On February 2, 2024, we said the following:
“True bears aren't impressed with this faux low in the Fed's Balance sheet. Neither are we. However, the lower it goes, the less government crowding out, the more markets boom.”
We also included the following posting to support our view:
Below is a graph of U.S. population compared to U-6 unemployment on a year-over year-basis.
see also:
Posted in Dow's Economic Indicator, population, U-6, Unemployment
“Remember that the industrial and railroad stocks used in the averages are essentially speculative. Only to a limited extent are they held for fixed income by people to whom safety of the principal should be the main consideration, and their holders are constantly changing. If they were not speculative they would be useless for a stock market barometer. The reason why railroad stocks during 1919 did not share the bull market in the industrials was that, through government ownership and government guaranty, they had in a real sense ceased, for the time at least, to be speculative. They could not advance in any market, bull or bear, more than enough to discount the estimated value of that guaranty.”
-William Peter Hamilton, 4th Editor of the Wall Street Journal (The Stock Market Barometer. Harper. 1922. page 186.)
Government’s Impact on Risk
According to Hamilton:
“It is plain, then, that with a government guaranty of a minimum return, based upon the average earnings of three years ended June 30, 1917, the railroads entered the fixed income class (page 189.).”
-William Peter Hamilton, 4th Editor of the Wall Street Journal (The Stock Market Barometer. Harper. 1922. page 189.)
Many are arguing that the government purchase of assets along the widest spectrum of risk is the cause of a more speculative investing environment. The work of Hamilton, with the citation of rail stocks after nationalization, point to the opposite outcome, suggests that if the government is so influential then markets should become more sedated rather than increasingly restive.
Fannie Mae: The Evidence
The proof of the strength in the claims made by William Peter Hamilton can be found in the share price of the Fannie Mae and the 30-Year Treasury from 1977 to 2020.
As soon as Fannie Mae lost the implicit guarantee and achieved the actual guarantee of government support the share price has gravitated to tracking the 30-Year Treasury. The chart below shows Fannie Mae from 2013 to 2020 being unable to track beyond the 30-Year Treasury.
For now, Fannie Mae has become a bond even though it is possible to vacillate between $0.50 to $6.00 (+11,000% or -91.67%).
William Peter Hamilton
Often cited by Dow Theorists Robert Rhea and Richard Russell, Hamilton was an intense follower of the writings of Charles H. Dow, co-founder of the Wall Street Journal.
see also:
On August 23, 2009, in our call that the recession was over, we said the following:
“I doubt that the general public will agree that the recession is over since jobs will not be as plentiful as the past.”
From the low in 2009 to 2014, many questioned the rising stock market and economy because job growth was not as strong as hoped. However, it should have been understood that to achieve such accelerated job growth comes at a very expensive price.
On July 2013, we said the following of the unemployment rate:
“It is important to understand that the 10% and 3.8% unemployment rates are undesirable scenarios. The 10% unemployment rate is in the depths of a “recession” and the 3.8% unemployment rate at the height of a overextended economic boom.”
On August 24, 2018, we said the following of the unemployment rate:
“Presently, we anticipate the unemployment rate rising to the 6.30% level as a natural reaction to the current low levels. While the unemployment rate can go lower, there is a tremendous tradeoff to achieving lower levels. It is quite possible we have seen the best of times with a declining unemployment. Anything below the current levels will come at a tremendous cost in the next recession.”
The current environment bears out the concerns that we’ve had about the unemployment rate decreasing below 3.80%. Once we get beyond a certain tipping point the reaction is swift and unnecessarily painful.
The Outlook
According to the Washington Post dated March 23, 2020, the projected unemployment rate is likely to range from 9% to 30% based on the fallout from the coronavirus (COVID-19). Our August 2018 projection of 6.30% remains, as it is the first stopping point to any higher level beyond Goldman Sach’s 9% or St. Louis Federal Reserve President James Bullard’s 30%.
These estimates, in our view, are knee jerk reactions in a vacuum. As we were concerned about going below 3.80% in the unemployment rate back in 2013, we’re going to wait until we reach 6.30% before we can offer up a measure perspective on the situation.
Please keep in mind that none of what has occurred, at least from a data standpoint, is unusual or unexpected. Of course we couldn’t predict that a pandemic was coming. Yet, the data, from a historical standpoint, suggested that the low range was at an extreme and was bound to react to the upside.
On August 4, 2019, we said the following:
“A trend doesn’t define the future prospects. However, we believe that the declining trend has not completely played out. This means that we expect that the economy and stock market will languish, in the best case scenario.”
When you combine Charles H. Dow’s consumer sentiment indicator, the Dow Jones Industrial Average on a year-over-year basis, with Dow Theory we see that all indicators have been in place for the decline that we’ve seen so far.
The only question that remains is how far will the decline extend? We’re working to generate a measured response to this question.
On August 4, 2019, we said the following of Consumer Sentiment:
A trend doesn’t define the future prospects. However, we believe that the declining trend has not completely played out. This means that we expect that the economy and stock market will languish, in the best case scenario.
Alternatively, if the Dow Jones Industrial Average can exceed the 28,750 level, the Consumer Sentiment Survey will reflect this change of direction and move above the short-term peak of May 2019.
