Much to the surprise of economic spectators, the Consumer Confidence Index clocked in at 108, well above August’s 103.2 reading and the September projections of 104.5. This continues a somewhat baffling trend, with confidence up 9.11% year over year.
When you step back and look at this data in the context of a plunging stock market, significant currency turmoil abroad, considerable geopolitical risks on the horizon, and more, these readings might not make intuitive sense. That disconnect warrants further exploration. Why are consumers so confident in the middle of the storm?
Generally speaking, consumer confidence data is intended to be a snapshot of where people think we are now and where things might be headed. There are multiple indices that attempt to capture confidence readings. The most commonly referenced indices include the Conference Board’s Consumer Confidence Index and the Ipsos-Forbes Advisor Consumer Confidence. Today’s data comes from the Conference Board’s Consumer Confidence Index (CCI), so that’s what we’ll consider here.
As of 2022, this index relies upon a survey of 5000 participants. This number has steadily increased over the years, in part because of a shift to online response collection. Each participant is asked a series of five questions. The Conference Board website describes the index this way:
The Consumer Confidence Survey® reflects prevailing business conditions and likely developments for the months ahead. This monthly report details consumer attitudes, buying intentions, vacation plans, and consumer expectations for inflation, stock prices, and interest rates. Data are available by age, income, 9 regions, and top 8 states.
The granular breakdown of that data in a historical and modern context could fill multiple volumes on your bookshelf. We’ll try to keep it simple. What’s most important is how that data ties into the big picture.
It can be understandably difficult to keep track of the diverse economic reports that pepper our news headlines each week. This is especially true when considering the barrage of consumer readings that get doled out each month. Three data points, in particular, garner a great deal of attention: confidence, sentiment, and spending.
We’ve already discussed what confidence readings are meant to indicate, but you are forgiven if you’re not sure why a sentiment measure would, on face, be any different than a confidence measure. It’s all about feelings, right?
The name might not provide much distinction, but it’s reflected in the questions asked and the intended implications. Generally speaking, confidence measures seek to gauge a consumer’s view of the economy writ large, while sentiment measures how they feel about their own financial well-being. That’s the theory, at least. The most commonly referenced data in this category comes out of the University of Michigan. Their survey asks 50 core questions of 500 respondents by phone about topics like personal finance and business conditions.
Both of these readings (at least in principle) are intended to be leading indicators, meaning they give us an idea of what comes next. In contrast, consumer spending tells us how that confidence and sentiment translated into dollar signs later, making it a lagging indicator. Reported by the Bureau of Economic Analysis (BEA), it tracks how much consumers spent in total on goods and services in a given time period. This is also known as personal consumption expenditures, and can include everything from grocery bills to concert tickets, hospital bills, public transportation, and more.
These pragmatic definitions, however, seem to speak more to intent than they do historical patterns.
Though everyone and their mother is trying to figure out what’s next in the market at any given point in time, current concerns fueled by high inflation, rising interest rates, and shaky markets has turned up the volume on a desire for prognostication. The most common refrain is pointing at specific economic data points and proclaiming that x = y.
If it was that simple, there would be a lot more billionaires walking around. We’re never ones to back down from a good spreadsheet, though, so we took a closer look at the data.
For our exercise, we started with three data sets using available data back to 1978: consumer confidence as measured by the CCI, consumer sentiment as measured by the University of Michigan, and consumer spending (PCE) as measured by the BEA. We considered whether there was a correlation between confidence or sentiment and PCE on a direct, leading, or lagging basis.
Correlation refers to how closely different data sets move in conjunction with one another on a scale of 1 to -1. A positive correlation indicates that the data tends to move in the same direction, while a negative correlation indicates the data moves in opposite directions. When correlation is closer to zero, the data sets move independently of one another. There is a lot of literature discussing what a meaningful level of correlation might be (see here and here and here… as a starting point), but we kept it simple. For the purpose of our discussion today, we’ll default to the standard of levels at or beyond -0.5 and 0.5 as meaningful.
