The sharp drop in the February Conference Board’s Consumer Confidence numbers surprised many. After climbing for three consecutive months and reaching a 16 month high it dropped 10.5 points (from 56.5 to 46). The “Present Situations Index” fell to 19.4 - the lowest since 1983. The US consumer is hurting real bad. In case the sky high unemployment, food stamp figures and credit contraction statistics didn’t give it away, the consumer confidence numbers reflect a totally despondent consumer.
Naturally, a lot of pessimists are talking about how this is presaging a “double dip” and there is much wailing and gnashing of teeth. I prefer the contrarian approach so I decided to take a look at the actual numbers and see the relationship between consumer confidence and the stock market. My hunch is that if there is a relationship, it is an inverse one.
Since this is a hot topic, Barry quoted Bianco Research’s study of the effects of a drop of 10% or more in Consumer Confidence on the S&P 500 index.
While Bianco’s approach is interesting, I found their data and presentation confusing. For example, I’m not sure what “That Month” and “Next Month” are referring to exactly. As well, I’m assuming that for April 30th 1980 they missed the negative sign in front of the 20.30 drop.
I decided to keep my own study really simple. For each instance of a large monthly drop in Consumer Confidence, (starting from the very next day in the market) I looked at what would happen if you bought the S&P 500 index and held for 1, 3, 6 and 12 months. Here are the results:
On average the S&P 500 performs well for all time frames. The “sweet spot” seems to be between 3-6 months from the drop in sentiment with a return of 5.69-9.08% (+20% annualized). Not surprisingly, the worst instances of 12 month returns occur during the recent bear market. As does the best return when the market bounced back strongly. If we follow the script provided by history, then August 2010 will see the S&P 500 at 1205. If.
For my 3 long term readers, this is old hat. We’ve gone over the contrarian nature of consumer confidence more than a few times already. But it is nice to put some numbers on the board nonetheless.
After a discussion (see below in the comments section) it became clear a consensus was developing on looking at this data from a relative, rather than nominal lense, as Bianco Research had. To be clear, instead of looking at 10 percentage point drops, we should instead look at a percentage drop. So for example while the recent drop from 56.5% to 46% represents a 10.5% point drop, it is an 18.5% decrease.
Being statistically challenged, I turned to Jason Goepfert of SentimenTrader.com and asked for his assistance. Here’s his response:
I show that with any monthly drop larger than 15%, six months later the S&P 500 was positive 14/16 times with an average of +13.3%. The two negative ones were in 1970 and 1973, since then then last 14 signals have been positive. One year, later, it was up 15/16 times with an average of +18.2%.
Barry Ritholtz was curious to know how these returns compared to a random return over the same time period lookup. While Jason didn’t run such a robust study, according to him, looking at the number of times we had a positive return minimizes the chance that it is due to just chance.
The “sweet spot” I found at the half-year point continues with an average return of +13.3% - this is significantly higher than the non-relative study that I did for the same period. So there you have it. A definitive edge from looking at drops in Consumer Confidence, going above and beyond what Bianco Research submitted to their paying clients.
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