Consumer Credit and Stock Returns

Some investing experts cite consumer credit as a potentially important indicator of future stock market behavior, hypothesizing that an expansion (contraction) in credit indicates growing (shrinking) corporate sales, earnings and ultimately stock prices. Is there a reliable relationship between historical variation in consumer credit and stock market returns? The Federal Reserve collects and publishes U.S. consumer credit data on a monthly basis with a delay of about five weeks. Using monthly seasonally adjusted total U.S. consumer credit data for January 1950 through May 2010 and monthly S&P 500 Index closes for January 1950 through June 2010 (725-726 months), we find that:

The following chart depicts total U.S. consumer credit and the S&P 500 Index over the entire sample period. Both series have generally risen as the U.S. economy grows (and inflates), but the stock market is far more volatile than consumer credit. Visual inspection is not helpful in discovering any actionable relationship between the two series.

To dig deeper, we relate changes in the two series.

The following scatter plot relates the S&P 500 Index monthly return to the same-month change in consumer credit over the entire sample period. The Pearson correlation between the two series is -0.01, and the R-squared statistic is 0.00, indicating that monthly variations in consumer credit explain nothing about concurrent monthly stock market movements.

The Federal Reserve releases monthly consumer credit data with a delay of about five weeks, so investors know the change in consumer credit with about a one-month delay. The Pearson correlation between the S&P 500 Index monthly return and the prior-month change in consumer credit is -0.03, with R-squared statistic again 0.00, over the entire sample period.

To investigate potential non-linearity in the relationship we consider average monthly stock return by decile of change in consumer credit.

The next chart summarizes average S&P 500 Index returns across deciles of ranked changes in consumer credit, with the latter lagged by one month to account for the release delay. For example, the change in consumer credit for May 2010 relates to the change in the S&P 500 Index for June 2010. There are 72-73 observations per decile. There is some indication that extreme contractions in consumer credit indicate relatively strong stock returns the next month, but the relationship between change in consumer credit one month and stock market returns the next month appears largely random.

Standard deviations of returns within deciles are generally higher for low deciles than high deciles.

Might changes in consumer credit lead changes in stock market returns by some interval greater than one month?

The next chart summarizes correlations for lead-lag relationships between monthly S&P 500 Index returns and monthly changes in consumer credit ranging from stocks lead consumer credit by 18 months (-18) to consumer credit leads stocks by 18 months (18). There is some indication that stock returns lead changes in consumer credit by many months, but there is little or no indication that changes in consumer credit lead stock returns.

To investigate further, we look at annual changes.

The final two charts relate annual S&P 500 Index returns and annual changes in consumer credit, offset by one year to investigate whether stocks lead consumer credit or vice versa. For both charts, the 12-month change in consumer credit lags the 12-month change in the S&P 500 Index by one month to account for release delay. Sample size is 60 annual observations.

The first chart indicates that annual changes in consumer credit explain nothing about next-year stock market returns.

The second chart indicates that annual stock market returns explain 13% of next-year changes in consumer credit. The relationship is positive, so a strong (weak) stock market indicates future credit expansion (contraction). Results suggest a somewhat diffuse wealth effect, wherein high (low) equity prices encourage (discourage) consumer borrowing and bank lending.

In summary, evidence from simple tests does not support a belief that consumer credit is a useful indicator of future stock market behavior. There is some support for a belief that bull (bear) stock markets predict future credit expansions (contractions) over many months.

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