market, or one rising less than 0.7% monthly, will cause this adjusted measure to fall. That is why the graph shows an underperforming stock market over the past year. The market has actually been flat to rising slightly, but compared to its average gain over the past 38 years it has been underperforming.
Since consumers have been conditioned to expect modestly rising stock prices, it seems reasonable that only unexpectedly large gains in the stock market will have a measurably beneficial effect on consumer confidence or expectations. Falling, flat or even slightly rising stock prices, are likely to have a negative effect on economic confidence.
Looking at the chart we see the obvious general correlation between the two indicators. Specifically, over the last 38 years this measure of consumer confidence and stock market performance was about 69%, a very high correlation. But as I’ve also noted on the graph, that correlation has been increasing over time. The correlation between confidence and the stock market was relatively modest for the first eight years of this period, from 1978 to 1986. There was a correlation of about 50% over the period, indicating only a modestly positive correlation. In fact, it’s easy to see periods within that timespan when the stock market fell, but consumer sentiment rose and vice versa.
Over the following 14 years to the year 2000, the correlation between these two variables would increase further to about 67%, and since 2000, the correlation has increased still further to about 73%. In fact, during the stock market bubble, crash and recovery, from 2000-2003, the correlation between the two variables reached an incredible 90%. (The magnitude of the changes in the stock market was obviously much higher than with consumer sentiment, but the monthly direction of the two variables was nearly identical.)
In the graph we can also see how extremely overvalued the stock market became by the late 1990s. Above the broad trend line from 1978 to the mid-1990s, during which time the market averaged 12% yearly gains, we see how by 1999, the relative outperformance of the stock market soared, by more than 140% over the long-term trend of the entire 38-year period. It’s also worth noting that the subsequent “crash” of the stock market did not even return the stock market to its long-term trend, but only to a more normal, reasonable valuation.
The obvious implication of the high and increased correlation between the two variables on this chart is that the stock market is having a more direct impact on consumer confidence. That’s because despite the myriad list of questions asked in this survey, ranging from interest rates to inflation to employment income, the biggest variable, by far, affecting consumer optimism or pessimism is the stock market. And as I have noted in other posts we now see a very high correlation in spending in certain areas, such as autos, home improvements, and others, and the level of the stock market.
Of course the Federal Reserve knows this. The Fed’s (and that of Central Banks in general, now) overarching goal (misguided though it is) is to promote as much consumer spending as possible via an inflated stock market. This then explains their relentless efforts to boost and support the stock market with low interest rates, negative interest rates, bond-buying schemes, etc . They see other benefits too from stock market headiness, such as boosting tax revenues and supporting pension funds, but pushing consumer spending is a big reason for the Fed’s anti-saving, pro-spending campaign.
The very high correlation between the stock market and consumer sentiment is actually dangerous. It means that the economy has become dependent upon the stock market, instead of a stock market that is dependent upon and reflects the underlying strength or weakness of the economy.
For the government to change the economy in any positive, meaningful, structurally-reforming way, would be very difficult. But what they can do quite easily, courtesy of their 4th branch of the government, the Federal Reserve, is to pump up the stock market. Simple money printing is their response to an economy with any sort of structural weakness, malinvestment, recessionary conditions or stock market weakness. But though consumers may watch the stock market for signs to be confident or not, consumers will need to regain their own footing after the next stock market crash or another five or ten years of lethargic markets and economic growth. For that, they have a good example to model: Japan. More on that next time.