Wednesday, December 29, 2010

Consumer Confidence, Consumer Sentiment and S&P 500 Index

Strategist tend to focus attention on consumer related data when attempting to forecast the future direction of the stock market. The consumer receives attention since he/she accounts for two-thirds of the data that goes into the GDP calculation. Because of this focus on the consumer, there are a number of different data points one can follow. On this blog we highlight the AAII sentiment survey data from time to time. Other sites have their own sentiment data. On the SentimenTrader site, they track a smart money/dumb money indicator. Technical Take has another version of sentiment.

Beyond these consumer oriented data points, more publicly reported data is reported by the Conference Board in its Consumer Confidence Index (CCI) and the University of Michigan's Consumer Sentiment Index (MCSI). The two surveys are similar, but have two differences investors should be aware of. The MCSI survey asks one less question about employment. This fact makes the Conference Board survey a better indicator of consumers' expectations about employment. But the MCSI survey's questions focus on consumer expectations one year ahead instead of six months for the CCI. The Michigan survey therefore attempts to predict economic conditions a full year into the future. For a more detailed discussion on these two indicators click here. It should be noted that the CCI is a component of the Composite Index of Leading Indicators. Having highlighted these two indicators, do they predict in any way the future direction of the stock market?

Earlier this week the Conference Board reported that the CCI came in at a lower than expected 52.5 versus expectations of 56.0. As the below chart shows, there does appear to be a positive correlation between the CCI, MCSI and the S&P 500 Index. From the graph perspective, one could argue which is the dependent variable.

From The Blog of HORAN Capital Advisors

As noted in a research paper by Sydney Ludvigson(PDF):
"...the evidence from in-sample regressions suggests that measures of consumer confidence—taken alone—have important predictive power for quarterly consumer expenditure growth...the results indicate that both the Michigan and Conference Board overall indexes have modest incremental forecasting power for total personal consumer expenditure growth."
Given the significance of the consumer as it relates to GDP, tracking these indexes can have important implications for investors. The recent below expected CCI result is worth watching near term. Although the trend is higher since the beginning of 2010, it is beginning to flatten out.

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