Consumer confidence is at its highest level in 14 years, so it’s time to lighten up on stocks and build up cash. You read that right: The stock market tends to perform worse when consumer confidence is high.
That is the conclusion I reached upon analyzing the S&P 500’s
correlation to the University of Michigan consumer sentiment index — which last Friday reached its highest level since 2004. (See chart, below.)
Specifically, I compared each month’s index reading with how the stock market performed over the subsequent month-, quarter-, year-, and two-year period. I also measured how the S&P 500 reacts to big jumps or declines in the index. I then did the same for the Conference Board’s consumer confidence index.
Consumers are most confident at market tops
I found that consumer confidence is a meaningful contrarian indicator in the stock market. Like other sentiment indicators, consumer confidence tends to rise and fall along with the stock market itself. Accordingly, consumers are most confident at market tops, just as they are most pessimistic at market bottoms.
My findings are in line with those reached by a study conducted almost two decades ago by Meir Statman, a finance professor at Santa Clara University, and Kenneth Fisher of Fisher Investments. They found that there is a statistically significant correlation between, on the one hand, measures of investor sentiment like that compiled by the American Association of Individual Investors, and consumer confidence indicators such as the ones maintained by the University of Michigan and the Conference Board.
So it shouldn’t be a surprise that consumer confidence measures behave in the same contrarian fashion as investment sentiment indicators.
Notably, the increase in the latest University of Michigan consumer sentiment index came after the stock market’s correction in late January and early February. It’s relatively rare for consumer confidence/sentiment to rise when the stock market is falling, and suggests that many investors are stubbornly clinging to their bullishness no matter how scary the market’s volatility. That’s a bad sign from a contrarian point of view.
The bottom line: Be careful not to interpret the latest consumer sentiment levels as being bullish for the stock market. Far from being a reason for the bulls to celebrate, the latest consumer sentiment readings suggest that we could be close to a top.