On August 30, 2019, the University of Michigan Consumer Sentiment Survey (UMCSENT) came out with a reading of 89.8 for August 2019.
The year-over-year change in the index, along with the Dow Jones Industrial Average (DJIA), is charted below:
So far, our belief (that the trend for consumer sentiment is down) has played out. This was not a feat of economic forecasting, just an observation of the overall trend since the October 2017 and January 2018 peaks in the UMCSENT and the DJIA, respectively.
A quick resolution on the tariff front could bode especially well, pushing the DJIA higher (on a YoY basis) which will be quickly translated into the UMCSENT.
Data Review
Some discussion has been made of the fact that on a month-over-month (MoM) basis, the August 2019 UMCSENT number has declined the most in seven years. However, the -8.74% MoM decline ranks 25th among the largest declines since the inception of the UMCSENT. We’re in a wait and see mode as the economic picture evolves. We believe that the DJIA will be the real-time indication of the direction for the September 13, 2019 release of the UMCSENT.
See Also: Dow’s Theory on Consumer Sentiment
Review
On April 1, 2019, we wrote an extensive piece on the work Charles H. Dow and how the Dow Jones Industrial Average is a consumer sentiment indicator that precedes the widely quoted University of Michigan Consumer Sentiment Survey.
When we say that the Dow Jones Industrial Average precedes the University of Michigan Consumer Sentiment Survey, an appropriate response should be that, when compared to the actual data, the University of Michigan Consumer Sentiment Survey generally peaks and troughs before the Dow Jones Industrial Average. As this is an accurate claim, we are required to point out that University of Michigan Consumer Sentiment Survey is delayed and revised every two weeks whereas the Dow Jones Industrial Average is instantaneous and unrevised.
Is a two week delay all that important in the big scheme of things? It is likely that the Dow Jones Industrial Average influences the outcome of the University of Michigan Consumer Sentiment Survey. As a reminder, the Consumer Sentiment Survey is a phone survey consisting of 50 questions across 500 or more individuals/households versus the stock market that reflects millions of transactions on a daily basis.
Current Take
In the chart of the Year-Over-Year comparison of the University of Michigan Consumer Sentiment Survey and the Dow Jones Industrial Average, we have included the current cycle from the recession of 2007-2009 to the present.
In the chart above, the current view is best reflected in the late-2017/early-2018 declining trend. We’ve highlighted, in a green circle, the Dow Jones Industrial Average as it reverses a rising trend and then starts to decline. Likewise, the Consumer Sentiment Survey starts to flatten rather than continue to move higher.
Forward View
A trend doesn’t define the future prospects. However, we believe that the declining trend has not completely played out. This means that we expect that the economy and stock market will languish, in the best case scenario.
Alternatively, if the Dow Jones Industrial Average can exceed the 28,750 level, the Consumer Sentiment Survey will reflect this change of direction and move above the short-term peak of May 2019.
In the Review and Outlook section of the Wall Street Journal dated February 27, 1902, Charles H. Dow said the following of labor and unemployment and their impact on prices:
“Periods of depression in business and in prices are invariably preceded by periods of good business and advance in prices. At such times, which usually last for several years, there is a gradual increase in the employment of labor until at the high point abundance of work, large production, large profits and high prices go together.
“It is equally certain that periods of depression begin with over trading, over production, over confidence and general excess in all directions. Upon this condition of affairs comes some sudden shock. It may be an important failure; it may be some great catastrophe or national event; it is something which arrests attention and makes people stop and think.
“They see that they are extended, and begin to restrict operations in whatever line of business they may be in. Lenders of money restrict credits, merchants restrict purchases, creditors urge payments, and, as a result of this shrinkage, the demand for labor lessens a little in each case, but enough to make a large aggregate. This begins to be felt in reduced consumption, and this is the first turn of the wheel which brings about general contraction.
“It is evident, therefore, that the bearing of the employment of labor upon prices of securities is only that restricted employment is one of a number of causes operating to produce smaller profits; hence lower prices.
As showing how closely the demand for labor follows the lines of expansion and contraction, which find their ultimate expression in the prices of securities (Sether, Laura. Dow Theory Unplugged: Charles Dows Original Editorials & Their Relevance Today. W & A Publishing, 2009. page 83.).”
The distinction of Dow’s theory on unemployment and labor is that it is based on a rationale of the active participants in the economy which reverberates throughout the economy generating cycles.
Stock prices follow the prospects affecting unemployment and not the reverse. However, the full scale reporting of unemployment data by government agencies lags that of stock prices. This causes a feedback loop in the period when the primary trend of the economy is at a reversal stage. The magnitude of declines in employment seem large in relation to the prior increase especially relative to the speed with which they occur as highlighted by Dow in the following August 8, 1901 commentary:
“If the general theory of swings is correct in the assumption that the top of the 'boom' has been seen, declines will average larger than rallies for some time to come (Sether, Laura. Dow Theory Unplugged: Charles Dows Original Editorials & Their Relevance Today. W & A Publishing, 2009. page 334.)”
The question of when and if a reversal is due is an important question as Dow makes clear in the following commentary on July 26, 1899:
“Reports from all directions are that business is active, labor is well employed and business men are making money. Such a condition has already brought about high prices in every department of trade.
