A perspective from E*TRADE Securities1
Confidence is an attribute generally valued in most cultures—particularly when it applies to one’s own abilities and worth. Confidence in others can be a bit harder to come by. If you don’t believe this, try doing a group trust exercise. Just make sure it’s on a soft surface.
But what about confidence in the economy? Turns out, that may have a lot to do with how well your stock portfolio is performing.
Consumer confidence: An inexact science
Every month the Conference Board releases the Consumer Confidence Index®, which details consumer buying intentions and serves as a forward-looking economic weather vane of sorts. Note the word “intentions” and the fact that the index only considers the views of consumers. It’s an unscientific way to make an economic forecast, to be sure—kind of like looking to the western skies to predict the next day’s weather.
But because consumer spending makes up nearly 70% of US GDP, you can understand why economists take measures of consumer sentiment seriously. If consumers expect economic conditions to deteriorate and they budget accordingly, the aggregate impact can be measurable—particularly if readings break from long-term patterns.
Consumer confidence is in decline
That’s exactly what happened over the last three months. After a steady long-term climb, consumer confidence began to drop in November and has been falling ever since. In fact, the Consumer Confidence Index is down 13% since late October—its lowest reading since 2012.1
Source: FactSet Research Systems
Incidentally, the Conference Board also tracks what’s known as the Present Situation Index, which is based on consumers’ assessment of current business and labor market conditions. While down slightly from December, the latest Present Situation Index is more sanguine. The percentage of consumers viewing business conditions as “good” is virtually unchanged from the previous month.1
So, sentiment hasn’t changed much in the present. But consumers aren’t so sure about the future. This invites two questions: Why has consumer confidence fallen so precipitously, and does it really matter?
Why has consumer confidence fallen?
While consumer confidence may appear to be flagging, the effects of the recent government shutdown can’t be ignored. According to the Conference Board, “Shock events such as government shutdowns tend to have sharp, but temporary, impacts on consumer confidence.”1
Consider, too, how volatile the markets were in the fourth quarter. That matters because some economists consider consumer confidence to be a lagging indicator vis-à-vis the stock market (not to be confused with the business cycle). In essence, consumers may be feeling less confident after seeing their retirement funds take a hit.
Does consumer confidence really matter?
If investors are reacting to the markets, does consumer confidence really tell us anything significant? In a word, yes. Because consumer spending comprises such a large part of the overall economy, many economists, including those from the Organization for Economic Cooperation and Development, consider consumer confidence to be a leading indicator in the traditional sense—i.e., a data point that runs ahead of changes in the business cycle.
History lends some credence to that notion. In the chart below, note the sharp dips in consumer confidence just before recessionary periods, shown in grey.
Source: FactSet Research Systems
So, it seems that consumer confidence is something to be taken seriously, though it's far from a scientific bellwether. For now, let’s just call it late-cycle warning sign—one of many signals that the current economic expansion may be long in the tooth.
• Bear in mind that there’s a lot of noise in the latest consumer confidence numbers, including a lengthy government shutdown that may have artificially pressured the data. Consumer confidence in February and March may be more telling.
• Despite many cautionary signs, the markets have been remarkably resilient of late. Consider that, in addition to the government shutdown, investors have stared down an escalating trade war, economic slowing in China, slumping oil prices, and a shift in the political makeup of Congress. And stocks still posted their best January in 30 years.
• A strong secondary matters. To the extent that slumping consumer confidence is sending a cautionary signal, some investors might be considering defensive sectors or even emerging-market stocks, which have performed well even as consumer confidence has eroded.
Ultimately, however, investor decisions should have more to do with personal financial goals than what US consumers believe will happen over the near-term. If an investor can sleep well while others are getting insomnia, that’s a pretty good indication that they’re on the right track.
And that’s what we’d call real confidence.