04/11/2002: "An Imperfect (But Very Real) Relationship"
Stock market volatility is a way of life these days. The slightest signal and the sell offs begin. Buying sprees happen for little apparent reason, though not often enough for all the folks who are still waiting for their portfolios to regain lost ground. As I’ve said before, good economic news is often bad for the markets while negative news can send stocks into positive territory. (Overemphasis on anticipating what the Fed might do if the news is too good is a big part of the reason for this seeming lack of logic.)
I have often said that information drives the market. A study was released this week suggesting that the emphasis on consumer confidence is misplaced because, in fact, there is little relationship between consumer sentiment and actual consumer spending. I disagree—sort of.
This announcement makes some sense, of course, if you stop and think about it. The consumer confidence surveys generally measure an emotional state—the degree of our feelings of well being, if you will. Most of the time, how we view the world has something to do with our economic prospects. But there are notable exceptions. The most recent example in the negative direction is, of course, last September 11. Confidence measures dropped like rocks. One would have thought the brakes would be put on consumer spending as well, but not so. Instead, Americans went out and bought cars in record numbers the following month.
We took advantage of great financing deals and a patriotic rallying cry to spend, spend, spend. Although September 11 did devastating things to our national psyche, it hardly touched the pocketbooks of the vast majority of Americans. Yes, there was an economic slowdown underway which may have dampened some incomes, but the bottom didn’t drop out of our capacity to spend in those few horrific hours. So the pattern of consumer sentiment wasn’t a good indicator of the level of actual spending.
But Wall Street pays close attention to the consumer confidence numbers. If consumers stop spending, after all, the economy slows and all companies’ earnings stand to suffer. There is no doubt that the US is a consumer-driven economy. Thus, it is appropriate for the market to dislike a bleak outlook in the area of confidence. (Ignore for the moment, if you will, that the market also might not like GOOD consumer confidence news either if it sparked fears of perceived economic overheating and—heaven forbid—a potential interest rate hike.)
Is the market wrong? I think not. First of all, there is evidence that the consumer sentiment surveys generally capture whether spending momentum is building or waning. And it is certainly true that the economy will be hard pressed to recover or grow if Americans hoard their money. Just because the patterns in sentiment and spending don’t track hand in hand doesn’t mean they aren’t related. If I feel optimistic about things, I am more likely to spend money. However, no matter how great I think the future will be, my current assets and income are what they are today. We can’t spend our future raises indefinitely, though credit card debt can make it seem that way for a while. (That’s a whole other story we need to talk about at some point.) So no matter how bullish I become, my current financial situation is still a constraint on my spending.
Similarly, gloomy consumers do tend to spend less, dampening the level of economic growth. But the exact nature of the statistical relationship is complex, and few would suggest that a survey can precisely measure what is in people’s heads. The implications for the stock market are even more complicated. In its incredibly omniscient way, the market is considering each bit of information as a part of the whole.
The market does great at reading between the lines. At present, consumers are feeling better than they have in long months, but they’re shelling out extra at the gas pump. Their tax rebate checks are a memory. They wonder if the interest they’re paying out is going to begin to edge up. And so many of them don’t actually spend any more on consumer goods even though they’re feeling better. Some of us just don’t have any more to spend. Just like they didn’t suddenly have less to spend on September 12.
The relationship between consumer sentiment and consumer spending is clearly there, but its imperfect. No huge surprise.