"The question is now whether Wall Street has discounted this condition in full, or has it still more to discount? (Sether, Laura. Dow Theory Unplugged: Charles Dows Original Editorials & Their Relevance Today. W & A Publishing, 2009. page 67.)"
Consideration of Dow’s Theory has been the basis of our previous work on the unemployment rate which bears reviewing.
Stage 1: Recognizing the Change
On August 21, 2009, we said the following:
“Based on the combination of the Dow Theory confirmation of July 23, 2009 and the IPI [Industrial Production Index] turning up from the June low, I will have to guess that the National Bureau of Economic Research (NBER) is going to proclaim June 2009 as the official end to the recession. The end to this recession will be lackluster and questioned from all corners.”
Throughout the period from August 21, 2009 to the present, economists and analysts have questioned the legitimacy of the growth of the U.S. economy and based their opinion primarily on the rate of growth as an indication of the weakness or sustainability of the rising trend. Below is an excerpt from the Congressional Budget Office dated November 24, 2012:
Also a part of our August 21, 2009 commentary we said:
“Additionally, the stock market will only follow the pattern of a cyclical bull market (bear market rally) within a secular (long term) bear market. I doubt that the general public will agree that the recession is over since jobs will not be as plentiful as the past.”
Not surprisingly, many news outlets seized on the idea that anemic job growth was a reflection of poor policy action as highlighted in the following Washington Post article dated October 23 ,2012.
The first thing that stands out about Charles H. Dow’s commentary of employment and unemployment is that there is no reference to government intervention as the source of recovery (or contraction). Instead, active participants with skin in the game are the ones who, based on the level of prices, decide when to commit to hiring and firing.
The second observation is that even if we were lucky in our call that the National Bureau of Economic Research would say that the recession ended in June 2009 (the September 2010 announcement here), Dow’s Theory points to why we would say that the recovery would be “lackluster”, “questioned”, and that jobs wouldn’t be as plentiful in the past. Dow referenced the “gradual” increase for a boom and the “sudden” nature of busts.
With this in mind, it bears noting that if a recovery is actually in place (at the time), it will be slow and that if it is slow it will take a lot of time for the realization and acceptance of the change in conditions which highlights the importance of the famous quote by Charles Mackay, author of Extraordinary Popular Delusions and the Madness of Crowds:
“Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, one by one (Goodreads. Charles Mackay; quotes. accessed April 11, 2019. link.).”
Stage 2: After the Turn, Assessing the Conditions
On July 26, 2013, we said the following:
“Applying Dow Theory’s 50% principle suggests that the best we could expect for the unemployment rate, on the downside, is for 6.9%. It is important to understand that the 10% and 3.8% unemployment rates are undesirable scenarios. The 10% unemployment rate is in the depths of a “recession” and the 3.8% unemployment rate at the height of a overextend economic boom.”
Many economists critical of the presences of an economic recovery would often say something like, “…there is no recovery, just look at the unemployment rate, it is nowhere near the prior low of 4%…” Again, the push for the belief that the recovery is finally in place once it achieves the prior low levels ignores the process and change in the economy that is necessary as outlined by Dow.
Other critics are concerned that the reported data on the declining unemployment rate doesn’t reflect “…all persons marginally attached to the labor force, plus total employed part time for economic reasons, as a percent of the civilian labor force." This set of unemployment data is commonly known as the U-6 rate which is contrasted by the more widely quoted data set of the U-3 rate. What’s the difference?
The chart above shows the U-6 rate (Total unemployed, plus all marginally attached workers plus total employed part time for economic reason) in blue and the U-3 rate (Civilian Unemployment Rate) in red from 1994 to January 2018. What should stand out is that there is a huge divide between the U-6 rate and the U-3 rate.
What some commentators get wrong when they look at these numbers is the absolute levels, which should never be done. Below, we have generated the appropriate way to determine how to look at the data from these two data sets when making a comparison.
The chart above shows the annual Year-over-Year Percentage Change in the U-6 rate, U-3 rate and U.S. population since 1995. Using this method of comparison, a reviewer of the data can draw meaningful conclusions that are accurate (minus the absences of population data from 2015 to 2019).
By all accounts, U-6 and U-3 rates have improved at the same rate since the 2009 peak, with the U-6 data showing a marginally better rate of change than the U-3 rate, all this while the population of the U.S. has increased slightly more than 0.75% per year.
Critics of the use of U-3 data, when asked to look at the data from this perspective, often become defensive and attempt to revert to the “U-6 rate is better than the U-3 rate” argument. Unfortunately, the data as represented in the Year-over-Year Percentage Change is more definitive and appropriate when attempting to determine what has changed in the data since 2009.
