Confidence Game

I find that most of the day-to-day market action is simply noise. The moves up and down are for myriad reasons, but hardly what is ascribed to them.

Take for instance the recent bounce on “better than expected” confidence numbers. Markets took off on the number earlier this week, rallying 200 points. Why?

History teaches us that Confidence does not forecast future economic activity; rather, it is closely correlated to recent stock market gains or losses. Markets go up, and people feel better; markets go down and people feel worse.

One of the ironic things about the data is how conclusive it is that sentiment is a contrarian indicator. Mark Hulbert looked at consumer confidence data (via the Conference Board’s index) to its beginning — 1977.  He then looked at how markets did over the ensuing periods. His conclusion?

“The biggest monthly jumps in the consumer confidence index were, on average, followed by sub-par returns. Conversely, big drops in the index were typically followed by above-average returns.

The starkest patterns in the data, however, were between monthly changes in the consumer confidence index and how the stock market had performed in prior months. When the stock market is going up, their confidence rises too — and vice versa. So, given the stock market’s impressive rally over the last couple of months, it was entirely to be expected that consumer confidence would rise smartly.

In other words, focusing on consumer confidence tells us more about how the stock market has performed in recent weeks than it does about the future.”

That makes perfect sense to me.

Howard Simons of Bianco Research pointed out sentiment tracks past — and not future — activity. He notes the absurdity of believing future activity follows sentiment changes:

“For this to be otherwise, we would need to believe consumer sentiment and expectations were truly leading indicators and completely independent variables, with the reductio ad absurdum being the U.S. economy was based in large measure on mood swings.


Consumer Confidence and S&P500


Chart via Bianco Research, May 2006


Even more amusing:  Consider the big Homebuilder’s bounce on Tuesday — they were one of the strongest performers that day. But if you looked at the part of the sentiment survey about houses, it was the most negative aspect of the survey: The outlook for home purchases over the next 6 months fell — not surprising, given the recent activity in the housing market — falling sales and prices.

Since that’s the case, why did the Homebuilders rally?


Sources: Consumer confidence is a contrarian indicator Mark Hulbert MarketWatch, May 27, 2009

Sentiment Is Not An Independent Variable Howard L. Simons Bianco Research, May 27, 2009

Originally published at The Big Picture blog and reproduced here with the author’s permission.

5 Responses to "Confidence Game"

  1. Guest   May 29, 2009 at 5:12 pm

    Americans are addicted to speculative bubbles; the quick buck. The Fed is quite adept at using monetary policy to generate asset bubbles. Currently the Fed is printing money and loaning it to banks at zero. The banks in turn are generating profits (their only source of profits) by trading securities (including bidding up each others’ share prices). The interest rate spreads combined with the recent farcical “stress tests” have generated a rally in stocks. A new bubble is born.

  2. Anonymous   May 30, 2009 at 12:40 am


  3. John Ware   May 30, 2009 at 7:17 pm

    It’s no surprise that the people who have made the most money investing, especially since June 2006 (a good place to peg, as that’s exactly one year prior to Bear Stearns’ two mortgage securitization hedge funds went belly up), are the ones who bet against the noise, against the crowd, and called it right. The Paulsons, the Ackmans, the Chenos’…those are the guys who listened only to themselves (and to the data). It never ceases to amaze me that, since I started trading in equity and index option spreads, I’ve had over 80% of my trades as winners when I bet against the crowd, stopped watching CNBC, and allowed a proper mix of technical and fundamental analysis rule my stances instead of excessively fearful (down markets) or greedy (up markets).

  4. Guest   June 5, 2009 at 11:11 pm

    investors are board and impatient. thats the only reason. some must be making money or they wouldnt be doing it.some companies will actually show earnings this quarter but its not because of consumers. <— prolongs recession.i thought it was just a push out of holding dollars.

  5. Nick Marshall   June 6, 2009 at 6:35 am

    There is nothing absurd about the US economy revolving around mood swings. The whole rationale of Elliott Wave Theory is based upon that. The major stock indexes are a reflection of aggregate mood are generally a good predictor of economic activity in the future. Aggregate mood is not affected by feedback loops i.e. it is endogenous or self generated from within. The idea that when markets go up, people feel better (and vice versa)is a very simplistic interpretation of what happens. If that was true, then rising markets would generate an endless feedback loop of confidence and so driving markets up endlessly. So why do markets reverse? Simple – the aggregate mood changes. It is really like a tide going in and out and, like moon tides, they are not even over each cycle. Some are stronger than others. Elliott Waves reflect this with waves within waves in a general 3 steps forward, two steps backward progression. The chart above shows two significant events. The first is when the S&P crosses through the confidence index which is a diversion signifying a potential top which subsequently happens. the second event is when the confidence index crosses through the S&P despite the higher low on the S&P. These events are what contrarians look for – sentiment is strongest at market tops and weakest at market bottoms.