Are sentiment metrics important to the markets?

Consumer spending accounts for nearly 70% of the United States’ nominal GDP. As such, consumer sentiment should have some correlation with market performance.

Financial journalists certainly act as if they do. Whenever new confidence or sentiment figures are released – consumers or otherwise -, pundits spring into action, anticipating the data’s effects on markets and the economy in general. But how important are these actions actually to market performance?

To answer this question, we explored the associations between measures of consumer and business confidence and market returns. Specifically, we examined monthly data from the University of Michigan Consumer Confidence Index, the Conference Board’s US Consumer Confidence Index (CCI), and the Business Confidence Index (BCI) and compared their relationship to the performance of nine different MSCI-in-progress stock and bond indices. Back in the 1970s, we focused on US high-yield bonds, US long-term bonds, US short-term bonds, US total fixed income, US equity, US value equities, US small cap, and US equity. Big American Money, International Stocks.

In all, we found no significant or persistent association between market returns and the three sentiment measures over the 50-plus sample period. The highest correlation, between the University of Michigan Consumer Opinion Survey and U.S. small business stocks, peaked at a weak 0.21.

Relationships between changes in indicators of consumer confidence and investment returns, from the 1970s to the 1920s

However, over time, the correlations show some enlightening trends.

The University of Michigan Consumer Confidence Index has diminished correlation with equity returns. In fact, since 2010, it has fallen sharply and is statistically indistinguishable from zero.

University of Michigan Consumer Confidence Index: Historical Market Correlations

However, the CCI has shown the largest positive correlation with equity returns since the 2000s. And since 2020, the average correlation for stocks and bonds is 0.30.

Consumer Confidence Index (CCI): Historical Market Correlations

BCI shows a similar trend. The BCI has the highest positive correlations with measures of stock return, with the upward trend beginning in 2010.

Business Confidence Index (BCI): Historical Market Correlation

That markets correlate more with the CCI and BCI than with the University of Michigan Consumer Confidence Index has many potential implications. The CCI and BCI have probably grown in stature over time relative to the Michigan index and now the market is paying more attention to them. Or perhaps their methodologies better reflect an evolving market and economy.

Of course, whatever the roots of these phenomena, the larger implication is that given the relative weakness of these correlations, financial journalists and commentators may derive more meaning from these metrics than they justify.

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All posts are the opinion of the author. As such, it should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of the CFA Institute or the author’s employer.

Photo credit: © Getty Images / Natee Meepian

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