Stage 3: The Primary Movement Revealed
In attempting to assess markets, Charles H. Dow’s April 27, 1899 commentary in the Wall Street Journal can be applied to any market where “price” is updated on a regular basis:
"The point of importance for those who deal in industrial stocks is whether the capitalization of the companies into which they propose to buy is moderate or excessive, when compared with the aggregate earnings of the various concerns forming the combination in a period of depression. It is probable that consolidated companies will be able to earn as much in the next period of low prices as the companies forming the combine were able to earn in the last one; hence the very foundation of investments in industrials should be knowledge of what these companies earned, say in 1893 to 1896, making, perhaps, reasonable allowances for economies under consolidation. Where the earnings so shown would have provided dividends for industrials now active, the fact must be regarded as a very strong point in favor of those stocks (George W. Bishop Jr., Charles H. Dow: Economist, Dow-Jones & Company,Princeton, 1967, page 11.)"
As we pointed out in July 2013, based on Dow’s claim, the 3.8% unemployment was the “period of depression” by which we measured the extent that the market could go before being over-extended. The last period that was lower than the 3.8% low was May 1969. We cannot account for this prospect at least until the 3.8% level is achieved. However, why would we even considered the 3.8% level when the previous low in unemployment was May 2007 at 4.4%?
In Dow’s reference to primary movements, he says the following in the Wall Street Journal on July 20, 1901:
“It is impossible to tell in advance the length of any primary movement, but the further it goes, the greater the reaction when it comes, hence the more certainty of being able to trade successfully on that reaction.”
From the May 2007 low in unemployment at 4.4%, the unemployment rate increased to as high as 10% by October 2009, which had not seen similar levels since June 1983. Dow’s perspective suggests that the reaction (decline) should be as dramatic as the preceding extreme. In this case, the last low after a 10% unemployment rate was the low of April 2000 at 3.8%.
The primary trend of any market is not revealed until many years have passed. This is unfortunate because by default it eliminates from the collective memory of the market those who were lucky enough to correctly assess (guess) the conditions, either in general or precisely.
Is Unemployment Really Low?
There are many concerns of whether the unemployment rate is actually as low as it is claimed to be. Again, as previously mentioned, there is a distinct difference between the U-6 and U-3 data on unemployment.
Without debate, the U-6 data has declined equally as much as the U-3 data from 2010 to 2019. However, there is the segment of the population which, by no fault of their own, cannot be participants in the labor market. As Described by Charles H. Dow in a December 11, 1901:
“One of the surest marks of the coming of bad times is the falling off in the employment of labor. As labor does not voluntarily deprive itself of employment, the cause of lack of employment must be found in inability to borrow money on favorable terms by those who depend on borrowed money to carry on lines of business in which labor is employed.”
The claim that “…labor does not voluntarily deprive itself of employment…” is reflected in a majority of the nonparticipation rate as outlined by the Brookings Institution’s paper on the topic, saying:
“After excluding caregivers (approximately 40 percent of nonparticipants), men and women report the same reasons—and at similar rates—for not participating in the labor force. Almost 30 percent of nonparticipants report being ill or disabled, while 8 percent are students, and 5 percent are early retirees (Diane Whitmore Schanzenbach, Lauren Bauer, Ryan Nunn, and Megan Mumford. “Who is Out of the Labor Force?”. August 17, 2017. link. accessed April 29, 2019.)”
A contrasting argument to the unemployment data being exceptionally low is that it isn’t as good as it is made out to be due to voluntarily leaving the marketplace for jobs. Some have cited the fact that since 2000, the labor participation rate, as reflected by employment relative to working age population, has been in considerable decline with a dramatic distance between the prior peak and the current level (Sherman, Erik. “Sure, Unemployment Went Down - Because More People Left The Workforce”. Forbes. May 5, 2018. accessed April 29, 2019. link.)
As indicated in the data above from the Brookings Institution, 30% of non-participants in the workforces were due to illness or disability while another 40% were caregivers. This confirms Dow’s claim that few are out of the workforce on a voluntary basis. Additionally, that small minority of individuals who voluntarily take themselves out of the work force (not related to health issues) are generally in a supportive environment that allows for such changes in their life.
Where does the work of Charles H. Dow leave us on the topic of employment and unemployment? In spite of technological changes and the dramatic shift from labor intensive and industrial jobs to service related industries over the last 120 years, the expectations from employers and employees remain the same. Being able to recognize these inherent needs allows for a reasonable model for what to expect when attempting to forecast the trend of employment and unemployment.
See Also:
Posted in Dow's Economic Indicator, Unemployment
On November 30, 1977, Richard Russell of the Dow Theory Letters said the following:
"Bill Bretz, editor of the excellent new Juncture Recognition report (Box 1209. Pompano Beach, FL 33061), has just presented a fascinating sentiment study, the Dow vs. the University of Michigan Consumer Sentiment Index. Normally, says Bill, consumer sentiment and stock prices have a long-term influence on each other. And the chart does show this interesting correlation. But in the recent 214 point decline in the Dow, consumer sentiment has stayed bullish. Says Bretz, “The market has never fallen so far in an atmosphere of such total unconcern...I can't help but wonder how far down the Dow will have to go in order to produce the kind of fright that is the hallmark of an important market bottom.” (Russell, Richard. Dow Theory Letters. November 30, 1977. page 5.)."
As we highlighted in our article titled Dow’s Theory on Consumer Sentiment dated April 1, 2019:
“…when we change the data for each indicator to reflect the percentage change from the prior year, we get a useful representation of the data that is relative to each indicator that can also be compared to one another.”
