Low Consumer Confidence Is Bullish For Equities

Includes: DIA, IWM, QQQ, SPY
by: Daily Trading

The latest reading of the Conference Board Consumer Confidence Index was released Monday and it came in at the second worst reading since the inception of the index in 1967 (well at least since Bloomberg began keeping records). The low level of consumer confidence was given as one of the reasons as to why the S&P 500 fell some 2%. Yes it does seem that the sky is falling.

Conference Board Consumer Confidence Index

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Either which way we look at it - consumer confidence/sentiment remains in a toxic state. Take a look at the Bloomberg Consumer Comfort Index below. This index is based on Americans' ratings of the national economy, the buying climate and their personal finances, reported in a four week rolling average of 1,000 random-sample telephone interviews of about 250 consumers a week aged 18 or over, and is based on a four-week moving average of 1,000 responses. The percentage of households with negative views on the economy, personal finances and buying climate is subtracted from the share with positive outlooks and the difference is divided by 3. The results can range from 100, indicating every participant in the survey had a positive response to all three components, to minus 100, signaling all views were negative. It is interesting that this index is at the same level as it was during the height of the GFC.

The Bloomberg Consumer Comfort Index

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Everyone has this preconceived idea that low consumer confidence is very bearish for the long term prospects of stock prices. However, on the contrary, extreme low levels of consumer confidence is a very bullish sign for equities in the long term at least.

I have been over John B. Templeton's famous quote many times before: "Bull markets are born in pessimism, grow in skepticism, mature in optimism and die in euphoria." Extreme lows in consumer confidence tend to coincide with long term bottoms in equity markets. It also coincides with moms and pops sunning the equity market and crowding into the perceived safety of "safe haven" assets like treasuries. And when this happens stocks end up being held by a relative few (call them strong hands or smart money or what you will).

Below is the Conference Board Consumer Confidence Index going back to 1967 and the 18 month rate of change of the S&P 500 Index. I was trying to illustrate the point that over the long term when the CB Consumer Confidence Index goes above 110 bear markets develop soon thereafter. When the index falls below 60 then substantial upside in equities results over the following months (call it a bull market or whatever takes your fancy). Granted it is not perfect but if it was perfect then it would soon stop being perfect.

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The point of this discussion is that consumer confidence is at such low levels that "the end of the world as we know it" seems to have already been priced into "risky" assets like equities. You can talk about the euro debt "crisis" and the U.S. going into a recession until the cows come home but you are missing the point - tell me something that isn't already priced into the market.

Contrary to popular belief I think the ultimate safe haven is the equity market (namely the Dow). Why? Because stocks are being held by strong hands (moms and pops have sold en masse), valuations are at very reasonable levels, and your next best investment alternative, treasuries, are extremely expensive (the earnings yield differential between equities and treasuries is close to 40 year highs). So I see substantial upside in large cap equities over the coming months purely for the reason that, given the extreme levels of sentiment, it won't take much for positive surprises to occur.

Remember, when everyone thinks alike the opposite is most likely to happen. If you are bearish on equities now then you should feel very safe because you are in fine company. Think about it.

Disclosure: I am long DIA.