It was widely reported today that consumer confidence has fallen to an all-time low. Here’s the story in the Washington Post. I’ve mentioned the Odd-Lot Theory in prior posts. It and other contrarian theories of investing would take this as good news. The general idea is that when things look worst they are about to turn around. Warren Buffet has been widely quoted as saying, “We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”
There is much merit to contrarian investing, but like all investing theories it has limitations and false signals. A number of indicators have signaled multiple “bottoms” over the past year only to be followed by new lows. Consumer confidence, for example, hit a previous new low in October.
It could be that consumer confidence is at a record low because the economy is truly in very bad shape and it may not be a contrarian indicator at all. In fact, record low consumer confidence could reinforce a deteriorating economy as consumers pull back on purchases.
As stated by George Loewenstein, a professor of economics and psychology at Carnegie Mellon University,
Because I study the role of emotions in economics, a lot of people have been asking me questions about whether the current downturn is driven by irrational negative emotions, such as fear and anxiety, with the implicit assumption that if we could only calm these emotions, things might return to normal.
It’s possible that those emotions do play some role, especially in the collapse of credit markets, but it isn’t obvious to me that the anxiety and pessimism are unfounded. People have good reason to be fearful.
Every investor who doesn’t have his or her head in the sand is struggling with the question of whether the economy and stock markets have bottomed out or have a lot further to fall. Unfortunately, no one knows the answer, which creates a lot of uncertainty and a lot understandable misery as a result of not knowing how one should behave.