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Consumer confidence in the US is at its lowest level in 16 years. Surely, it is a terrible time to buy stocks when consumers are so pessimistic. The media usually believes so and propagates this unhesitatingly Consumer confidence plunged, causing stocks to fall" It sounds logical. Maybe, but it is not true. Markets do rather well when the sentiment is truly downbeat.
The fact is: The lower the consumer confidence level, the greater are the chances of making money. Conversely, the more sanguine the investors are about stocks, the greater is the chance that the market is headed down. Remember the euphoria in January about the great wall of money that was supposed to flow into India, the crazy real estate prices and the confidence of Indian business men in taking on the world. All that was reflected in the high confidence that the lay person and the expert alike expressed about the market.
India does not have consumer confidence surveys; so we have to go by anecdotal evidence. But in the US, such surveys are done by the conference board (A global independent membership organization that creates and delivers knowledge about management and the marketplace) and the University of Michigan.
The conference board surveys 5,000 US households and asks them five questions that cover current business conditions, expected business conditions for the next six months, current employment conditions, employment conditions for the next six months and total family income for the next six months. The respondents are asked to answer each question as positive, negative or neutral. The results of the survey are released in the form of an index on the last Tuesday of each month at 10 AM. The surveys commenced in 1985. The University of Michigan Consumer Sentiment Index was devised by George Katona, University of Michigan, in the late 1940s. This is now a nationally representative survey based on telephonic interviews of households. The Index is normalized to have a value of 100 in December 1964. It assesses consumer sentiment about the business climate, personal finance and spending. Its index of consumers expectations offers pointers to how consumers view prospects for their own financial situation and for the economy over the near term and the long term.
There are now enough data points from both the consumer confidence surveys to correlate the indexes with market movements. The correlation is often inversely proportional. For instance, the first of the two most important points of the US market was in 1990 when pessimism was very high. The stock market started its long upward journey exactly around that time. It was one of the best times ever to buy stocks. The second euphoria about the new economy- was at its peak in 1999. Consumer confidence too was at its peak. We know what happened to the market thereafter. It was the worst time to be left holding stocks, no matter how cash-rich and fast-growing the companies were.
The relationship between consumer confidence and the market is surely not perfect. Many criticize the methodology of these surveys; measuring sentiment is always fraught with peril. But when the indexes are at their extremes, there is a high probability of market turns. This is exactly what happened recently. A 16 year low level of consumer confidence in late February 2008 presaged a rally. The rally came in March 2008. You wish India had these kinds of sentiment surveys, which would signal market turns from extreme levels. In the absence of a popular consensus view, we can go by the commentaries in the media, especially business TV. When concern, despair, pessimism and worry are written large on the faces of TV anchors, you can start getting ready with your cash to invest. This squares well with one of Warren Buffetts aphorisms: Be greedy when others are fearful and be fearful when others are greedy.
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