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Bullish equity trend intact unless consumer sentiment falls sharply

THE news flow on trade wars recently has been weighing down on the US equity market. For the past two weeks, the US equity market moved in a depressed manner. On March 9, US President Donald Trump signed an order to impose 25 per cent tariffs on steel imports and 10 per cent tariffs on aluminium imports with Canada and Mexico exempted. On top of that, back in January, Mr Trump had also imposed tariffs on imported washing machines and solar cells. More recently, US unveiled tariffs on US$50 billion worth of imports from China over intellectual property theft.

Despite all the talk about how trade war is bad for the economy, the current outlook from US economic data remained robust. More specifically, consumer sentiment is at a multi-decade high, confirmed by all three survey providers - Conference Board, University of Michigan and Bloomberg.

Our study has shown that consumer sentiment and the S&P 500 index have a strong positive correlation. When consumer sentiment is soaring, it means that the animal spirit is in high gear and people are feeling overly optimistic. That should feedback into greater aggregate demand from the economic perspective and greater willingness to participate in the stock markets as risk-on sentiment flourishes. All in all, when consumer sentimentis rising and accelerating, we should see a pick-up in economic activity as well as a bullish equity market.

For this article, we will be referencing the Conference Board (CB) Consumer Confidence Index as the proxy for consumer sentiment. The results are tabulated from a random sample of approximately 300 US households. Do note that the other consumer sentiment indicators such as University of Michigan Consumer Sentiment and Bloomberg Consumer Comfort index do track a similar movement to the CB Consumer Confidence Index. Both the dot-com bubble and Global Financial Crisis tops were forewarned by the CB Consumer Confidence Index when the multi-year uptrend broke to the downside shown by the vertical line. For instance, since 1994, the S&P 500 index has been moving in a steep uptrend as the consumer sentiment supported the optimistic view.

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A multi-year uptrend line was established as a result, and it kept the general equity bull market alive until late 2000. Somewhere in October 2000 was when the CB Consumer Confidence broke below the multi-year uptrend line and confirmed a reversal of the overly optimistic view of the general public. As soon as the CB Consumer Confidence broke below the key multi-year uptrend line, the market went into a severe risk-off mode and tumbled 42 per cent over the next two years.

A similar warning shot happened in September 2007 when the CB Consumer Confidence Index broke the multi-year uptrend line that started in 2003. The break below the multi-year uptrend line reversed the prior upbeat outlook into a gloomy one where the CB Consumer Confidence Index fell precipitously from a high of 111.94 to a low of 25.3 in February 2009. As a result, the global financial crisis unfolded and shook the world adversely. The S&P 500 index fell as much as 50 per cent after the CB Consumer Confidence Index broke below the multi-year uptrend line.

Fast forward to today, the CB Consumer Confidence Index is exhibiting strong growth and optimistic view once again. It has been rising firmly since 2011 from a low of 40.87 to the current high of 130.8. Note that the last time the CB Consumer Confidence Index was at such an extreme height, the market was in the midst of the dot-com bubble. Hence, from the consumer sentiment perspective, we might be in another euphoric market.

The general trend of the S&P 500 index has also mirrored the move in the CB Consumer Confidence Index since 2011, and it is currently trading at a record high. Thus, as long as the CB Consumer Confidence Index continues to improve and stay above the multi-year uptrend line, we believe the US general equity market should continue ascending.

The bull market in the S&P 500 index should stay intact until a sharp reversal in the CB Consumer Confidence Index occurs. The confirmation for that would be a drop in the CB Consumer Confidence Index below the multi-year uptrend line at 116. Keep a close look out on that.

When the CB Consumer Confidence Index goes below the multi-year uptrend line, the other consumer sentiment gauges from University of Michigan and Bloomberg should also trigger the bearish signal of moving below their multi-year uptrend lines. Currently, all the consumer sentiment indicators remain exceptionally rosy, suggesting all is well.

With the recent trade war related sell-down in the S&P 500 index, some key levels to watch for a rebound back into the uptrend are the 200-day moving average at 2,600 points and 2,550 support area.

  • The writer is chief technical strategist, Phillip Securities Research.

Disclaimer: Chartpoint is provided by Phillip Securities Research for information only, and should not be construed as investment advice.