Consumer Confidence Is Falling. That Could Mean Trouble for Stocks.

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Consumers are sending worrisome signals that investors aren’t heeding. It’s time to pay attention.

The stock market and consumer sentiment usually rise and fall in tandem. Take the past 18 months. Ultraloose global monetary policy, record levels of fiscal stimulus, and rising earnings forecasts have sent stocks to successive highs. The same stimulative forces, plus a pandemic that curtailed social activity, helped U.S. consumers amass more than $2 trillion in savings, even as the labor market tightened and wages climbed. Those stock market gains made consumers feel even more flush, and flush consumers made investors more bullish.

Recently, though, the correlation has broken down. Consumers have become far less cheery while the stock market has marched higher, with the S&P 500 index hitting an all-time high on Thursday. As Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, notes, the University of Michigan Consumer Sentiment index bounced up only slightly in September—to its March 2020 pandemic low—after dropping in August to the worst level since 2012. The Conference Board’s Consumer Confidence Index similarly tumbled.

The gap between those readings and the change in the stock market remains uncharacteristically wide, Shalett says. The difference between current readings and future expectations is also widening, suggesting that consumers don’t see their concerns as temporary. The confidence gap has persisted even as the latest wave of Covid-19 infections appears to have peaked, meaning there’s more to the story than the virus.

So, who is right? Shalett leans toward the consumer’s view, and she’s not alone.

In a paper earlier this month, David Blanchflower, an economics professor at Dartmouth College and a former external member of the Bank of England’s monetary-policy committee, and Alex Bryson, a professor of quantitative social science at University College London, wrote about what they call “the economics of walking about.” The idea: that people on the ground possess information about economic trends based on their own experiences and the experiences of those they know, which allows them to assess future economic trends.

Their conclusion: Economic shocks are hard to predict, but qualitative metrics about consumer expectations are predictive of downturns. They show that consumer-expectations indexes from both the University of Michigan and the Conference Board predict downturns up to 18 months in advance in the U.S. They find that all recessions since the 1980s have been predicted…