Trader’s Narrative

The most recent consumer sentiment numbers from Reuters and the University of Michigan show an extreme pessimism. To be exact, in October, the “current conditions index” dropped to 91.0 while the “expected index” fell to 64.7 — the lowest since Hurricane Katrina.

We haven’t seen numbers like these since 2003 when the bear market gave way to the current bull market. Other than 2003, we’d have to go back 15 years to find a similar consumer sentiment reading.

Now that is extreme. And yet, from a contrarian point of view, comforting. That’s because consumer sentiment is a lagging indicator and by the time extreme pessimism has seeped into the masses, a new horizon shortly appears and the darkness is dispelled. Check out these graphs of the Michigan Consumer Sentiment and you’ll see what I mean.

According to a research study by Meir Statman, a finance professor at Santa Clara University and Kenneth Fisher of Fisher Investments:

Low consumer confidence is followed by high stock returns more often than it is followed by low stock returns.

Although it is extremely difficult to go against the crowd, the best time to buy is when there is “blood on the streets”. With consumer confidence this low the retail sales could be a disaster — although you wouldn’t guess that from the crowds on Black Friday.

The technical indicators (new lows relative to new highs) are aligning and now sentiment is falling into place.

I was unavailable yesterday due to travel. Thanks for the kind messages

Yesterday the market tumbled on sustained selling which according to the pundits was due to the release of low consumer confidence numbers by the Conference Board. It was the largest drop and the lowest reading since September 2005 which was right after hurricane Katrina.

While the market’s decline can’t really be traced to the release of this data point, the correlation does cause some to incorrectly conclude causation. But I suspect the market needed to give something back after a breathless sprint upwards last week.

Last year I mentioned the Michigan Consumer Sentiment Survey and how paradoxically, the low readings seemed to coincide with inflection points in the stock market.

After all, significant bottoms are formed when all seems darkest and hope is for the most part, abandoned.

Mark Hulbert mentions the same in relation to the Conference Board sentiment survey:

The historical record shows there to be a slight tendency for the market to move inversely to consumer confidence, with high returns following periods of low confidence and below-average returns following periods of high confidence. In addition, big monthly drops in the index are more often than not followed by market gains than market losses.

By the way, the Michigan survey dropped to 83.3 in August - its lowest reading in a year. So both surveys are showing significant consumer reaction.

Basically, sentiment surveys provide more insight on what has happened and how the consumer is now responding to previous economic situations (the sub-prime mess for one). They do not really provide any insight into the future, except as a contrarian signal.

I don’t see anything catastrophic to cause me to give up on the bullish correction thesis. In fact, this weak consumer confidence reinforces it. Had the consumer been sanguine, that would have given me a new worry.