American consumers don’t feel great, despite stocks near record highs and a job market that’s powered the U.S. economy past recession calls. However, according to Ned Davis Research, the market is starting to get used to economic data beating dour predictions in the last few months.
VettaFi contributor Dan Mika spoke with Ed Clissold, chief U.S. strategist at the firm, about what a stock market that’s less reactive to economic data beats means for investors.
This interview has been edited for clarity and brevity.
Dan Mika, VettaFi: Tell me a little bit about why you think the persistent pessimism we’ve seen over the past few months is a contrarian driver of the bull market.
Ed Clissold, Ned Davis Research: We look at lots of things when we’re talking about how to invest. But in the long run, it really is the fundamentals. How strong is earnings growth? How is the economy doing? Those things really matter more.
But there’s another element: How do people feel? And then, when the data comes out — be it an earnings report or economic release — how does that perform relative to expectations? That sentiment driver, as we like to call it at Ned Davis Research, can be extra fuel for the market.
On the other side, if everybody’s already bullish and good data that comes out, who’s left to buy? That’s why we like to use sentiment as a tool in the toolbox for seeing how much more of a rally is available, or if a decline is almost over, or if we are in a mode where the current trend can keep going.
Mika: What’s interesting with this research is we’re seeing less economic surprises to the upside. What do you think has changed over the past few years regardinghow economic surprise indicators are a way to measure sentiment? The pandemic made it much harder to accurately measure sentiment and economic activity. In just at the first half of this year, AI drove the S&P 500 to new heights. We’re at the tail end of a pandemic and still dealing with those effects. And we’re at the beginning of what the market seems to think is a really transformative technology. How does that change the base case of how we should think about what an economic surprise is?
Clissold: Take it a little bit deeper into how a lot of economists come up with their projections for data. What we’re talking about is the Citigroup U.S. Economic Surprise Index. They take a lot of economic data that comes out every week, look at consensus estimates, and ask if this data is better or worse than consensus. They really look back over the past few months, on average. We think above zero (on the Citigroup U.S. Economic Surprise Index) means, on average, the data is better than expected. We thinkbelow zero, on average, worse than expected.
The point about the pandemic is very important. The economy itself gone through all sorts of disruptions, with the obvious shutdown, reopening, international travel not being an option so we travel domestically. Then international travel opens. I think what we’re still dealing with is the increase in spending on goods. We’re trying to transition back to the balance in 2019 between service spending versus goods spending, and that gets at why some economists have been so negative.
From 2022 until very recently, the consensus was that the economy was going to go into recession.
The Fed was hiking rates, and that usually causes a recession. Then some of the data that typically tells you’re going into recession was giving you these really big signals. There’s something called leading economic indicators. Those are sets of data that are supposed to lead the economy. Most of them are manufacturing-based, even though the U.S. economy is not very manufacturing-based.
So, consumers are spending, but manufacturing is much more cyclical. When you go into a recession, manufacturing goes out first and pulls the rest of the economy down. That’s why I mention the rotation from spending on goods to try and get back to services (spending). U.S. manufacturing had to rebalance for that, and a lot of this manufacturing data wasn’t looking great.
But there’s more to [the leading recession indicators]than that –i t just tells you sentiment.
When they put their forecast together, that bias was in there. In reality, we had things like savings from the pandemic. We had a massive fiscal stimulus because the cost-of-living adjustment from Social Security really drove the consumer to continue to spend. The economy kept beating those expectations. It took a while for most economists to come around to the idea that maybe we’re not going into recession. So that’s why the data for so long kept beating these expectations.
Mika: You make this distinction in your research that the indicators for stock market pessimism have gone down. But most consumers are more concerned about inflation. How much do you think pessimism over inflation affects pessimism about where the stock market is going, and vice versa?
Clissold: When we were doing our research, we looked at three different groups. The University of Michigan does a consumer survey, and the Conference Board does another survey. They ask consumers how they feel about the economy: How do you feel right now, and how do you feel going forward in the next six months, next year, or something like that.
The inflation component is a big part of why those surveys have shown a little bit more pessimism than you would expect given the strength of the actual economic data. What we’ve seen consistently is people saying, “Right now I’m OK, but I’m really worried about the future.” And economists may say, “Well, the inflation rate, versus a year ago, is only 3%.” But versus what it was four years ago, this is like 20%, 25% more. It feels worse, and that’s how most people interact with the economy, versus economists looking at statistics. That’s part of it, and that does relate to the stock market.
Like any other sentiment indicator, when consumer sentiment is very low, that tends to be good for stocks. If people are negative on the economy, then why would they buy a lot of stocks?
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