So we crunched the numbers. By numbers, we mean:
When we considered the data using that framework, this is what we found.
That was certainly unexpected. By and large, both sentiment and confidence moved mostly independently of consumer spending, regardless of whether we looked at the indices on a 1:1 basis with spending or as lagging or leading indicators of spending behavior.
We then wondered whether confidence or sentiment might predict or follow the stock market as investors tried to evaluate the data themselves, so we measured the data relative to S&P 500 movements going back to 1985. Even then…
Strike two. Confidence and sentiment did not seem to align, predict, or follow the performance of the stock market in any meaningful fashion. In fairness, other measures — like quarterly earnings for retailers or growth projections — are often turned to by investors to gauge the same things consumer confidence and sentiment should. A solid correlation was never a guarantee.
It was at this point that we came across an excellent article from Commonwealth Financial Network Chief Investment Officer Brad McMillan. As he explained:
The confidence number tends to be more oriented toward the job market from a worker’s perspective, while the Michigan number tends to focus more on things that affect business conditions, especially for the smaller business owner. Taken at face value, that could well explain the disconnect. Confidence for workers remains high as hiring is strong and there are lots of jobs available. On the other side, sentiment for business owners is hurting because they can’t hire people and their costs are going up with inflation. One group still feels pretty good, and the other not so much. That would explain the discrepancy.
It is also consistent with history. When the gap has been large before, with confidence higher than sentiment, it has been when the job market was quite strong, as in the late 1980s, 1990s and mid-2000s, as well as from 2015–2019. The other gap was in the late 1970s when inflation was high.
Given that we were looking for some statistical value to these measures, we followed McMillan’s lead and compared confidence and sentiment to unemployment as reported by the Bureau of Labor Statistics.
Once again, things weren’t adding up. Not all market conditions are the same, though. During periods of distress, data can get a little wanky. Given the ongoing debate about whether we are in or headed towards a recession, we took a look at how at least confidence, sentiment, and spending behaved during periods leading up to NBER-defined recessions and during the recessions themselves. We’d show you the charts, but it’s more of the same: correlation levels between -0.3 and 0.3.
You can compare these metrics to an untold amount of theoretically linked data sets, but the exercise is not necessarily productive. Was the data we looked at confounding and somewhat frustrating? For sure. Was it informative though? Yes… but probably not in the way you might expect.
When it comes to finance, we operate in a world of numbers. We assume that parsing data will reveal patterns and trends. It doesn’t always work out that way, largely because behind the machinations that spit these numbers at us are very human impulses and experiences.
That is what the data tells us. It shows us that numbers tied to confidence, sentiment, spending, stock performance, unemployment, and more do not necessarily yield absolute answers. They are threads in a larger economic tapestry.
We’ve got a choice when confronted by analysis like this. We can throw our hands up and say it doesn’t make sense because the numbers didn’t behave the way we had expected or hoped. We can twist ourselves and the numbers into knots trying to nail down a series of connections and progressions between disparate data sets to land on a conclusion despite the wisdom of Occam’s Razor.
Or we can listen.
That is what the data demands of us. At the end of the day, any economic climate boils down to a story. If we watch what the primary characters are doing, the story reveals itself. Right now, we’ve got characters like confidence, sentiment, spending, the stock market, and unemployment interacting with the bond market, housing, and currencies in a way that shows our protagonist (the U.S. and global economy) might be in for a world of pain.
What you do as an investor or a small business is your own contribution to this story, and what you should do is tied to your goals, available risk capital, and risk tolerance. It is complicated, to say the least. During times like this, the best thing you can do is keep a cool head and consult with a financial advisor before turning the page.
©2022. DailyDACTM, LLC d/b/a/ Financial PoiseTM. This article is subject to the disclaimers found here.
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