Technically BullishLast week, we noted “that from a purely technical perspective, the market remains on a bullish buy signal and has not become grossly overbought. On Friday, the market retested the breakout of the previous highs and held. Next week, if the market can hold these levels without breaking that support, the breakout will be confirmed, which should provide a bullish bias into the end of the month.”Such remains the case this week. Notably, completing the “cup and handle” pattern suggests a potential further upside to 6000 by year-end. While that target may seem ambitious, it aligns with recent Wall Street upgrades.“The pattern was first described by William J. O’Neil in his 1988 classic book on technical analysis, How to Make Money in Stocks. A cup and handle price pattern on a security’s price chart is a technical indicator that resembles a cup with a handle, where the cup is in the shape of a ‘u’ and the handle has a slight downward drift. The cup and handle pattern is considered a bullish signal, with the right-hand side of the pattern typically experiencing lower trading volume. The pattern’s formation may be as short as seven weeks or as long as 65 weeks.”That pattern seems quite evident in the following chart of the S&P 500 index. With the breakout of the “cup and handle” formation in place, a further rally into year-end seems to be the logical next step. Such suggests that any near-term correction to relieve overbought conditions should remain confined to the bullish trend. In other words, investors should consider buying any near-term declines.Just for reference, the last time we discussed a cup and handle formation was in December 2023, where we noted:“That pattern seems quite evident in the following weekly chart of the S&P 500 index. With the breakout of the “cup and handle” formation in place, an attempt at all-time highs seems to be the logical next step. Any subsequent correction to relieve overbought conditions should maintain the bullish trend line from the March 2020 lows.”While I received some pushback at the time, the market has rallied and set numerous new all-time highs this year.However, while the market’s technical backdrop is extremely bullish and could remain that way for some time longer, this week’s consumer confidence readings certainly raise some concerns.  The Confidence GameIt is an interesting time. Last week’s analysis noted the return of increasing bullish sentiment in investor positioning in the market. Of course, with the market already up more than 20% for the year, the need to “chase performance” has professional and retail investors pushing their chips onto the table.However, what is interesting is the growing confidence dichotomy between investors and consumers (and in many cases, those are the same.) Notably, the stock market and consumer confidence are vital indicators often used to assess the economy’s health. While they frequently move in tandem, there have been notable periods in history when the stock market surged despite faltering consumer sentiment and vice versa. For investors, understanding the dynamics of a confidence dichotomy is crucial.As such, we will delve into the relationship between consumer confidence and the stock market, analyze key historical moments when these two indicators diverged, and explore what typically happens when the stock market exuberance detaches from consumer sentiment. However, let’s start with consumer confidence.Consumer confidence reflects the optimism or pessimism consumers feel about their financial situation and the state of the economy. The Conference Board’s Consumer Confidence Index (CCI) is one of this sentiment’s most widely used measures; the other is the University of Michigan Sentiment Index. Logically, when consumer confidence is high, individuals are more likely to spend, borrow, and invest, driving economic growth. Conversely, when confidence is low, consumers tend to save more and spend less, which can slow down the economy.Confidence And EarningsAs former Fed Chairman Ben Bernanke pointed out in 2010, the link between consumer confidence and the stock market is critical to the Federal Reserve’s risk assessment.“This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.”
The last sentence is crucial. The Federal Reserve depends on a rising stock market to boost consumer confidence. Creating a “wealth effect” makes people feel more financially secure, which increases economic activity. Notably, as we have discussed previously, and should be obvious, corporate earnings are derived from economic activity.Naturally, if earnings are increasing, investors are willing to pay more today in exchange for increased earnings in the future, leading to higher asset prices. As shown many times, the annual earnings change is the best indicator of future stock market returns.However, the “confidence game” to which the Federal Reserve pays attention isn’t always linear. Sometimes, the stock market rallies even when consumers are skeptical about the future, leading to a disconnect between Wall Street’s exuberance and Main Street’s reality. That particular confidence dichotomy exists currently, but it isn’t the first time.The Confidence DichotomyThe latest Conference Board Consumer Confidence Index dropped sharply in the latest reading. While expectations were for a small decline from 105.6 to 104, the actual reading came in at 98.7. Yet, at the same time, the market has surged unabated.You will notice that confidence collapsed, as expected, in March 2020 and then sharply recovered as the Government sent $1500 checks to households. However, since then, the confidence trend has continued to trend lower as excess savings continue to erode. As noted by Albert Edwards this week, it could be claimed that the savings rate decline resulted from consumers dipping into their pandemic-era excess savings to support economic spending. However, that argument no longer holdsGiven the drain in savings, combined with rising concerns over job loss, it is unsurprising that consumer confidence has continued to weaken.However, consumer confidence in higher stock prices in the next year remains at the highest since 2018, following the 2017 “Trump” tax cuts.Of course, the differential is that those with money invested in the financial markets are “feeling great” about their portfolio, just not so much with anything else.However, the question is, is this “consumer dichotomy” an anomaly, or can we refer to previous periods? The answer is “yes.”This Time Is Different?The chart below is a composite consumer confidence index, the combined score of the University of Michigan and Conference Board measures. The composite gives us a broader measure of consumer confidence from a historical perspective. As shown, there have been three previous periods where the market rallied despite falling consumer confidence.More By This Author:Tax Cuts – An Examination Of The 2017 TCJA Impact
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