Let’s look at the same indicators on a monthly basis and see if the year-over-year percentage change provides a better perspective on the topic.
When viewed on a year-over-year percentage change basis, the period in question, from the 1976 peak to November 1977, the two indicators had the most correlation of a peak and decline up to that point since 1964.
When presented in this fashion (y-o-y % change) we arrive at an answer to the question stated above by Bretz:
“…how far down the Dow will have to go in order to produce the kind of fright that is the hallmark of an important market bottom.”
In fact, the Dow Jones Industrial Average (DJIA) and the University of Michigan Consumer Sentiment Survey (UMCSENT) did not need much in the way of declining to match each other as both indicators were well on their way to bottoming out, with the DJIA reversing to the upside well before the UMCSENT.
Consumer Sentiment and its Predictive Role
Consumer sentiment seems to be an arbitrary measure for deciding if the economy will grow or contract. However, having a reliable measure of consumer sentiment can aid in future planning for spending and investment. As outlined on Investopedia.com and reviewed by Will Kenton on January 26, 2018:
“Consumer sentiment is a statistical measurement and economic indicator of the overall health of the economy as determined by consumer opinion. Consumer sentiment takes into account an individual's feelings toward his or her current financial health, the health of the economy in the short term and the prospects for longer-term economic growth.”
It is our contention that consumer sentiment indications coincide with, and potentially follow, markets. The work of Charles H. Dow on the topic of sentiment of large banks, large speculators and small investors is said to have far reaching implications for short and long term expectations of the American economy. Dow says:
“Wall street will undoubtedly discount the turn in the industrial situation, but the people who discount it too long ahead may have to extend their notes. (Sether, Laura. Dow Theory Unplugged: Charles Dows Original Editorials & Their Relevance Today. W & A Publishing, 2009. page 170.)”
“As the stock market is always an effect and never a cause, it must respond to these conditions. As, however, the stock market, while an effect, is also a discounted effect, the decline in prices of stocks usually anticipates decline in prices of stocks usually anticipates decline in commodities, because operators for a fall sell in anticipation of the changes which they foresee in business conditions. (Sether, Laura. Dow Theory Unplugged: Charles Dows Original Editorials & Their Relevance Today. W & A Publishing, 2009. page 201.)”
In the years when Dow was writing on markets and their participants, the general public was not widely involved in stock speculation and investment. However, the activity of business owners, market operators and bankers and their decisions within the stock market reflected future business change whether higher (expansion) or lower (contraction).
Before getting into the details of consumer’s short-term and long-term views on economic prospects for growth, we need to cover the topic of the official accounting of recessions and expansions in the U.S. economy as presented by the National Bureau of Economic Research (NBER).
Periods of Expansion and Contraction
In the charts that follow, indications of the beginning and end of a recession are clearly noted in the gray vertical bands. The announcement of an end to a recession is usually indicated from six months to a year after the actual event by the National Bureau of Economic Research.
In the above business cycle data from 1953 to the present, we find that the “latest announcement” from the NBER’s Business Cycle Dating Committee was published on September 20, 2010 and said the following:
It was not until 15 months after June 2009 end of the recession that the organization responsible for all the gray vertical bands on every chart of economic data was able to inform the public that the economy had turned from recession to expansion. With the understanding of the lag that exists when waiting for the call on a recession or expansion, from the National Bureau of Economic Research, we can easily see why it is necessary to look for other sources as possible indicators on the economy.
Another concern is that the National Bureau of Economic Research seems to have arbitrary nature of a recession. There are periods when each indicator discussed in the outline declines significantly and reverses but there is no indication of a recession by the National Bureau of Economic Research. Naturally, the two indicators that we cover are not the only attributes that go into the calculation of a expansion or contraction. However, for now, we’ll presume that the University of Michigan Consumer Sentiment Survey (UMCSENT) and the Dow Jones Industrial Average (DJIA) are key indicators of consumer sentiment and accurate reflections of economic conditions.
DJIA as a Consumer Sentiment Indicator
Much of the work of Charles H. Dow was based on core economic principles that are currently taken for granted in U.S. monthly reports of economic activity. One area that Dow worked diligently on was the insights of markets as a reflection of general public sentiment for future expectations. According to Dow, sentiment was demonstrated through the stock market indexes that currently bear Dow’s name in the form of the Dow Jones Industrial Average (DJIA), Dow Jones Transportation Average, and Dow Jones Utility Average.
In the “Review and Outlook” of the Wall Street Journal dated April 21, 1899, Dow said the following of changing consumer sentiment, as a reflection of the “general conditions”:
“The time involved in theses turns is determined by natural causes. The change is that the stock market reflects general conditions and it takes years for such a change for the better or for the worse to work its way through the community, so that the mass of people are either optimistic or pessimistic in their views. Some people foresee changes in the situation much quicker than others, but it takes a change of opinion on the part of millions of people to produce a well defined sentiment throughout the country. (Dow, Charles H. Review and Outlook. Wall Street Journal. April 21, 1899.)”
The general conditions is a reference to the overall economy and is reflected in sentiment throughout the United States.
