Article 4: Stocks

The Stock Market and Consumer Sentiment Are Telling Different Stories

By Paul Vigna | May 27, 2020

Topics: Unemployment, Recession, Consumer Confidence, U.S. stock markets

Summary: Stocks have rebounded dramatically off their March lows, while consumer sentiment is hovering near the lowest level in nearly a decade. The divergence is one of many realities investors are struggling to reconcile. The spread between the monthly percentage change of the S&P 500 and the University of Michigans consumer sentiment survey climbed to 32 percentage points last month, the widest-ever gulf in data going back to 1978, according to Dow Jones Market Data. The drop in sentiment reflects the wave of challenges unleashed by the coronavirus pandemic. Almost overnight, the economy swung from an expansion into a deep contraction. Unemployment rose to record highs from record lows. Personal incomes in March suffered the steepest drop since 2013, and consumer spending fell at the fastest rate since 1959. The numbers for April, due Friday, is expected to be worse. Yet stocks have continued to rise.

Classroom Application: This article provides an opportunity to discuss stock market valuations and their relationship with the underlying macroeconomic environment.

Article

Article: The Stock Market and Consumer Sentiment Are Telling Different Stories

Stocks have rebounded off March lows, while sentiment is near the lowest level in nearly a decade

Stocks have rebounded dramatically off their March lows, while consumer sentiment is hovering near the lowest level in nearly a decade. The divergence is one of many realities investors are struggling to reconcile.

The spread between the monthly percentage change of the S&P 500 and the University of Michigans consumer sentiment survey climbed to 32 percentage points last month, the widest-ever gulf in data going back to 1978, according to Dow Jones Market Data.

The drop in sentiment reflects the wave of challenges unleashed by the coronavirus pandemic. Almost overnight, the economy swung from an expansion into a deep contraction. Unemployment rose to record highs from record lows. Personal incomes in March suffered the steepest drop since 2013, and consumer spending fell at the fastest rate since 1959. April numbers, due Friday, are expected to be worse.

Yet stocks have continued to rise. The S&P 500 has surged 36% since bottoming March 23, cutting its losses for the year to 6%. The current situation is quite unique, said Richard Curtin, a research professor who is the chief economist of the University of Michigans sentiment surveys. Consumers are very negative about the current economy. Its about as bad as weve ever recorded.

The Gulf of Sentiment Stock investors are confident while consumers are not, opening up a huge gap in sentiment between the two groups.

The stock market and sentiment both ultimately reflect conditions in the economy, he said. But sentiment surveys tend to closely track economic trends, while stocks can also be influenced by other factors, including Federal Reserve policy.

The S&P 500s 13% rally in April marked its best month since January 1987, a rise most market observers attribute to the unprecedented level of stimulus provided by the Fed. The pace of the rebound suggests many investors are betting on a V-shaped recoverya sharp drop-in economic activity, followed by an equally rapid rebound.

The U.S. economy contracted 4.8% in the first quarter of 2020. With the coronavirus crisis continuing into the summer, economists are expecting an even steeper contraction in the second quarter. WSJ's Carter McCall explains how GDP is calculated and how the coronavirus is impacting the equation. Photo Illustration: Jacob Reynolds/WSJ

Although the University of Michigans consumer sentiment reading suffered its biggest plunge on record in April, falling 19%, there were also signals that respondents expect the downturn will be short-lived. The index of current conditions drove the decline, while the fall in the expectations index was much more modest.

Mr. Curtin said that is the opposite of what has happened on the cusp of previous recessions when current conditions peaked, and expectations bottomed out.

The final results of the May survey are due Friday. The headline sentiment reading is expected to pick up slightly but hovers near the lowest levels since 2011. In the preliminary report, the index of current economic conditions rose, but the index of consumer expectations edged lower, suggesting the path to recovery is likely to be rocky.

Mr. Curtin said there can be a lag of a month or two between stocks and sentiment surveys. In December 2018, for example, the S&P 500 fell 9.2% on worries about slowing global growth; the sentiment survey fell 7.2% the next month. In May 2019, the index fell 6.6% as trade tensions ratcheted higher; the sentiment survey didnt fall significantly until August when it dropped 8.7%.

The divergence between stocks and sentiment reflects two different vantage points within a business cycle, said Lakshman Achuthan, co-founder of the Economic Cycle Research Institute. The stock market is already betting on the recessions end, he said. The sentiment, meanwhile, is more closely connected to the jobs market, which is taking it on the chin right now.

In April, U.S. employers laid off a staggering 20.5 million workers. The official unemployment rate, calculated by the Bureau of Labor Statistics, rose to 14.7%. Standard Chartered analyst Steven Englander estimated the number is effectively closer to 25% because the official tally excludes people who have dropped out of the labor force and millions more that the agency itself said may have been misclassified as on temporary layoff rather than unemployed, given the difficulties of conducting the survey during a pandemic. At this point, it does not look like May employment data will show improvement or even stability, Mr. Englander said.

Stock investors, on the other hand, appear to be putting their faith in the Fed and Congress. The central bank created or expanded nine lending programs, committing $2.3 trillion, with the promise of more stimulus if needed. Congress, meanwhile, has appropriated $2.9 trillion to support households, businesses and state and local governments.

Because of those rescue packages, markets are betting that the economic damage has a time limit, said Andrew Zatlin, founder of South Bay Research, an investment advisory firm in San Mateo, Calif.

Expanded unemployment benefits will mitigate the consumer damage, he said, while the Feds liquidity inspired confidence among investors. Whether the market has gotten ahead of itself, he said, will become apparent over the next few months as more states relax restrictions and the economic damage is tallied.

Although the stock market and the economic data appear to be flashing different signals, the market historically bottoms out a few months before a recession ends. So even if the sentiment is sour now, its possible the economy has already hit its trough, Mr. Achuthan said.

In 2009, for example, the market bottomed in March, and the recession ended three months later.

Technically, you have a recovery, he said, but it wont feel like it.

Article 4: Question 1

What are the main factors influencing consumer sentiment referenced in the article?

Article 4: Question 2

What appear to be the underlying drivers of recent stock market performance?

Article 4: Question 3

What are selected explanations cited in the article explaining the disconnect between consumer sentiment and recent stock market performance?