the University of Michigan Consumer Confidence Index and Stock Market Returns – Strategy and Backtesting Insights

Consumer confidence Index tries to gauge the temperature of the economy. It swings from pessimism to optimism – just like Mr. Market who is rather manic-depressive. In the US it’s made by the Conference board and it casts doom and gloom on a monthly basis.

The University of Michigan Consumer confidence index measures optimism (or lack of optimism – pessimism) in the overall economy. Our backtests reveal that when the Michigan consumer confidence is bullish the stock market performs much better than when consumer confidence is bearish.

This article explains what consumer confidence is and at the end, we perform two backtests: one backtest showing that stocks perform well when consumer confidence is bullish, and a second test showing that stocks perform poorly when consumer confidence is bearish.

Before we go on to explain what consumer confidence is and how it’s calculated, we go straight to our backtests and look at the relationship between stocks and consumer confidence:

Consumer confidence and stock market returns – backtests

Let’s look at how stocks perform when consumer confidence is high and low to see if we can find any patterns.

In our backtests, we use US consumer confidence data from the database of OECD and not the specific data from the US Conference Board (see more below).

OECD collects consumer confidence data for all major countries that are published at the end of every month. OECD’s data varies slightly from the US version. The data we use in the backtests below are specific consumer confidence for the US economy (and not OECD overall).

In the graph below we show both the performance of S&P 500 (SPY) and OECD’s consumer confidence from 1993:

Consumer confidence and the stock market.

The blue line is consumer confidence (right axis) and the red line is S&P 500 (left axis and logarithmic scale). Clearly, consumer confidence seems to move down before the stock market heads down. Is this visual observation correct? Let’s test and finds out.

How does consumer confidence affect the stock market? – backtest 1

Our first backtest looks at the following:

Trading Rules

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  1. We make a 12-month simple moving average of consumer confidence.
  2. When the last monthly consumer confidence reading is above the 12-month moving average, we are long S&P 500 for the next month.
  3. When the monthly consumer confidence report is lower than the 12-month moving average, we switch to cash for the next month.
  4. Rinse and repeat.

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The equity curve looks like this:

The returns when being invested in stocks only when consumer confidence is above the 12-month moving average. Logarithmic scale.

We invest 10 000 in two hypothetical strategies in 1993: buy and hold (red line) or only being invested in S&P 500 when consumer confidence is above its 12-month moving average. Buy and hold ends up with 159 000 while our strategy has 99 000 USD 28 years later.

The CAGR for buy and hold is 10.4% while our consumer confidence strategy has a CAGR of 8.4%. Considering that the max drawdown is substantially lower for the consumer confidence strategy (23%) than for buying and holding (55%), we would say our strategy looks decent.  Additionally, our strategy is only invested 55% of the time. Thus, you might generate additional returns when the strategy switches to cash.

Consumer confidence and stock market returns – backtest 2

Let’s turn the backtest upside down and test the opposite signal: we are only invested in stocks when consumer confidence is below its 12-month monthly average. The equity curve looks like this:

Stock returns when being invested only when consumer confidence is below its 12-month moving average. Logarithmic scale.

A 10 000 investment in 1993 is only worth 15 000 28 years later – a miserable annual return of 1.58%.

What is consumer confidence?

Consumer confidence, which is measured by the Consumer Confidence Index (CCI), can be defined as the degree of optimism that the consumers pose in the state of the economy through their activities like saving and spending.

The CCI is put out by The Conference Board and serves as a measurement of the pessimistic or optimistic outlooks of the investors or consumers toward the economy with respect to the near future.

The CCI works on a simple concept which is that if consumers are optimistic about the economy, they will end up purchasing more goods and services, which will stimulate the economy consequently. On the o