“The market continues broad with an upward tendency. There is constant realizing, some of it on a large scale, but the largest interests give support when it is needed and then by judicious stimulation of one stock or another bring enough buying to retain and slowly increase bull sentiment. A great many people are buying stocks with the expectation of having to run in a great hurry on some unfavorable news before the election. Some of these people sell on the small declines that come along, but buy their stocks back again the next day, when it transpires that the dreaded slump has not yet arrived. Perhaps the large operators play a little on this condition of sentiment. (Dow, Charles H. Review and Outlook. Wall Street Journal. October 25, 1900.)”
At a time when telephones were not widely dispersed to survey the attitudes and opinions of the general public, Dow was able to infer behavior through the activity of the stock market, the most readily available real-time source for sentiment.
From 1899 to 1902, Charles H. Dow wrote in great detail of the intent and impact of individuals and their behavior and how it was a predictor of the direction of the economy. This was the basis of Dow’s creation of the indexes that still bear his name, more than 120 year later. However, since the 1940’s, there has been a more relied upon source for the sentiment of consumers.
University of Michigan Consumer Sentiment Survey
In the 1940’s, professor George Katona introduced the Survey of Consumer Finances, with the backing of the Federal Reserve Board, which outlined the views that consumers views on future spending can act as a possible leading indicator of economic activity.
The adoption of the survey for the purpose of determining expectations and intentions of consumers ultimately led to what we currently know as the University of Michigan Consumer Sentiment Survey. The survey is conducted through calling over 500 households to determine their preferences and expectations for the future.
It is very important to understand that getting to the point where a phone survey with 50 questions is used to determine the attitudes and opinions of consumers wasn’t an easy process. Chief among the critics of consumer surveys, initially, was the Federal Reserve Board, the very institution that was funding the project.
It took considerable effort on the part of professor George Katona to impart the value of collecting the necessary survey data. In addition, competing surveys, vying for funding and prestige, sprung up attempting to garner more attention and better outcomes. In the end, inertia and lack of better results led to Katona’s Consumer Sentiment Survey to become the preeminent survey in the nation.
University of Michigan Consumer Sentiment Survey: January 1978 to January 2019
According to Richard Curtin’s “George Katona: A Founder of Behavioral Economics”:
“Perhaps the most interesting postscript to the debates of the 1950's is what has proven to be an effective leading indicator over the next half century. The presumed predictive ability of purchase intentions data was tested using large samples and with probability measures by the U.S. Census Bureau in the 1960's. These surveys were discontinued due to its poor predictive performance, although the debates it spanned were also contentious (McNeil, 1974; Curtin, 2004; Dechaux, 2015). In contrast, the approach advocated by Katona has not only survived to this day in the U.S. but has been replicated by six dozen other countries in every inhabited continent in the world (Curtin, 2005). In the U.S. as in most other countries, consumer sentiment measures are recognized as leading economic indicators based on their predictive performance (for a summary, see Curtin, 2005). Notably, the predictive performances of Katona’s measures were at their very best at the most critical times: when the economy was about to turn from expansion to contraction, or visa-versa.(Curtin, Richard. George Katona: A Founder of Behavioral Economics).”
The strength of the University of Michigan Sentiment Survey surrounds the idea that “…the predictive performances of Katona’s measures were at their very best at the most critical times: when the economy was about to turn from expansion to contraction, or visa-versa.” As with the stock market, this ideas is particularly challenging in the moment and abundantly clear well after the fact.
UMCSENT versus DJIA
When viewed from the perspective of the absolute change in each indicator, we find that there is little difference between the stock index over the consumer sentiment indicator.
In both cases of the absolute change, the absence of a range makes it difficult to determine when a level has gone “too high” or “too low” or nearing a reversal. However, what does stand out in the DJIA is that the beginning of the recession is at or near a relative peak and the low appears within the recessionary period. In the case of the University of Michigan Sentiment Survey, a low is achieved within a recession but a relative peak does not occur at or near the beginning of a recession as cited earlier. This gives the Dow Jones Industrial Average a more meaningful indication of when a recession might begin as well as when it might end.
When reflected on a monthly basis from 1976 to 2019, the transition from expansion to contraction isn’t as clear as suggested by Richard Curtin. If measured by the amount of time (in months) from the peak to the beginning of a recessionary period, the shortest amount of time from the peak in the University of Michigan Sentiment Survey is eight months.
Even if we were to take out the UMCSENT peak of September 1984 (71 months), the average length of time would be reduced from 34 months to 20 months, or nearly double that of the DJIA. This makes it difficult to highlight the predictive value at the peak, when in some cases, the amount of time after the top could be almost six years for UMCSENT.
Overall, a simple comparison between the University of Michigan Consumer Sentiment Survey and the Dow Jones Industrial Average on an absolute basis is not easy. After all, when we look at data numbers for the University of Michigan Consumer Sentiment Survey of 93.8 for February 2019 and the Dow Jones Industrial Average at 25,928.68, as of March 29, 2019, there is little relationship that can be made.
However, when we change the data for each indicator to reflect the percentage change from the prior year, we get a useful representation of the data that is relative to each indicator that can also be compared to one another. In the chart below, from 1953-2019, we can see that at the trough of each recession both indexes, the University of Michigan Consumer Sentiment Survey and the Dow Jones Industrial Average, experienced relative lows and reversals within the recessionary period.
