Feb 17, 2008

Consumer Confidence & Stock Market returns - Part 1

Consumer spending accounts for more than two-third of US Gross Domestic Product (GDP). This would make you wonder about the kind of relationship that Consumer confidence index has on the stock market. Does Consumer Confidence Index has any predicting ability of the stock market returns? Can consumerconfidence serve as tactical asset allocation tool? Consumer Confidence predicts economic activity,but can it predict stock market returns?

The Consumer Confidence Index is measured by two main surveys, one from University of Michigan and the other one from Conference Board. Both the surveys measure public confidence in the current state of economy and in its future. These surveys ask questions about two main items:

  1. Current Business, economic and job conditions around respondent's area.
  2. Expected changes in the business conditions and in the respondent's financial situation.

Both surveys are conducted during the entire month, and hence this can represent, on average, the consumer confidence at the middle of the month.

Here are few of the findings from Kenneth Fisher & others, in a paper on Consumer Confidence and stock returns.

  1. Consumer Confidence increases with S&P 500 Index Returns. The correlation coefficient between monthly change in overall consumer confidence (University of Michigan survey) and monthly S&P 500 returns is 0.35. Similar coefficient for Conference Board Consumer confidence is 0.38.
  2. Consumer Confidence predicts some stock market returns.
  • 2a. Consumer Confidence is not a reliable predictor of S&P 500 stock returns.
  • 2b. Consumer Confidence can predict Nasdaq and Small cap stock returns. There is a negative and significant relationship between the level of expectations component of Conference board consumer confidence in one month and NASDAQ & Small cap stock returns in the following month.
Let us explore what data says about the correlation between these consumer confidence Indexes and stock market returns in the next post.

See the part 2 of Consumer Confidence and Stock Markets

-Nidhi