The Sentiment Indicator Signaling a Stock Market Slowdown

Each month, the University of Michigan publishes their popular consumer sentiment index, which gauges the confidence of the average U.S. consumer. Additionally, and with less fanfare, the Michigan survey also publishes data on whether consumers think the stock market will increase over the next year. With the stock market at all-time highs, it's not surprising these polls are showing elevated levels of optimism. This week, I'll analyze whether these polls mean anything for the S&P 500 Index (SPX).

Consumer Sentiment Index

We have monthly data from the University of Michigan's consumer sentiment index going back to 1978. Since then, I looked at the 12-month returns going forward depending on the results of the survey. I broke down the returns into four brackets, each with about 115 returns. The table below shows what I found.

The most recent reading was 95.1, and early reports are indicating the October reading topping out over 100. That puts them in the bracket at the bottom of the table, where consumers are most confident. The average S&P 500 return is highest when the readings fall in this bracket. However, it's also close to the average 12-month return when the sentiment reading is the lowest. Looking at the data across the four brackets then, this sentiment survey does not seem to mean much for the stock market.

Probability of a Stock Market Rise

It seems the University of Michigan consumer sentiment index tells us little about the direction of the stock market. That's not a huge surprise, since the stock market is not always directly tied to how consumers feel. What about expectations for stock increases?

The survey also asks consumers to state the chance of stocks going higher over the next year. The last reading showed an average of 65%, which was the highest reading ever -- with data going back to 2002.

The table below shows how the S&P 500 has done based on consumer's expectations of stock increases, and the question posed above seems to be relevant for the market going forward. Unfortunately, with the most recent reading showing record optimism, it appears to be a contrarian indicator.

When the reading has been at least 57%, the S&P 500 shows an average one-year return of just over 2%, with 67% of the returns positive. Both of these numbers are easily the lowest of the four brackets. When the probability is low, such as 53% or lower, the index gains double digits, on average, with 84% to 93% of the returns positive. With stocks hitting all-time highs, optimistic expectations aren't a surprise. However, the lofty expectations aren't conducive to big future gains. Hopefully, the consumers get it right this time.