Why Plunging Consumer Confidence Is Bullish for Stocks

Includes: DIA, QQQ, SPY
by: Lou Basenese

What do consumer confidence numbers mean to you?

I ask because the Conference Board reported this week that after hitting a three-month high in February, its Consumer Confidence Index dropped by 11.9% in March to 63.4 points.

Since the reading was below expectations, alarm bells immediately sounded. The newswires were overrun with panicked headlines about the disastrous state of consumer confidence.

Whatever you do, don’t buy into the fear-mongering.

Here’s the truth: a drop in consumer confidence, although seemingly foreboding, is actually a bullish indicator.

Why? Consider this…

The Curious Case of Consumer Confidence

Since the current bull market began, we’ve actually experienced four other instances in which consumer confidence fell by more than 10% in a month. And each time, the stock market responded by rallying noticeably higher.

In fact, the average one-month gain for the S&P 500 checked in at about 7%, according to Bespoke Investment Group.

By contrast, when consumer confidence soared by 10% or more in a single month, stocks only averaged a gain of about 1%.

So when consumers are overwhelmingly confident, stocks barely budge. But when consumers are extremely unsure, stocks rally.

I know… it’s totally counterintuitive. But I assure you that this odd relationship between confidence and stock prices is well documented. And it’s hardly isolated to this bull market, either…

Consumers vs. Investors: A Backwards Relationship

Ned Davis Research studied the impact of plunging consumer confidence, dating back to 1979.

It found that 77% of the time, the S&P 500 was actually higher six months and 12 months after a 9.8% drop (or more) in confidence.

And the firm’s research on the relation between consumer confidence and the Dow Jones Industrial Average’s performance is even more telling…

  • When confidence is high (above 113), the Dow trades flat over the next year.
  • When confidence is moderate (between 66 and 113), the Dow averages a 5.9% gain.
  • When confidence is low (below 66), the Dow rallies by an average of 13.1% over the next year.

Ned Davis also proved that this contrarian indicator is accurate at market extremes.

~ High: Take the tech bubble, for example. Consumer confidence hit a 20-year high about two months after the bubble started to deflate in March 2000. If you were tracking this contrarian indicator then, you could have escaped significant losses. Remember, although the dot-com bubble burst in March, the stock market didn’t bottom out until September 2002.

~ Low: By contrast, the lowest confidence reading in 20 years came in February 2009. And we all know what happened in March. Stocks set out on a massive rally, jumping by 50% in about six months.

Fight Your Gut and Bet on This Bull Market

Remember, the latest confidence reading just checked in below 66, so if history is any guide, this bull market could indeed charge higher.

You’ll find very few analysts saying that, though. They’d rather look at the headline number and hit the emergency button.

But what would you rather put your faith in? An analyst’s opinion? Or a contrarian indicator that’s proved deadly accurate for longer than most analysts have been alive?

Bottom line: Stocks might not be a massive buy at current levels. But there’s certainly no reason to scurry for the sidelines just because consumers are suddenly are unsure. They have a terrible track record for predicting stock market performance.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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