Consumer Sentiment: Leading Indicator or Reflection of Today’s News?

Friday, July 30, 2010

Consumer sentiment and confidence surveys make the headlines and influence the stock market (for the day, at least). The thought is that people’s feelings influence their spending. And with consumer spending making up a large part of the economy…

The question is are those feelings prescient and stable – a leading indicator that can be counted on – or are they knee-jerk and volatile – a reflection of the latest news story? We can examine past data to get the answer.

I will be focusing on the Reuters/University of Michigan Consumer Survey. There are two surveys we will be examining: Consumer Sentiment (containing all survey data) and Consumer Expectations (containing just the outlook data – 1-year personal, 1-year US and 5-year US).

Monthly noise reduces value

The survey results can produce quite different results month-by-month. A good example is the last two months. (June was accompanied by news reports of unexpected highs; July by lows.) The graph below shows each monthly result over the past 2-1/2 years compared to the 3-month average.

Consumer Sentiment and Consumer Expectations are similar

Although the Consumer Expectations results are one of the Conference Board’s ten leading indicators, they closely track Consumer Sentiment. This correlation provides an indication that consumers, as might be expected, are forecasting based on today’s situation – not on an analysis of the future.

Comparing Consumer Sentiment to the stock market

The stock market remains the best leading indicator because it responds rapidly to changes in expectations from careful analysis. And money flows provide a confidence weighting for those expectations. However, there are two forces that can hamper the forecasting ability, and, ironically, they are caused by individuals/consumers.

  • First, the consumer surveys, themselves, can affect the market.
  • Second, consumers (AKA individual investors), through buying and selling, can affect the stock market. From that standpoint, there can be a correlation between the survey results and the stock market.

Note that there is a limited relationship between the two. The longer time period (below) illustrates the same.

So… Consumer sentiment/confidence surveys continue to be a popular news item and investor discussion topic, but the value of each monthly reading is questionable given the measures’ volatility and the historically weak relationship with the stock market.

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John Tobey on Seeking Alpha

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July 2010