In the recession from 1990-1991 & 2001, the University of Michigan Consumer Sentiment Survey gave a better indication of a low and reversal as it was not followed by a lower level in a short period of time afterwards. In the case of the Dow Jones Industrial Average, a significant low was achieved on August 1988 and March 2003. We would consider the DJIA indications to be a failure of predictive value for the recessions of 1990-1991 and 2001.
The recession from January 1980 to July 1980 saw both the DJIA and UMCSENT fail to achieve a low and reversal within the designated recessionary period. However, The University of Michigan Consumer Sentiment Survey provided the closest approximation of a low and reversal nearest the recession period.
Of the 10 recessionary periods from 1953 to 2019, the University of Michigan Consumer Sentiment Survey coincided with relative lows within a recession 90% of the time. Meanwhile, the Dow Jones Industrial Average, over the same period had relative lows 80% of the time. This is a clear distinction between the two indicators. However, in either case, relative lows don’t say much when we considering that the low during the recession of 1960 is distinctly different than the lows of 1974 or 2009.
As indicated earlier, the University of Michigan Consumer Sentiment Survey and its forerunner, the Survey of Consumer Finances, began in and around the 1940’s or 1950’s. With a 90% track record for achieving a low and reversal within a recession, that is a track record that is hard to beat. However, let's look at how the Dow Jones Industrial Average performed from 1897 to 1950.
Of the 13 instances of a recession from 1897 to 1950, the Dow Jones Industrial Average experienced a relative low within a recessionary period 76% of the time. In three instances, the DJIA managed to be in an established rising or declining trend, as indicated by the blue arrows , which we consider to be a failure of predictive value.
The Roots and the Tree
It has been said that the roots of a tree are equal to, or greater than, what is seen above ground. For a homebuilder, when planning the placement of trees, they need to understand the impact of both what is appealing above ground and the implications of the roots and the damage it can cause to the foundation and pipes underground.
Looking at the University of Michigan Sentiment Survey is like enjoying what is above ground while disregarding what also goes on underground. It could be argued that the high level of certainty in the University of Michigan Sentiment Survey, at nearly 90% or above in reversing from a low, is exactly what a consumer or business owner would need for short or long term planning. However, in spite of the quality in the accounting for the reversals at the low, the University of Michigan Sentiment Survey has some short-comings when providing timely indications of a reversal from a peak in the economy. This leaves half of the equation unresolved.
In spite of the DJIA’s significantly lower level of consistency at designated reversals (76% to 78%) from the low, there are considerable benefits in the index arriving at a reversal indication at both the low and high ends of the spectrum. On the whole, Dow’s writing reflected current and future financial conditions which to this day works as a useful indicator of consumer sentiment.
See Also:
Supplemental Material:
Sether, Laura. Dow Theory Unplugged: Charles Dows Original Editorials & Their Relevance Today. W & A Publishing, 2009. page 190.
"There is a pronounced difference between bull markets that are made by manipulation and those that are made by the public. The former represent the effort of a small number of persons; the latter reflects the sense of country on values. It is possible to create a limited public sentiment by manipulation, but the sentiment that endures and sweeps away the strongest interests which oppose it is invariably founded upon general conditions which are sufficiently universal and sufficiently potent to affect the opinions of practically everybody.(Dow, Charles H. Review and Outlook. Wall Street Journal. April 24, 1899.)."
Sether, Laura. Dow Theory Unplugged: Charles Dows Original Editorials & Their Relevance Today. W & A Publishing, 2009. page 130.
”A third factor in estimating the duration of the bull market is the condition of public sentiment. That sentiment is the best indication of the condition of the thousands of lines of business in which the public is engaged. (Dow, Charles H. Review and Outlook. Wall Street Journal. April 25, 1899.)."
Sether, Laura. Dow Theory Unplugged: Charles Dows Original Editorials & Their Relevance Today. W & A Publishing, 2009. page 23.
"The market no longer moves together. On some days, the industrial list has declined while the railway list has advanced. This might easily grow out of a change in speculative sentiment which led operators to buy the railroads and sell industrials. The fundamental reason for doing this would be that the railway list has not been greatly expanded in recent years. There has been little addition to the volume of railway stocks except through the medium of reorganization. The growth of the business of the country accrues on the old stocks (Dow, Charles H. Review and Outlook. Wall Street Journal. May 31, 1899.)."
Sether, Laura. Dow Theory Unplugged: Charles Dows Original Editorials & Their Relevance Today. W & A Publishing, 2009. page 69.
"There can be no doubt about the bullish character of the stock market. Its present activity and strength are the result of a full appreciation of the splendid condition of the country from nearly all standpoints. It is often said that the stock market discounts a change in the condition of business. This may usually be the case, but in this instance the bullish sentiment is more in the nature of the appreciation of a result. Prices of commodities and manufactured product are on a higher and firmer basis than ever before and it is not strange that the prices of securities representing them should also seek a higher level of value (Dow, Charles H. Review and Outlook. Wall Street Journal. November 3, 1899.)."
Sether, Laura. Dow Theory Unplugged: Charles Dows Original Editorials & Their Relevance Today. W & A Publishing, 2009. page 136.
