Saturday, 14 July 2012

US ECONOMY (July 14th 2012): CONSUMER SENTIMENT - How We Use Michigan Data, What Did Yesterday's Number Mean?

US Consumer Confidence was released yesterday, declining from 73.2 to 72, the weakest level since December.

But why is this a useful indicator for the global economy? How can you use it as an investor to pick out LONG TERM market tops/bottoms or MEDIUM TERM trends and cycles? And what does this latest reading imply about the US and Global Economy?

There are two main Consumer Confidence indicators, one by the Conference Board and the other by the University of Michigan. We've been fairly quiet about these indicators in our analysis since we began the site, because both indicators have been issuing mixed signals for months. In this article we'll shine some light onto how we use the UoM indicator in our MEDIUM TERM and LONG TERM categories of analysis, and how we interpret yesterday's headline figure.

Note: If you're new to Big Macro Picture, check out how we look at the markets on different timeframes (LONG, MEDIUM and SHORT) to identify the different trends  that form our Big Macro Picture. Our review of leading economic data tends to help us get a lead on the month-to-month cycles of the market in the MEDIUM TERM category.


As you can see from the chart, Consumer Confidence can be quite volatile and is prone to revisions. When the reading drops dramatically and is far lower than expected (September 2005, July 2011 as two examples), it can reflect economic uncertainty that the market has yet to price in. Conversely, at the bottom of a bearish MEDIUM TERM or LONG TERM cycle, it's not uncommon for the indicator to flatten out and improve. Significant divergence from the market can provide us with useful signals - in May 2009 and November 2011 for instance, UoM Confidence could have been used to confirm that market recoveries were supported by improving economic sentiment.

Consumer Confidence isn't the most accurate leading indicator, and is susceptible to following the market's lead, which is probably to be expected. However, when Confidence peaks and then breaks down, economic weakness may be more serious than the market expects.

Bulls, as you'd expect, will want to see Confidence trending upwards having troughed. Bears meanwhile will want to see this indicator having peaked, and generally declining.



While trends are important in leading indicators, in the LONG TERM, there is also a contrarian factor to consider with Consumer Confidence. Analysts should not be put off making bearish or bullish calls when the absolute level of Consumer Confidence is high - as this will often reflect high or low equity valuations.

We wouldn't hold off being bullish, for instance, if UoM Confidence was in the 50s, so long as other leading indicators were particularly bullish - in fact, low Consumer Confidence along with bullish leading indicators will provide us with a more compelling reason to enter long positions.

Meanwhile UoM readings in the 70s coupled with poor leading indicators, might give us more reasons to enter short positions - confidence has a longer way to fall, meaning equity prices could have more room to decline.


While prone to being revised, yesterday's reading held up far better than last year's July release - which was one of the more compelling arguments to fuel equity market weakness last summer.

While 72 is far from a terrible reading, it is a lower low in the current trend, which appears to have peaked in May for the time being. The Absolute level, at 72, implies that there is certainly enough room for confidence to come down over the summer - readings in the 50s would seem more bearish, but would almost certainly be reflected in oversold market conditions.

On a whole, we believe this indicator is currently a tick in the box of our MEDIUM TERM bearish argument, although far from being too compelling yet. We'll be watching out for any big unexpected slips, or any reversal of the downwards trend from May onwards.

This leaves us with only a handful of MEDIUM TERM indicators giving us hope of favourable economic conditions going into the difficult late-summer period. The Regional Manufacturing Surveys, the PMI data for Europe, China and the United States, the relatively weak Unemployment data (asides from impressive Claims reports in the last two weeks), and now the downward trending Consumer Confidence data all seem to confirm the weaker conditions than earlier this year.

We eagerly await more data to either confirm or dispel these concerns going forward.

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