Tuesday, February 23, 2010

Confidence is weak, but so what?

Consumer confidence, according to the Conference Board's survey, unexpectedly fell this month (it was expected to hold steady, according to Bloomberg's survey), and this news today helped push the stock market down and the bond market higher. I have never paid much attention to confidence indicators, since they are reliably lagging indicators of what is going on in the economy. As this chart shows, confidence typically declines well after the end of recessions, and usually hits  new highs just before recessions begin. If anything, this chart is a great contrary indicator, and today's news should be taken as bullish. Consumers are usually the last ones to realize the economy is doing better.

For comparison purposes, the next chart shows confidence data as put together by the University of Michigan. Although their survey also declined in February, it was a very modest decline, and the trajectory of the index since the end of this recession has been noticeably stronger than the Conference Board's.

In any event, it's difficult to imagine consumer confidence improving significantly between now and the November elections, mainly because unemployment is likely to continue to be unusually high. There will be lots of talk this year about how this is another one of those "jobless recoveries." This in turn will predictably lead to more calls for another "stimulus" bill or "jobs package." That of course is exactly what we don't need. In my view, one of the main reasons this recovery has been unimpressive to date is the massive amount of stimulus spending that was approved last year. Most of the "spending" authorized by those bills was in the form of transfer payments, and those do little or nothing to create jobs or growth. What we are left with is more government interference in the economy, and a much higher debt burden. This in turn creates expectations of much higher tax burdens, and that stifles the incentives to take risk and create real jobs.

But even though confidence is low, it can improve slowly, as can the economy. We don't need new jobs to have a stronger economy, since the existing workforce can work harder and more efficiently, as indeed it has over the past year—nonfarm worker productivity rose an impressive 5% in the nine months ended last December. Over time, productivity tends to be about 2% per year; add this to a meager 1% growth in jobs (which is not enough to bring the unemployment rate down, since the workforce tends to grow about 1% a year) and you get economic growth of 3%. I've been saying we are likely to see growth of 3-4% this year; that's above the market consensus, but it is still consistent with only a very modest decline in the unemployment rate, and continued low readings of consumer confidence.


UFormula said...

Dunno Scott...looks like it's "an important driver of this recovery" According to your post written less than 2 weeks ago.


Scott Grannis said...

Good point. The point of this post (as I should have made clearer) is that a drop in confidence in any one month doesn't necessarily derail the recovery. I see confidence returning slowly and in a lagging fashion. As confidence slowly returns, money velocity slowly rises, and this should continue to be an important driver of this recovery.

septizoniom said...

you really should be more circumspect and balanced in your assessments. gullible people or people without as much sophistication may rely on your advice due to your credentials. i am not sure what agenda you have, but i will say your preturnatural boosterism warrants re examination.

Scott Grannis said...

Could it be that my position seems preternaturally optimistic because the market is still extremely pessimistic?

I'm not arguing for a huge recovery; 3-4% growth in the current environment is going to leave most people very disappointed.

The consensus view of 2-2.5% growth is extremely pessimistic given the depth of the recent recession.

Corporate profits have almost doubled since 1998, but the S&P 500 hasn't budged. I'm calling for 10-15% gains this year, but that would still leave equities at bargain levels.

I have been saying for many months that unemployment will remain uncomfortably high for a long time.

My most radical positions have been a) to predict that Obama would not be able to advance his agenda, since he was way too far to the left of the electorate, and b) the economy was not going to experience the deep depression and deflation that was priced into the market early last year.

I have built my optimism on a rejection of the market's extremely pessimistic hypotheses. So far I have been exactly right. The rally in stock and bond markets to date has been mainly a recovery from extremely depressed valuations.

septizoniom said...


Jake said...

rodrigo- ditto

Bill said...


Assuming that most money managers are experienced and can understand your very reasoned analysis, why would they react so negatively to a one month drop in consumer confidence? I can understand selling if quarterly profits fall short, or if some other robust economic stat drops, but what drives the seemingly emotional reactions to this other stuff (I confess I don't trade often and keep most of my investments in a retirement account)

Slinkeroz said...
This comment has been removed by the author.
Slinkeroz said...

It is worth noting that there is a strong seasonal tendency for the Consumer Expectations index to decline in February – down in 22 of the last 33 Februarys and the last 11 in a row.

Anonymous said...

You say corporate profits have doubled since 1998, but the S&P hasn't budged, and use this as a basis for arguing that stocks are undervalued. Could it just be that stocks were overvalued in 1998? Future returns are not determined simply by earnings, but by the price one pays for those earnings.

As for consumer confidence, you set up a straw man. No serious analyst would point to yesterday's number as proof of anything. We all know the recession has ended - even the Fed has declared it so!!! The question is the future. Some might argue that a 75% rally in stocks and a massive tightening in spreads beginning last March discounted this recovery. The question is the future. As today's prices, equities are discounting continued strong profit growth. If growth disappoints, so will equities.

Scott Grannis said...

Sneak: I apologize for the brevity of my remarks here in the Comments section. I have discussed a lot of this in greater detail in posts going back over a year or so.

As for profits and P/E ratios: I'm referring here to NIPA after tax corporate profits, but even GAAP profits have increased hugely since 1998. P/E ratios were not unusually high then by either measure, so I think my point remains valid: valuations look much more attractive today than they did then.

Consumer confidence slipping is just one of many things the market has been worrying about of late, and I typically try to put things into the larger perspective.

Over the past year the main thrust of my analysis has been to show that one year ago the market was priced to a horrible depression and deflation. I think the recovery in prices since then is largely the result of that likelihood failing to materialize. I don't see any sign that the market is getting ahead of itself. Credit spreads for example are still at levels that were consistent with the onset of nasty recessions in the past. I've posted on this subject numerous times.

I think the market today is priced to a very weak recovery and/or some chance of a modest double-dip. In contrast, I think we will see 3-4% growth. That's not all that difficult, but it is a lot more optimistic than the market I think.