Consumer Confidence At 6-Year High: Where's The Stock Market Heading?

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 |  Includes: DIA, QQQ, SPY
by: BB Research

Summary

The consumer confidence index hit a six-year high in June.

Amid this optimism, the Fed is on pace to end the QE program later this year.

Stocks may correct finally, despite real GDP touching 3% annual growth in 2015.

The U.S. consumer confidence index has hit a six-year high this month, according to The Conference Board, a private research group. The index is currently standing at 85.2 (1985=100), up from 82.2 in May. This is the highest level since January 2008, said Lynn Franco, director of Economic Indicators at The Conference Board. She added further:

June's increase was driven primarily by improving current conditions, particularly consumers' assessment of business conditions. Expectations regarding the short-term outlook for the economy and jobs were moderately more favorable, while income expectations were a bit mixed. Still, the momentum going forward remains quite positive.

Other Confidence Measures

The Bloomberg consumer comfort index stood at 37.1 in the period ended June 22, unchanged after three weeks of gains, and the Thomson Reuters/University of Michigan index of consumer sentiment unexpectedly decreased to a three-month low (see below).

Click to enlarge

While the mixed confidence measures may appear confusing, the indexes in general have remained at elevated levels post recession. Between 2008 and 2014, the Thomson Reuters/University of Michigan index has recorded a high of 85.10 and a low of 55.30, and currently the index is hovering around 80, much higher than before.

Implications for the Economy and Stocks

Conditions in the job market primarily drive the sentiment of consumers, and when the sentiment is bullish, it's certainly a bullish indicator for the economy in general. There is a statistical relationship between the unemployment rate of a country and its growth rate. Okun's Law investigates the relationship. Since the size of the labor force generally increases with time, to keep the unemployment rate at the natural level, a country's real GDP should grow at its full potential, the law says. Natural unemployment is the lowest level of unemployment an economy can sustain. In order to squeeze the unemployment rate further (or to boost employment, in other words), the government should let the economy grow above its full potential.

However, the big question is how it's possible for real GDP to grow above its actual potential? Well, it's certainly possible if you're ready to accept a higher level of inflation and we strongly believe that the Fed has done exactly this by embracing money printing, or quantitative easing (QE) to be more precise.

Although consumer sentiment has been hovering around an elevated level since the beginning of the year (see the chart above), inflation has just started to rear its ugly head. We believe that the trend will continue for some more time and stocks in general will continue to scale higher. Since the stock market is forward looking, asset price inflation always precedes product price inflation.

The Conference Board has forecast the U.S. economy will record an annual real GDP of 3% in 2015, which is certainly a strong possibility given that money printing will continue in the next few months, albeit at a slower rate. The Fed has trimmed its bond-buying program by $10 billion for the fifth straight meeting to $35 billion. However, what's really interesting is that the Fed is on pace to end the program late this year, which could act as a negative catalyst for the stock market in the short-term. The S&P 500 (NYSEARCA:SPY) could see a sharp correction, although temporary, and a rally will resume again.

Conclusion

Although the Fed will be moving away from QE, ECB chief Mario Draghi hinted that he will embrace unorthodox approaches for staving off deflation in the eurozone, which essentially implies that QE will continue.

Business relationship disclosure: The article has been written by a BB Research macro analyst. BB Research is not receiving compensation for it (other than from Seeking Alpha). BB Research has no business relationship with any company whose stock is mentioned in this article.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.