"Sustained sentiment lasts for months. The sustained sentiment of the public in a belief that the market is going to be better or going to be worse is one of the most powerful factors in speculation. and when it is widespread Will defeat the strongest speculative combinations which may be working against it. "Everybody," said Mr. Vanderbilt. from experience "is stronger than anybody. (Dow, Charles H. Review and Outlook. Wall Street Journal. December 30, 1899.)."Sether, Laura. Dow Theory Unplugged: Charles Dows Original Editorials & Their Relevance Today. W & A Publishing, 2009. page 70.
"The large operator is of necessity a close student of existing conditions in their relation to money, business, politics and public sentiment over the civilized world.(Dow, Charles H. Review and Outlook. Wall Street Journal. January 8, 1900.)."Sether, Laura. Dow Theory Unplugged: Charles Dows Original Editorials & Their Relevance Today. W & A Publishing, 2009. page 103.
"We referred some days ago to the fact that the market was controlled by sentiment, manipulation and business conditions as they worked out in the form of increasing or decreasing value of railway and industrial stocks. (Dow, Charles H. Review and Outlook. Wall Street Journal. January 15, 1900.)."Sether, Laura. Dow Theory Unplugged: Charles Dows Original Editorials & Their Relevance Today. W & A Publishing, 2009. page 103.
"This movement of the market is made, to considerable extent, by professional traders who are influenced chiefly by sentiment. (Dow, Charles H. Review and Outlook. Wall Street Journal. January 15, 1900.)."Sether, Laura. Dow Theory Unplugged: Charles Dows Original Editorials & Their Relevance Today. W & A Publishing, 2009. page 253.
"The main speculative question is whether the market is likely to have its spring rise from about this level or whether there will be first some days or weeks of decline. Large operators are divided on this point and commission houses are not clear. Those who are definite in their predictions disregard to a large extent the facts presented by the opposing side. It is clear from this that the street is not at all a unit in its forecast and this will probably have a tendency to keep the market rather narrow until sentiment begins to lean definitely to one side or the other. (Dow, Charles H. Review and Outlook. Wall Street Journal. January 18, 1900.)."Sether, Laura. Dow Theory Unplugged: Charles Dows Original Editorials & Their Relevance Today. W & A Publishing, 2009. page 33.
"There have been essential changes in rates for money, although falling bank reserves have exerted a little influence on sentiment (Dow, Charles H. Review and Outlook. Wall Street Journal. March 5, 1900.)."Sether, Laura. Dow Theory Unplugged: Charles Dows Original Editorials & Their Relevance Today. W & A Publishing, 2009. page 108.
"The establishment of a gold standard has had a good effect on sentiment abroad as far as increasing purchases of American stocks are concerned, and a still greater effect may be felt her¢after. (Dow, Charles H. Review and Outlook. Wall Street Journal. April 28, 1900.)."Sether, Laura. Dow Theory Unplugged: Charles Dows Original Editorials & Their Relevance Today. W & A Publishing, 2009. page 46.
"The market continues broad with an upward tendency. There is constant realizing, some of it on a large scale, but the largest interests give support when it is needed and then by judicious stimulation of one stock or another bring enough buying to retain and slowly increase bull sentiment."A great many people are buying stocks with the expectation of having to run in a great hurry on some unfavorable news before the election. Some of these people sell on the small declines that come along, but buy their stocks back again the next day, when it transpires that the dreaded slump has not yet arrived. Perhaps the large operators play a little on this condition of sentiment. (Dow, Charles H. Review and Outlook. Wall Street Journal. October 25, 1900.)."
Sether, Laura. Dow Theory Unplugged: Charles Dows Original Editorials & Their Relevance Today. W & A Publishing, 2009. page 114.
"Large operators, especially if they are in for an extended campaign, a re always sorry to see too great confidence on the part of the public: as this always means pyramiding and the creation of a weak account which breaks down and makes trouble. It is, therefore, the part of wise manipulation to create enough uncertainly in regard to the course of the market to keep accounts within reason and at the same time maintain a strong bull sentiment. Something of this kind may be under way. (Dow, Charles H. Review and Outlook. Wall Street Journal. November 14, 1900.)."Sether, Laura. Dow Theory Unplugged: Charles Dows Original Editorials & Their Relevance Today. W & A Publishing, 2009. page 136.
"The market is governed by sentient, manipulation and facts. Sentiment rests on facts as they are supposed to exist, but the supposition is often wrong. Manipulation on a large scale is always in line with essential facts for the long run. but temporarily is often directly opposed to the facts. (Dow, Charles H. Review and Outlook. Wall Street Journal. December 30, 1899.)."Sether, Laura. Dow Theory Unplugged: Charles Dows Original Editorials & Their Relevance Today. W & A Publishing, 2009. page 136.
"It is evident, therefore, that whether speculation is considered from the standpoint of sentiment or of manipulation, it all comes back to a question of facts. The small operator who can foresee the facts correctly for next spring can trade in stocks with full confidence that he is doing very nearly what the largest operators are doing. (Dow, Charles H. Review and Outlook. Wall Street Journal. December 30, 1899.)."
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