EC Understanding The Disconnect Between Consumers And The Stock Market

Understanding the Disconnect Between Consumers and the Stock Market

Consumer sentiment indices are relatively accurate indicators for the outlook of an economy. They rise during periods of growth as consumers become more financially confident, and fall during recessions as consumers cut back on discretionary spending.

Since the direction of the overall economy also affects stock markets, measures of consumer sentiment have historically moved in tandem with major indices like the S&P 500. Since the COVID-19 pandemic began, however, consumers and stock markets have become noticeably disjointed from one another.

To help us understand why this may be the case, this infographic charts the University of Michigan’s Index of Consumer Sentiment against the S&P 500, before diving into potential underlying factors for their divergence.

A Tale of Two Indices

Before we compare these two indices, it’s helpful to first understand how they’re comprised.

The Index of Consumer Sentiment

The University of Michigan’s Index of Consumer Sentiment (ICS) is derived from a monthly survey of consumers that aims to get a snapshot of personal finances, business conditions, and buying conditions in the market.

The survey consists of five questions (paraphrased):

  • Are you better or worse off financially compared to a year ago?
  • Will you be better or worse off financially a year in the future?
  • Will business conditions during the next year be good, bad, or other?
  • Will business conditions over the next five years be good, bad, or other?
  • Is it a good time to make large purchases such as major household appliances?

A score for each of these questions is calculated based on the percent of favorable and unfavorable replies. The scores are then aggregated to arrive at the final index value, relative to 6.8—the 1966 base period value.

The S&P 500

The S&P 500 is a market capitalization-weighted index of the 500 largest publicly traded U.S. companies. A company’s market capitalization is calculated as its current stock price multiplied by its total number of outstanding shares.

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Edward Simon 1 week ago Member's comment

So seems investors should be using the SMCCF as an advisory service. The lists above are amazing, but somehow I feel this is not going to end well. None of the listed funds or bond issues should need to look to the Fed as a buyer.

William K. 1 week ago Member's comment

This is indeed an interesting article and discusses an interesting question. Not totally certain about the conclusion, though. My thinking is that some of the damage to the economy will be repaired within a year, while other areas will take much longer to come back and may never be the same again. If "the fed" is far more tightly regulated and becomes far smarter than it is, and if some of the members are dealt with very harshly for some of their errors. then the rest of us may be more secure financially.

One difference between the stock market and consumers that I did not see brought out is that almost without exception, people buy, hold, and sell stocks for only one purpose, which is to increase their wealth. Consumers, on the other side, buy, hold, and sell things with the primary goal of improving their quality of life. That is a wide range, from satisfying hunger and staying warm to enjoying expensive luxuries of various kinds. None are intended to increase their wealth.

This difference may be a big portion of why the two are so quite disconnected, even though at times they may track each other. Keep in mind that "correlation does not prove causation", an important fact that scientific researchers must remember to avoid embarrasment.