A Steep Drop in Confidence

Four months ago, the Conference Board’s Consumer Confidence Index reached an 18-year high. Since then, consumer sentiment has deteriorated rapidly, leading some investors to wonder if a drop in confidence could eventually lead to a downturn.

As shown in the LPL Chart of the Day, the U.S. economy has entered a recession an average of 19 months after a peak in consumer confidence, and a drop in sentiment has been a warning sign for past economic cycles. While confidence shifts can be meaningful obstacles to economic activity, we think the severity of the current decline is due, in part, to temporary factors such as the government shutdown, and the pieces are still in place for sentiment to stabilize.

Confidence Shifts could be late cycle red flags

Over the past several months, U.S. consumer sentiment has had to weather increasing trade risk, a 35-day government shutdown, disconcerting headlines on geopolitical issues, a slowdown in global growth, and a near bear market in the S&P 500 Index. Many of these headwinds have understandably chilled confidence, and their collective impact can be intimidating.

However, we think these headwinds will subside in the near term, if they haven’t already. Trade tensions have had a widespread effect on corporate sentiment and economic activity, but we expect a U.S.-China trade resolution soon, which could help. Government shutdowns, especially when prolonged, have historically dampened consumer sentiment, but economic activity typically has rebounded quickly after shutdowns.

“While the current environment is uncomfortable, the steep drop in confidence is exaggerated given favorable economic conditions,” said LPL Research Chief Investment Strategist John Lynch. “We expect strong fundamentals to prevail over the near-term headwinds.”

We believe solid fundamentals are especially important this late in the business cycle. The bulk of economic data we’ve seen lately has been sound, corporate earnings are at record levels, and policy is still accommodative. We also have yet to see any alarming signs of late-cycle excesses or “red flags,” which have doomed expansions in the past.

For more of our thoughts on the recent drop in sentiment, check out our most recent Weekly Economic Commentary.

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