Last night I made three assertions about the “Consumer Confidence Index.” Here is a brief analysis of each point made; click the charts if you need a larger view:

The “Consumer Confidence Index” is a strong reactionary indicator to things that have already happened, that is, when the “Consumer Confidence Index” is plunging, you can be pretty damn sure that something else has already “plunged.” This chart has the prior S&P 500 returns across the bottom, and relative “Consumer Confidence” running up and down. “Relative” means the current month’s index is divided by the rolling 12-month average of the index, so numbers far below 1.00 mean the index has recently “plunged.” Note the obvious shape of the data, moving up and right, inferring what the statistic shows – generally speaking, “Consumer Confidence” is shaped and molded in large part by what has already happened in the stock market.

The “Consumer Confidence Index” has less value as domestic market predictor, but its value is contrarian, that is, low numbers are bullish for the domestic stock market. You can see a very low R-Squared for this regression, and not much of a slope, but the F-statistic is significant at the 1.3% confidence level. In the history of the “Consumer Confidence Index,” there is only one instance of a subsequent negative 12-month return on the S&P 500, following a sub-70 index reading. Need a statistics refresher? Visit my links page.

The “Consumer Confidence Index” has a lot of value as a contrarian indicator for subsequent GDP growth, that is, low numbers generally mean that “Real GDP” will grow substantially from that point forward. Good R-Squared, good slope, notice that we’ve never failed to get positive 12-month GDP growth following a sub-100 reading at the end of a quarter. Also note that all four instances of superior growth came in the year after very poor readings on the “Consumer Confidence Index.”

These relationships should be no surprise to any non-turnip. The essence of contrarian trading is finding the mass of stupid, dumb money at extremes, and looking for a counter-trade, and this holds true no matter what sentiment indicator is used; ISEE or CBOE equity put/call ratio, Investor’s Intelligence or AAII surveys, or the “Consumer Confidence Index.” I don’t consider these relationships robust enough, nor fast-moving enough, to craft a “trading system” around them (or modify an existing TA-based or fundamental-based system to include them), but I do think that an institutional asset allocator would be well-served to consider fading extremes in “Consumer Confidence.”

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