Confident in Consumer Confidence?

In September 2008, the subprime mortgage crisis reached a crescendo. Several banks asked for government bailouts and loans or filed for bankruptcy. Mortgage guarantors Fannie Mae and Freddie Mac were placed in conservatorship. The Federal Reserve and central banks around the world scrambled to pump liquidity into the credit markets. To top it all off, the world’s stock markets drifted lower as the crisis unfolded.
At the time, it seemed as though the sky was falling. No surprise then that the consumer confidence index (CCI) fell to what was then the lowest point recorded to that point. The October reading was 38.8 points, more than two times lower than it was a year earlier.

You are no doubt familiar with the CCI because the news media faithfully reports it every month. But how useful is this economic indicator to individual investors?

Lag of Confidence
The CCI measures the public’s confidence in the health of the U.S. economy, which can be useful in anticipating future spending patterns. To calculate the CCI, The Conference Board polls 5,000 households who rate current and expected business conditions for their regions. Their answers are used to create a numeric score, which rises when consumers are confident and falls when they are not confident.

One study of the CCI dating back to 1977 found that the index has some correlation to stock market performance, but it’s not what you might expect. In general, large jumps in consumer confidence were followed, on average, by sub-par returns. Conversely, large drops usually preceded above-average returns.2

Another study found that consumer confidence erodes when stock prices decline, but low CCI readings are more likely to be followed by high stock returns than low returns.

The lesson here is that a low CCI is not always bad news, and a high CCI is not always good. The consumer confidence index can be a useful tool, but it should play only a minor role in your overall outlook.

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