Consumer confidence: stock market implications

The Conference Board Consumer Confidence Index

The Conference Board, a private economic analysis company, released the latest figures for its Consumer Confidence Index on February 23.  They showed a sharp, and unexpected, drop in consumer sentiment.  What does this mean?

How it’s calculated

The Conference Board hires an outside surveying firm to poll 5,000 families each month.  They answer five questions concerning their assessment of:  job prospects today, job prospects in six months, overall economic activity today, activity in six months, and the family’s income in six months.  The answers can only be:  positive, neural or negative.

The Conference Board throws out the “neutrals” and calculates the percentage of positives in the group of positives + negatives (for what it’s worth, this is called a diffusion index). It then compares its results with those of a base year, 1985, to come up with the final result.

The Board also produces two sub-indices, the Present Situation and Expectations Index.

What the interviewees said

They’re the most pessimistic they’ve been since 1983 about the current situation.  It only took a few respondents swinging from positive to negative to achieve this result (where have they been the past three years?).  And I think that historically the Present Situation index has had less predictive value than the Expectations Index.

Expectations about what the economy will look like in mid-summer have also deteriorated, however, after months of steady improvement.  And the numbers of respondents shifting from optimism to pessimism is considerably larger.

How Wall Street uses this information

Economists argue that there’s a direct relationship between consumers’ confidence and their spending behavior.  A dip in consumer expectations about the path of economic recovery, therefore, may be signaling that retail spending is about to fall off.

There’s some question, though, as to whether sentiment indicators give much insight into future economic activity or are simply reflective of conditions as they are today.  Certainly, other survey information like business confidence, employment trends or overall leading economic indicators are all continuing to tell a more positive story.  In addition, publicly-listed consumer companies have by and large been saying that the economy is past the worst and business is picking up.

Can Wall Street be good if consumer confidence is bad?

No, if confidence remains depressed for, say, another year.  But there are several factors that argue the stock market can do well, despite poor consumer confidence numbers.

–this is the worst economy for the US in the past seventy years, and one of the longest recessions, so it would be surprising if consumers weren’t feeling bad.  Remember, too, that the previous low point was in 1983, an economic recovery year.  So confidence can act at times as a lagging indicator.

–in the textbooks, economic recoveries start by low interest rates stimulating industrial production.  That spending results in companies hiring new workers, sparking consumer spending as the second leg of the upturn.  In past recessions in the US, however, this order has been reversed.  Consumer spending has come first, triggering hiring and then industrial expansion.  But this time around, the banking crisis has destroyed the housing industry, a key engine in consumer spending revival.  So, I think, we’re going to have a “textbook” recovery.  This means new hiring will come later than normal in the cycle.  Peoples’ expectations are being disappointed–but maybe only for six months.

–I think that for years to come there will be a higher level of structural unemployment in the US than we are used to.  Though not really hard evidence, a recent story in the New York Times about “The New Poor” illustrates what I mean.  The problem of older, less skilled, computer-illiterate workers has been with us for a decade or more, but has been disguised by the artificial economic vigor induced by the housing boom.  This is a national tragedy.  And the negative responses to consumer sentiment surveys from the long-term unemployed and their relatives and neighbors will likely depress consumer confidence indices for a long time to come.

Taking off my hat as a human being and putting on my hat as an investor, however, it seems to me that this 5% or so of the population will have very little effect on the profits of publicly-traded companies that cater to US customers. (For example, look at my post on an FDIC study showing that 25% of US households, most of them less affluent, are outside the mainstream banking system.) Revenue growth may be a little slower, but profit growth may not be affected at all.

–Looking at the composition of the S&P 500, half the revenue comes from outside the US.  The consumer discretionary sector, where the brunt of the falloff in spending will likely be felt, comprises about 11% of the index.  Let’s say that this group gets all its revenue from US customers (the high end has lots of foreign revenue, though).  If we assume it loses 5% of its customers (which is too high) that comprise 2% of its revenue (again too high), profits may be 2%-4% less than they would be otherwise.  The effect on the S&P as a whole?  –a loss of .20%-.45% to the index growth rate.

Again, I don’t mean to minimize the social and political cost of having a permanent underclass of older unemployed citizens.  But the numbers alone seem to argue that the S&P will be relatively unaffected.

2 responses

  1. Good insights, as usual. I wanted to add a thought about the impact of the growing, older, underclass. While they may not have a direct impact on the S&P profits, or the mainstream banking system, it is likely that, with not much else to do, they will vote. Unskilled, disengaged, and frustrated, I worry that they will support candidates that will cater to their short term needs, and not those that favor longer term viability.

    Arguably these older workers should be trained and incented to continue to contribute, productively, going forward, and not be left to position themselves for a long, slow decline, fighting for transfer payments and tax breaks….heck, the same argument could be made some older industries!

    • Thanks for your comment. I think you’re right.

      I think people are only beginning to realize how much national wealth was destroyed in the past decade by reckless banks and legislators/regulators who were asleep at the switch. So far only Washington and the top management of banks seem to have emerged from the financial crisis unscathed. I agree with you that there will be a visceral electoral response to the feeling that this is just wrong. The Tea Party movement is probably the initial sign of it.

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