Tuesday, August 28, 2012

Consumers remain uncertain in spite of increased net worth

The weak consumer sentiment number today was a surprise. After all, the S&P500 index is up 13.7% year to date (including dividend). The recent equity market rally should have boosted the consumer net worth and improved consumer confidence.

A quick empirical analysis (below) shows that a large portion (r^2 =84%, beta = .33) of the change in consumer net worth is explained by the moves in the stock market. This is a recent relationship, as the US consumer exposure to equities has been larger over the past 20 years than previously (the relationship was weaker during the previous 30 years: r^2 = 68%, beta = .18).

Source: Bloomberg

In fact the US consumer wealth has increased considerably since the financial crisis, to a large extent driven by the stock market (particularly given that housing has been stagnant until very recently).

Source: ISI Group

But increased wealth does not seem to be improving how consumers feel. Actually over the past few months the divergence between consumer sentiment and the equity market (which reflects improved net worth) is quite striking.

Source: Bloomberg

Something is spooking the consumer enough to cancel out the effects of the market rally. And the divergence is not just with the market. The recent uptick in the Citi Economic Surprise Index - indicating better overall economic data - is also not reflected in the sentiment trend.
WSJ: - Perhaps more worrisome, though, is the divergence between some of the hard economic data – such as jobs, manufacturing and housing reports – compared to soft data such as sentiment surveys. Much of the hard data have gotten better this summer, as measured by Citigroup’s Economic Surprise Index, which has risen in each of the last four straight weeks. But sentiment surveys are still lagging.
Part of the explanation is that the consumer is not as worried about the current situation (including a strong stock market) as she is about the future. The "present situation" portion of the Conference Board index was basically flat, while the "expectations" component was down 7.9. The consumer is not confident in her ability to retain this improved net worth.
LA Times: There was little change in how consumers viewed their current situation. For example, 34.4% of people surveyed said business conditions right now were bad, the same percentage as in July. And 40.7% of those surveyed in August described jobs as "hard to get," down slightly from 41% a month earlier.

But consumers' long-term view headed south. The percentage of respondents who expected business conditions to improve over the next six months dropped to 16.5%, from 19% in July. And 23.4% of those surveyed in August said they expected the economy to produce fewer jobs in the same upcoming period, up from 20.6%.
Not surprisingly the poor "forward looking" sentiment is also visible in the increased steepness of the VIX curve (discussed earlier).

The US fiscal cliff (see discussion), the Eurozone uncertainty (particularly with the scary looking September calendar), the upcoming election, and weak labor markets are some of the more common explanations for poor consumer expectations.
WSJ: - “Households continue to worry about a difficult job market, the European debt crisis, the upcoming ‘fiscal cliff,’ and the political wrangling in Washington and in the presidential campaign,” says Steven Wood, chief economist at Insight Economics.
But the spike in gasoline prices and the expectation of rising food prices due to the drought could be even more damaging to confidence, because consumers face these cost increases on a daily basis. Related to this, the US consumers are also concerned about the possibility of QE3, which may exacerbate the "headline inflation" (fresh in consumers' memory from 2011). As discussed before (see this post), even the anticipation of asset purchases by the Fed could have negative ramifications on the US consumer (in spite of driving equity prices higher).

Whatever the case, the divergence between economic indicators that have trended up recently (particularly the equity markets) and consumer confidence can not continue indefinitely. Something's got to give. The concern of course is that consumer sentiment in the long run could end up being more accurate than other forward looking indicators.
WSJ: - At some point, both sets of data points will start moving closer in tandem. “By its very nature this divergence is unlikely to persist,” ... “Our expectation is that the convergence will be toward the sentiment indicators, suggesting that the current upturn in economic momentum could prove fleeting.”

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