The Google Panic Indicator

This might be the worst recession in a generation if only for one reason: People are choking on more information than ever before.

Yes, dozens of factors contributed to the downturn. But there's something to be said for the fact that the unprecedented flow of information -- a lot of it bogus -- greatly contributed to fear and panic. In past recessions, the average Joe's awareness was contained to a morning newspaper and an infrequent chat with a stockbroker. Today, we're inundated with constant CNBC coverage, millions of blogs and message boards, hourly email updates, text-message alerts, Tweets, and cell-phone stock tickers. No matter who or where you are, you're bombarded with opinions.

Now, no one's claiming that this flow of information is inherently bad. Of course, it's a wonderful thing. But it can, and does, accentuate emotions. Those who aren't interested in the economy can't hide from the headlines. And those who are interested get bombarded with so much useless and repetitive information that their ability to think rationally and independently is squashed. A herd mentality arises.

Into sight, into mind                                                                                                 
For example, consider what former Treasury secretary Larry Summers recently said:

Fear was widespread and confidence was scarce. Traditional measures of consumer and business confidence fell to low levels not seen in decades. The anxiety stretched well into the mainstream. Take one example as an indicator: Google searches for the term "economic depression" were up fourfold from their pre-crisis levels. 

I find that fascinating: Google (NASDAQ:GOOG) has become so ubiquitous in our lives -- much to Microsoft's (NASDAQ:MSFT) and Yahoo's (NASDAQ:YHOO) consternation -- that tracking Google search terms is now used to measure an economy's state of mind.

Intrigued by Summers' Google gauge, I used Google Insights to look up the number of searches conducted on various terms. The results, not surprisingly, show how things have mellowed out since the world collectively went into cardiac arrest in the past year:

*As of July 20, 2009.

Since last fall, search queries for doomsday-related terms have steadily plunged. For many terms, these searches are back down to normal levels. That's encouraging news, despite the abyss that might yet lie ahead.

Search terms synonymous with the boom years have also, thank goodness, petered out:

*As of July 20, 2009.

OK. What's this have to do with my investments?
More than you might think. We can safely guess that if someone's searching for information about building a bunker, that person isn't too confident about the economy. And confidence is exceptionally key to a recovery. Businesses need confidence to hire workers. Workers need confidence to innovate. Everyone needs confidence to invest. The unemployed even need confidence to go out and look for work.

What's more, when it comes to stocks rebounding out of a recession, there's probably no better indicator than consumer confidence -- even though that's something notoriously impossible to predict beforehand. Here's how things turned out in previous recessions:

*Still anyone's guess whether this is the bottom.

This is hardly a perfect gauge, and many other factors are at play. But the correlation between consumer confidence and stocks is pretty tight. The two usually bottom out within a few months of each other.

And the correlation makes sense: For most people, the stock market is the primary indicator by which to judge the economy, and vice versa. Is it coincidental that confidence bottomed out this year at nearly the exact time companies such as Alcoa (NYSE:AA), Wells Fargo (NYSE:WFC), and General Electric (NYSE:GE) hit bottom as well? Not at all. Declining share prices erode confidence, and eroding confidence ignites more selling.

That's how these things work. Confidence begets confidence, and panic begets panic. The two feed on each other and largely dictatewhere we're heading. And that's why it's encouraging -- albeit mildly -- that the panic showcased in a list of Google search terms has, for now, subsided.

For related Foolishness:                                                                                                       

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