Consumer Confidence Just Tanked -- and That Could Be a Great Sign for the Stock Market

Pessimism is growing among American consumers. The University of Michigan's preliminary results from its survey of consumers for November fell 6.2% from October and plunged 29.9% year over year. The consumer sentiment index reached its lowest level in three years.

There are plenty of reasons behind the negativity. Americans' current personal financial situations have deteriorated. The longest federal government shutdown in history continues to drag on. Inflation is rising, with prospects of further increases as the full brunt of the Trump administration's tariffs is felt. The U.S. experienced its worst month for corporate layoffs in October since 2003, according to a report from global outplacement company Challenger, Gray & Christmas.

Should investors worry about all this bad news? Not necessarily.

Image source: Getty Images.

Surprising history

Historically, low consumer sentiment levels haven't been as bad for stocks as you might expect. For example, the University of Michigan Consumer Index fell to a low of 50 (near the current level of 50.3) in mid-2022. The S&P 500 (SNPINDEX: ^GSPC) bounced over the near term before falling again. Importantly, though, within a few months, a new, strong bull market began.

US Index of Consumer Sentiment data by YCharts

A similar pattern occurred in 2011. The consumer sentiment index tumbled to 56. The stock market didn't sink. Instead, the S&P 500 rallied shortly afterward.

US Index of Consumer Sentiment data by YCharts

What about when consumer sentiment hit rock bottom during the financial crisis in 2008? Sure, the S&P 500 declined further for a short period. However, the index soon began a strong rebound.

US Index of Consumer Sentiment data by YCharts

When consumer sentiment reached a nadir in 1980, the S&P 500 had already begun to bounce back from its low. That momentum continued through the rest of the year.

US Index of Consumer Sentiment data by YCharts

Why the stock market has often behaved unexpectedly

Clearly, the stock market has often behaved unexpectedly in the past when consumer sentiment tanked. But why?

Probably the best explanation is that consumer sentiment is backward-looking, while the stock market is forward-looking. Consumer sentiment is typically considered to be a lagging indicator, which means that it reflects events that have already occurred and doesn't predict future events.

Another potential factor is that government policy changes are already either under way or will soon be made by the time consumer sentiment reaches a low point. The Federal Reserve could have read the tea leaves and begun to cut interest rates, or the U.S. Congress could have passed economic stimulus legislation to help consumers.

Several investing adages support the idea that dismal news, such as a very low consumer sentiment index, could present a great opportunity to buy stocks. "Buy when there is blood in the streets" is a good example. So is "the stock market climbs a wall of worry."

Will history repeat itself?

Could the past precedents, where the S&P 500 performed well shortly after consumer sentiment bottomed out, bode well for the stock market now? Perhaps.

The University of Michigan's latest consumer sentiment survey might provide some reason for optimism. Although expectations of inflation over the next year rose slightly in November, long-run inflation expectations declined and are lower than they were a year ago. Also, not every American consumer was gloomy in the recent survey. The sentiment of consumers with the largest top third of stock holdings increased 11% from the previous month.

There's no guarantee that history will repeat itself this time. However, bad news from the University of Michigan's widely followed consumer sentiment survey just might be good news for investors yet again.

Keith Speights has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.