confidence and narratives

Two recent items coming across my inbox:

I’d known there has been a striking favorable turn in consumer confidence in the US since the presidential election, but I hadn’t focused on how large a jump there has been until I read the latest strategy piece by Jim Paulsen of Wells Fargo.  We’ve gone from being mired deep in the bottom half of confidence readings over the past thirty years to high in the top quartile–over the 90% mark by some measures, and at the highest levels since before the Internet bubble burst in early 2000.

Paulsen’s conclusion:  earnings growth may be higher, and stock market performance in 2017 better, than the consensus expects.  I’m not sure I’d bet the farm on this, but it is at the very least a reason to refrain from selling–and to be wary of becoming too defensive.


I’ve also read the Presidential Address for the American Economics Association, titled Narrative Economics, by Robert Shiller, a former Wall Street economist who is now a professor at Yale (he’s also the Shiller from the Case-Shiller Home Price index).

I’ve never been a particular Shiller fan, and this is a weird paper, but it’s relevance is in its attempt to identify and measure the psychological influences that affect economic performance.  Its point is that story lines like those encapsulated in slogans like “Drain the Swamp” or “Make America Great Again” can have an unusually strong positive influence on actual economic outcomes.  This can come well in advance of delivery on the promises being made.  So even though my reading of Donald Trump’s career is that his sole personal success has been as an actor portraying a successful businessman on a reality show, it may be that his being a symbol of the need for change may be enough to energize the US for a while.  If he actually can achieve tax reform and an infrastructure spending program, so much the better.



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.