Consumer sentiment: A contrarian indicator?
The University of Michigan Consumer Sentiment Index, which gauges how U.S. households view their financial health and the economy, recently hit a record low in June. It’s no surprise that inflation concerns have dominated recent responses from participants. Even so, it’s surprising to see the index so low – suggesting a degree of consumer pessimism that is worse than it was during the Global Financial Crisis.
But does pessimism about the future mean the worst is yet to come for investment returns? Every cycle is different, but history suggests that the short answer is no; in fact, the opposite has been true over time. Since 1960, the S&P 500 has returned an average of about 30% in the 12 months after a cyclical bottom in Consumer Sentiment. Interestingly, the average return in the year after the index peaks is also positive, albeit much lower, at about 4%.
While peaks and troughs can only be identified with the benefit of hindsight, the recent all-time low in the Consumer Sentiment Index is meaningful. It certainly doesn’t guarantee that the collective mood couldn’t stagnate or even sour further in the coming months. It does illustrate that today’s extreme pessimism is comparable to prior cyclical lows, providing a reason to be more optimistic about future return potential for stocks. It also illustrates that opportunity is borne out of periods of uncertainty. You may recall the adage from Warren Buffet: “Be fearful when others are greedy, and greedy when others are fearful.”
Of course, market volatility may remain elevated as the Federal Reserve attempts to thread the needle on policy tightening as geopolitical risks rise on multiple fronts and recession risks rise. However, with the S&P 500 tipping into bear market territory in mid-June, consumer sentiment reaching an all-time low, and equity valuations improving, history suggests that the outlook for long-term forward-looking returns has also brightened.
Past performance does not guarantee future results. All investments include risk and have the potential for loss as well as gain.
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