Collapse of Confidence

Many investors and market pundits describe themselves as contrarians. They argue the way to investment success is to zig when others zag. Warren Buffet encapsulates the idea well with his famous quote, “Be fearful when others are greedy and greedy when others are fearful.”

It sounds simple, but how do you know when others are greedy, or fearful? Sometimes, it might be obvious. During the early 2000s, tech bubble, greed in tech-related IPOs might have been easy to spot. We would argue that the picture today is a lot more nuanced and a lot less clear. In this article, we will summarize the data and provide an update on what we are terming 2022’s collapse of confidence.

The Data

Economists and consulting companies have a rich history of conducting and publishing surveys. In our assessment of sentiment and confidence, we rely on three categories of surveys: investor, consumer, and business surveys. Each category has its own implications for markets and the economy as shown in the corresponding table.

First, let’s distinguish between investor sentiment readings and confidence readings. Investor sentiment captures respondents’ outlook for the market. Specifically, the AAII Bearish Sentiment Index asks investors to predict whether the stock market will be higher (indicating bullish sentiment) or lower (indicating bearish sentiment) six months into the future. The survey is done on a weekly basis and dates back to 1987.

In the first half of 2022, the survey returned three of the most bearish readings on record indicating investors’ expectations for stocks to fall further in the second half of the year. We will see how the rest of the year shapes up, but historically, extreme levels of bullish or bearish sentiment have actually been a pretty good contra-indication of what’s to come.

Similar levels of bearishness arose in October of 1990 in the wake of the oil price shock following Iraq’s invasion of Kuwait and in March of 2009 following the financial crisis. Just when it seemed like things could only get worse, the tide turned. Stocks returned 33% in the 12 months following October 1990 and finished 2009 66% higher.

Consumer Confidence

Confidence readings are intended to capture respondents’ attitudes about the path of economic conditions as opposed to necessarily the path of the market. We do acknowledge the relationship between the economy and financial markets, but think the distinction here is important.

The University of Michigan Consumer Sentiment Index, which dates back to 1978, declined to a record low in June. Based on this measure, consumers feel less confident today than they did at any point in the last 44 years, including at the onset of the pandemic and in the throes of the financial crisis. Another metric, the Conference Board Consumer Confidence Index, shows a precipitous decline over the last year, but to levels that align more closely with historical averages.

Rampant inflation has been a headline issue and a significant overhang for confidence levels. Arguably, most U.S. consumers have very little historical reference or experience with the inflation levels we face today. Living through the highest inflation in over 40 years is both uncomfortable and unfamiliar. Tacking large price increases onto big ticket items has changed consumers’ perceptions and attitudes, and potentially their intentions with regard to large purchases.

We can see this pessimistic shift reflected in surveys designed to evaluate automobile and homebuyer optimism. Fannie Mae’s survey only dates back to 2010 but suggests consumers feel substantially worse about the prospect of buying a home today than at any point in the last twelve years. In fact, only 17% of respondents believe it is a good time to buy a home right now. Respondents are so sour on the housing market that both the percentage of people who think it is a good time to buy as well as the percentage of people who think it is a good time to sell have fallen this year. The Conference Board Auto Confidence Index has also declined sharply over the last year.

Business/CEO Confidence

Corporate executives and business owners have to consider future economic and business conditions when determining how to run operations and allocate capital. Changing attitudes among consumers, and business owners’ own feelings as consumers likely influence their forward views on the economy. Relative to last summer, when readings were fairly strong, surveys of business owners and corporate executives have weakened significantly. Optimism among small business owners, as measured by the National Federation of Independent Business (NFIB), is now lower than it was at the onset of the pandemic. Think about that. Business owners are more concerned today than they were when the global economy came to a screeching halt in the face of the most significant public health crisis in 100 years!

 Summary

This year has marked a collapse of confidence and time will tell if it is justified. Do valid concerns about deteriorating economic conditions accurately manifest in our feelings ahead of time? Or… could our feelings (however misguided) influence behavior to create a self-fulfilling prophecy? While either could be the case and there’s no shortage of risks to consider, we would argue that, for now, the economic landscape is stronger than survey respondents would have you believe. Keep in mind that the unemployment rate just hit 3.5% in the US, matching its lowest level since we’ve had sentiment data to analyze.

We have to wonder:

• Is this really one of the three worst environments for US equities in the last 35 years? If you believe investor sentiment surveys, it is.
• Is this really the worst period for consumers since 1978? If you believe the University of Michigan consumer sentiment survey, it is.
• Are things really worse for both homebuyers and sellers simultaneously? Fannie Mae respondents say so.
• Is the business outlook really worse than when the economy was shuttered for COVID?

Harkening back to Warren Buffet’s quote, we encourage you to ask yourself another question: does it seem like now is a time people are feeling greedy or fearful? Thank you for your continued support of Greenleaf Trust and for the opportunity to serve on your behalf.