The narrative on Wall Street is stocks and investors are approaching extreme bearishness. From a contrarian perspective, when market or investment sentiments turn decisively negative, it signals an impending stock market bottom.
The current wall of worry call does not appear to be as strong as in the past, evidenced by the lack of follow-through to the March oversold rally and weak market breadth readings. Today’s broad market sell-off is again weighing on the mindsets of investors as a critical inflation report, the consumer price index (CPI), will be released before the market opening tomorrow.
So, will stocks retest their March 2022 lows and even break down, or has a bottom already occurred?
Two sentiment surveys to monitor each month are the Conference Board Consumer Confidence and the University of Michigan Consumer Sentiment Indexes. Both surveys attempt to quantify the behavior and mood of American consumers. Since over two-thirds of the American economy (US GDP) is consumer spending, the surveys can offer insights into the degree of optimism or lack of it among American consumers.
Consumers are also investors. Consumer confidence can influence future spending, savings, and investing. Another mid-term election year is around the corner, and the sentiment numbers will again play a pivotal role in deciding the balance of power in the Senate and House.
Consumer Confidence Index (CCI) is a popular survey released by the Conference Board, a not-for-profit research organization for business. The monthly report comes out on the last Tuesday of each month and involves 3,000 households across the US. (1) current business conditions; (2) business conditions over the next six months; (3) current employment conditions; (4) employment conditions in the next six months; and (5) total family income for the next six months.
University of Michigan Consumer Sentiment Index (MCSI) is another popular survey. Like CCI, it surveys around 500 American households each month. The survey compiles information on consumer expectations of the economy in seven areas. (1) current economic index, (2) expected economic index, (3) current personal finances, (4) personal finances expected, (5) buying conditions durables, (6) business conditions 1-year out, (7) and business conditions 5-year out. MSCI is a more detailed survey and is a better proxy to measure spending issues like gasoline and food consumption in an inflationary environment.
The interpretation of the two surveys is similar. The objective is to detect changes in the numbers from the prior month and the directional trend changes in the numbers. If the numbers rise, consumers are optimistic about their future, implying more consumer spending, less saving, and more investments. On the other hand, if the numbers decline, it warns of consumers being less willing to spend, higher savings, and lower investments in the future.
Rising commodity prices such as a jump in gasoline prices or a sharp collapse in the stock market can quickly impact sentiment numbers and future trends. Since the Conference Board CCI surveys larger households, it is dependable in identifying the sentiments shifts associated with the job market and job security.
When President Biden took office on January 20, 2021, the University of Michigan Consumer Sentiment Index (MSCI – 59.40) traded at 77.98. The index would rally to a high of 88.30 by March. However, MCSI has broken below its Covid-19 pandemic low of 71.80 (March 2020). The speed and the magnitude of the decline suggest MSCI will fall to the 2008/2011 lows at 55.30-55.80. Below this 51.70 or the 1980 recession low.
The Conference Board’s Consumer Confidence Index (CCI – 97.07) has fallen precipitously, violating its 2020 pandemic low (98.32). The next crucial support resides near 97.13-97.14, coinciding with the Jan 1982 and Oct 1990 recession lows. Below 97, warns of a deeper downturn, toward 96.24-96.357 (Nov 1974 recession, Apr 1980 recession, Jan 2009 global financial crisis, and the Aug 2011 European Debt crisis/US debt downgrade.
Consumer confidence and consumer sentiment surveys have correlated closely with financial markets and economic conditions. Both of the sentiment indicators are dependable in measuring the confidence levels of Americans and their financial well-being, which tends to influence their spending habits, savings rate, and investment decisions.
Although the sentiment indicators can swing widely, the contrarian indicators have been uncanny in predicting stock market tops and bottoms, often associated with extreme bullish (economic peaks and speculations) and bearish sentiments (recessions and crises).
The final stock market bottom will likely coincide with another extreme bearish sentiment reading of fear and toward a panicky phase. Also, because investors tend to vote with their wallets and pocketbooks, the sharp decline in the sentiment indicators does not bode well for the incumbent party heading into the mid-term elections, suggesting negative sentiments may persist into the second half of the year.