Wall Street’s celebration of this week’s U.S. consumer confidence reading may be premature. The numbers are not as promising as they appear on the surface, and there are warning signals that shouldn’t be ignored.
Although it may take some effort to uncover these signals, the latest news seems incredibly positive at first glance. Economists surveyed by the Wall Street Journal had initially predicted a Consumer Confidence Index (CCI) of 112.0 for July. However, the index surprised everyone with a significantly stronger reading of 117.0.
It is crucial to note that the CCI alone is a weak indicator of the stock market’s trajectory. To obtain a more reliable measure, we should focus on the gap between the CCI and the University of Michigan’s Consumer Sentiment Index (UMI). A concerning trend emerges when the CCI surpasses the UMI.
Presently, we find ourselves in such a situation. In recent months, the gap between the two indices has widened. Since April, the CCI has climbed by 13.3 points, while the UMI has increased by 9.1 points. Consequently, the difference has grown to 4.2 points, now placing it at the 98th percentile based on data available since 1979, when monthly records for both indices commenced.
The accompanying chart illustrates the monthly readings of the CCI-versus-UMI spread over the past four decades. It also includes the subsequent 12-month returns of the S&P 500 index (SPX) for each month. Although this indicator is not flawless, it becomes apparent that higher spread levels often lead to below-average returns for the S&P 500. The correlation between these two datasets in the chart is statistically significant at the common confidence level of 95% used by statisticians to assess the authenticity of a pattern.
Wall Street-Main Street Disconnect
The current disparity between Wall Street and Main Street can be attributed to the contrasting measurements of consumer sentiment by the Consumer Confidence Index (CCI) and the University of Michigan Index (UMI). According to James Stack of InvesTech Research, who introduced me to this indicator, the CCI primarily reflects consumers’ attitudes towards the overall economy, while the UMI gives greater weight to their immediate personal circumstances.
Despite the constant influx of positive news about the economy, such as decreasing inflation rates and the likelihood of an economic “soft landing,” everyday consumers continue to face financial hardships. It is no surprise, then, that there exists such a significant divide between the two indices. This widening gap exemplifies what I refer to as the “Wall Street-Main Street disconnect”: Wall Street thrives as Anytown, USA struggles. The Nasdaq Composite Index, for instance, has experienced a substantial increase of nearly 40% since its lowest point in October, while the S&P 500 is just shy of reaching an all-time high.
In sharp contrast, median pay has only risen by less than 1%, when adjusted for inflation, over the past nine months.
It is concerning that such a sizeable disconnect exists between Wall Street and Main Street, from various perspectives. Historical precedents indicate that periods of stock market decline often follow disconnects of this magnitude.
(To be continued…)