StockWatch

It's Darkest before the Dawn

By Mark Hulbert,
Editor of the Hulbert Financial Digest, a service of MarketWatch.com

The markets were shocked by the news in late February that consumer confidence was even lower than economists had expected.

According to the Conference Board's "Present Situation Index", which measures how consumers are feeling about the economy right now, consumers are even more pessimistic today than they were at the depths of the 2007 - 2009 bear market. In fact, you have to go back several decades to find another occasion when consumers were this glum about the economy.

However, here's one thing to remember before we get too dejected by this news: The last time the Present Situation Index was as low as it is now was at the end of 1982. Coming as it did at the beginning of a two-decade-long bull market, the low Present Situation Index was a signal that it was a great time to get into the stock market.

It turns out, in fact, that consumers are a great contrarian indicator. They feel the best at the end of economic expansions, just when they should be becoming more cautious. And, they feel the worst at the depth of recessions.

That low point for consumer sentiment in late 1982, for example, came right at the end of the 1981 - 1982 recession. Indeed, the latter stages of every recession since the 1960s have been accompanied by a plunging Present Situation Index. And, in all cases, the stock market, at such times, represented very attractive long-term values.

My contrarian-based argument closely parallels Norman Fosback’s rationale for his so-called Recession Buy Indicator. Fosback, of course, for several years, has edited an advisory service called Fosback's Fund Forecaster. For several decades before that, as head of the Institute for Econometric Research, he edited a number of other services, most prominently, Market Logic.

Fosback's indicator triggers a buy signal whenever all four components of the government's index of coincident economic indicators are below where they were six months previously. When that is the case, Fosback writes, "History tells us that the economy is so tenuous that stock investors looking well out to the future are able to perceive the seeds of the next economic expansion…when everything seems gloomy, it's time for the smart money to buy."

To be sure, you cannot expect pinpoint accuracy when using the Present Situation Index as a contrarian indicator. There is no guarantee that the stock market won't take several months or longer to anticipate the better economic times that eventually are around the corner. During that time, the Present Situation Index could fall to even lower levels.

But, as Nathan Rothschild famously once said, the time to buy is when blood is running in the streets. If you, instead, wait until consumer confidence is soaring before getting back into stocks, when it feels good to do so, then you will be perennially too late.