Has Consumer Confidence Peaked?

The latest reading of consumer confidence (103 for September) was a bit of head-scratcher. With the market in the midst of a 10% correction, layoffs rising, job, wage growth stalling, and China on the verge of implosion, how could confidence rise? 

While the media, and the Federal Reserve, focus on lifting asset prices to spur consumer confidence, as I discussed previously, such actions have relatively little impact on the vast majority of American's currently. However, there is a very high correlation between actual economic activity and consumer's confidence as shown in the chart below.

This should not be a surprise since consumers drive roughly 70% of economic growth. When the economy slows down enough to curtail consumer actions, confidence will once again drop. 

For investors, however, the question of the relationship between confidence and market behavior is more important. The chart below shows consumer confidence as compared to the S&P 500 index.

Sharp contractions in confidence have historically been coincident with sharp declines in the market and the onset of economic recessions. Currently, the decline in the market has not resulted, yet, in a decline in confidence as only a small portion of the economic makeup has been affected by the drop. Furthermore, the drop in the markets has not been dramatic or sustained long enough to break the “hope” of a continued “bull market.” 

However, if we look at the annual rate of change in the S&P 500 as compared to confidence, a potential warning signal emerges. 

Declines in the rate of change of the financial markets have generally preceded more marked declines in confidence as well as economic activity. Due to the rapid onset of the recession and market decline in 2008, the declines in both measures were more coincident.  

Currently, the annual rate of change in market performance has been declining since the beginning of 2014 when the Federal Reserve began extracting excess liquidity from the financial markets. This suggests that the current levitation of confidence will likely be transient unless market performance begins to reaccelerate.