Is Consumer Confidence A True Leading Indicator ? - By: Gen Wright

Stock market action on June 30, 2009 was a direct result of economic news which included the Consumer Confidence reading for June, 2009. The release of this data and subsequent selloff in the markets offered a rare opportunity where fundamental and technical analysis intersected to possibly magnify insight into where prices were headed in the near future.

(The link to first chart in author information area below.)

Above is a monthly chart of retail sales (gray bars) and consumer confidence (blue line) from January, 2006 thru June, 2009. The chart gives an excellent visual of just how tough things became for the U.S. economy beginning in the summer of 2007. The green circle highlights the sudden downturn which was reported on the morning of June 30, 2009. This was the first dip since the bear market rally began in early March, 2009. While all of this is very interesting, it's not enough data to be useful as an indicator of future market direction. For that we need a look back over multiple months of consumer confidence data to see if there is indeed correlation. To that end, we have lifted the blue line off the chart above and placed it upon the monthly chart of the S&P 500 Index below.

(The link to second chart in author information area below)

Since the beginning of the bear market that began in the fall of 2007, there have been distinct points when consumer confidence (blue line) provided a "heads up" to forthcoming stock market price action. The first (orange oval) was a warning that began three months prior to the beginning of the market down turn as a divergence between the S&P (still going up) and Consumer Confidence (starting to wane) began. The next (red circles) gave about one month lead time to the second leg of the major decline. And the third (green circle) came approximately one month prior to the market's rally off the March, 2009 lows. This look back does give credence to the performance of consumer confidence as a leading indicator.

One could reason that the shorter lead time of the last two consumer confidence reversal events (red and green circles) may simply be from the fact that traders sat up and took notice after the first leg of the stock market rout that began in the fall of 2007. This prompts further investigation of a correlation between volatility and the length of time it takes for the market to react to a reversal of consumer confidence, but this is a topic for another article though.

The magenta oval highlights the confluence of the consumer confidence decline after a very steep increase over the previous three months and the monthly doji pattern on the chart which is generally accepted as a pattern indicating pause in price action and possible reversal. If the period of history that we have examined here holds true and the Consumer Confidence Index follows through to the downside, the market could very well have a retest of the early March 2009 lows.

ShadowTrader Chief Equity Strategist Peter Reznicek examines the correlation between the Consumer Confidence Index and the S&P 500 Index. The results show that the Consumer Confidence Index provides a comfortable lead time for both traders and investors alike as an indicator of future price direction of stocks. Links to the charts referenced in the article can be found in the author information area of this article.

By: Peter Reznicek
Chief Equity Strategist
ShadowTrader

http://www.ShadowTrader.net

Link to first graph in article: http://assets.shadowtrader.net/charts/090701cc.gif

Link to second graph in article: http://assets.shadowtrader.net/charts/090701spx.gif