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With consumer confidence up, will stock returns follow?

Consumer Reports News

Headed into the Memorial Day holiday, stocks, as measured by the Standard & Poor's 500 index, have returned more than 17 percent to investors in 2013. And consumer confidence is finally ticking upward as well. The Consumer Reports Index is sharply higher this month, and is now at a level not seen since 2008. Other confidence indexes show an increase as well, but far from the giddy levels of 1999 and 2000.

So what does our index—which measures consumer sentiment, employment, and financial stress of U.S. consumers—or other consumer confidence indexes, say about stocks going forward? Academics, never a group to shy away from a comparison, have regularly looked at the pair of data. What they usually found is that, if anything, consumer sentiment is a negative predictor of stock prices. One of the more cited research papers on the topic, by Meir Statman and Ken Fisher, concluded that when consumer sentiment is low, stock prices rise 6 and 12 months later. And when sentiment is high, stocks do poorly in the short-term (12 months is short term performance here at Consumer Reports).

This and other studies conclude that consumer confidence increases because stocks are up, not the other way around. This may be one of the ways that the wealth effect—the idea that consumers who own assets that are increasing in price will make them comfortable enough to spend more—is, finally, expressing itself. Some market observers, particularly in the past few years, have suggested that the wealth effect, if it hasn't disappeared altogether, may have shrunk over the past few years. The recent confidence data may in fact show that the wealth effect hasn't shrunk, but may simply be a bit late to the party. After the headache the consumers have had over the past 5 years, that isn't surprising.

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