Trader’s Narrative

The early March preliminary Reuters/Michigan consumer sentiment survey results were bad enough, coming in at 70.5 and they got worse when they were finalized at 69.5 in late March.

“A recession has occurred whenever the Sentiment Index has declined as much as it has fallen during the past year, including the recessions occurring from the mid 1950’s to the early 2000’s,” according to Richard Curtin, the Director of the Reuters/University of Michigan Surveys of Consumers

The full press release is available on the Reuters/Michigan website and also in my box of free trading goodies (in the Articles & Reports folder, named “Michigan Consumer Survey March 2008″).

A recession you say? Well, I’ll be!

There are several measures that Reuters/Michigan tracks. One of them is the “expectations index” which looks ahead to quantify how consumers see their future. In March 2008, this index hit (47.9) the lowest it has been since the 1973 recession (45.2).

Yes, you read that right. Today… US consumers feel almost as hopeless about the future, as they did in the days of the oil shock, a brutal bear market, the rationing of gas (depending on your plate number), etc. Unbelievable!

Here’s a historical chart of the Reuters/Michigan survey going back to early 1970’s:

As you’ve probably surmised by now, each time that consumer sentiment has scraped the bottom of the graph, the stock market and the economy have stopped their decline.

Starting with 1975, this was the end of the brutal bear market. Although equities didn’t bounce back, they stopped declining and entered a period of consolidation.

The early 1980’s saw the break out from this consolidation and the launch of the great secular bull market.

In 1990, the consumer sentiment spiked lower and the stock market followed with another significant long term bottom. Subsequent shocks in 1992 and 1993 don’t show a concomitant reaction from the market.

The next time consumer confidence approached such levels was in early 2003, which was the bottom of the bear market that followed the bursting of the tech bubble.

And now we are once again approaching these same levels. Which makes me wonder why consumers don’t have a long term memory? Collectively we seem to react with the IQ and recall ability of a one cell amoeba.

Here are some more historical charts of consumer sentiment as measured by the Michigan University survey.

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.