The US consumer boom is over. Official figures show that retail sales were lower in October than in July.
This should worry equity investors. Our chart shows that the ratio of consumer spending to net wealth has been a useful predictor of changes in the S&P 500 in the following two years. When spending is high relative to wealth shares subsequently rise. And in when spending is low relative to wealth shares subsequently fall.
An influential paper (pdf) by Martin Lettau and Sydney Ludvigson, two US economists, says: "Fluctuations in the consumption-wealth ratio are strong predictors of both real stock returns and excess returns over a Treasury bill rate." Indeed, they estimate, it's an even better predictor than the dividend yield.
The consumption-wealth ratio is now well below its long-term average, which augurs badly for the market.
The standard explanation for this is that consumer spending embodies the wisdom of crowds. Low spending is a sign that consumers see bad times coming, and so are hunkering down. As these bad times materialize, shares fall.
You might object that consumers are wrong this time; the US economy will continue to thrive. According to Consensus Economics, economists expect real GDP to grow a healthy 3.3 per cent next year, after 3.5 per cent growth this.
However, a new paper (pdf) by Sean Campbell and Francis Diebold, two US economists, suggests that this optimism is, paradoxically, bad news.
They've studied 50 years of GDP forecasts, as complied by the Livingston Survey of Professional Forecasters, and found that high forecasts lead to falling share prices. "Growth expectations have a robust negative impact on expected excess returns" they conclude.
What's more, this is true even controlling for the consumption-wealth ratio.
This is really bad for investors. It means the current combination of low consumer spending and professional forecasters' optimism, is the worst possible one for future share prices.
How come? There are two different things going on here, say Campbell and Diebold.
A low ratio of spending to wealth, they say, implies low aversion to risk, and therefore low expected returns. This might be because fluctuations in this ratio are due in part to changes in share prices. High share prices - and hence a low consumption-wealth ratio - are a sign of low risk aversion and hence low expected returns.
By contrast, they say, optimism about GDP leads to low risk - that is, low market volatility; economists agree that market volatility is counter-cyclical. And this, in turn, also leads to low equity returns.
Maybe then the outlook for the US market is poor not despite the optimism of professional forecasters, but because of it.
