A Quick Reminder: Feelings Don’t Foretell

The University of Michigan’s widely watched consumer sentiment index fell to 50.2 this month—the index’s record low, if the final reading confirms the preliminary estimate on June 24. This confidence measure matches other recent dour polls: See Bank of America’s June fund manager survey (73% of respondents anticipate a weaker economy over the next 12 months) or a Financial Times/University of Chicago Booth School of Business poll (nearly 70% of economists expect a US recession next year).^[i] In our view, the U-Michigan index’s record figure is an opportunity to revisit an important lesson. Sentiment gauges are, at best, coincident—moods don’t foretell economic activity, and it is often wiser to view them as a sign of what markets pre-priced already than what is to come.

All components of the U-Michigan index fell in June, from the outlook on business conditions over the next year (-24% m/m) to consumers’ assessment of their personal financial situations (-20% m/m). Among consumers, 46% attributed their negative views to inflation—the second-highest share since 1981. Half of respondents “spontaneously” mentioned rising gas prices in survey interviews, up from 30% in May and just 13% in June 2021, with consumers projecting gas prices to rise by a median of 25 cents over the next 12 months. From a historical perspective, the U-Michigan’s sentiment measure undercut its prior record low of 51.7 in May 1980, amid that year’s recession.

Exhibit 1: Feelings at a New Low?

Source: FactSet, as of 6/13/2022. University of Michigan Consumer Sentiment Index, monthly, January 1978 – June 2022 (preliminary). Recession shading based NBER’s monthly business cycle dating.

But past steep drops in consumer confidence said little about what stocks and consumer spending did afterwards. Consider: From April – June, the U-Michigan consumer sentiment index fell -23.0%. Using -20% as a threshold, we found six similar sharp index declines over short timeframes since 1978, depicted in Exhibit 2.^[ii] Some stretches came amid broader bear markets (2008); others didn’t (2005 and 2011). Yet nearly all of them show prior market and economic conditions—or fears of them (e.g., Hurricane Katrina’s landfall in 2005)—afflicted confidence. Yet that didn’t foretell poor market returns in the next 12 months, and only one (2008) coincided with falling consumption.

Exhibit 2: Plunging Sentiment Didn’t Hurt Consumer Spending or Stocks

Source: FactSet and Global Financial Data, Inc., as of 6/14/2022.  University of Michigan Consumer Sentiment Index, monthly, January 1978 – June 2022 (preliminary), S&P 500 Total Return Index, monthly, January 1978 – April 2021, and real personal consumption expenditures, in billions of chained 2009 dollars, January 1978 – April 2022.

On the flipside, soaring confidence hasn’t meant automatic rising market returns, either. The U-Michigan survey’s all-time high was January 2000—just a few months before the dot-com bubble popped and bear market began. In our view, broad-based euphoria had taken hold at that time, blinding investors from deteriorating fundamentals. How people feel today just doesn’t tell you where markets and the economy will head tomorrow.

In our view, gauges like U-Michigan’s show you mostly what folks were experiencing, fearing and therefore pricing into stocks already. We understand times today are difficult for many households and businesses, and the latest sentiment surveys provide a snapshot of real hardships. Those challenges may persist for a while, which is frustrating. But sentiment measures can provide a sense of where expectations are relative to reality. Today, surveys of consumers and experts alike paint a similar picture: Few expect much in terms of growth, with forecasts of economic troubles or recession increasingly common.

We don’t dismiss the myriad fears taking turns at weighing on stocks today, but given how widespread the dour discussion is, efficient markets have likely pre-priced those issues already, sapping surprise power. Low expectations set the stage for upside surprise, as even weak-but-positive numbers could provide relief—especially with so many expecting the worst. Finding disconnects between expectations and reality could indicate where markets—which often do what the crowd doesn’t expect—are headed next.