This fall, economic doom and gloom would seem to be lurking just around the corner.
It’s embodied in fears of fallout from the eurozone sovereign-debt crisis spreading across the Atlantic and the possibility that U.S. lawmakers might not strike a deal during the lame-duck session of Congress to prevent the country from facing an abrupt combination of tax hikes and spending cuts, the so-called fiscal cliff.
In terms of the economy’s performance, the story of the last few months isn’t great, either. Payroll growth has averaged fewer than 100,000 jobs — roughly the amount needed to simply keep pace with population growth — for the past five months. The Federal Reserve Board is so worried about the anemic jobs market that it embarked on a controversial new round of bond-buying earlier this month.
Yet despite the lackluster employment picture and the risk of a big hit to growth from expiring tax cuts and automatic spending cuts, consumers are feeling more optimistic. Just this week, the Conference Board’s Consumer Confidence Index hit a seven-month high. A preliminary reading of the Thomson Reuters/University of Michigan Index of Consumer Sentiment for September shows it climbing to its highest level in four months. After plunging last summer amid the debt-limit standoff, the trend for confidence has been upward and onward. Why?
Ross DeVol, chief research officer at the Santa Monica, Calif.-based Milken Institute, has a simple answer: stock prices. They are the single most important factor for month-to-month changes in confidence. Recent signs that the housing market has stabilized also play a key role, as homes are a major source of household wealth.
“This is kind of the “˜wealth effect’ on consumer confidence, and I think is the principal reason why confidence has rebounded more than you might think in the middle of a eurozone crisis and all the uncertainty surrounding that, the domestic fiscal cliff,” DeVol said.
As of this writing, the S&P 500 is up more than 25 percent from last September. By injecting cash into the economy, the Fed’s bond-buying has helped drive up stock prices, boosting the confidence numbers. “There’s more liquidity in the market, and equity markets love that,” DeVol said.
Amna Asaf, a Toronto-based economist at Capital Economics, cites gasoline as well as equity prices as crucial determinants of confidence. As equity prices have climbed, gas prices have been relatively stable over the past year, rising just 6 percent on a seasonally adjusted basis, Asaf says, helping to account for the rise in confidence.
Although Washington is transfixed by the looming fiscal cliff and the fear that the economy will plunge over the edge, few Americans are paying attention to that right now. The impact on consumer psychology probably won’t show up until November and December, after the election gives way to a discussion about the country’s fiscal future. “My guess is, we’re going to have to get a lot closer and it’s going to have to look a lot more ominous,” said Dean Baker, codirector of the Center for Economic and Policy Research.
CEOs, who are already factoring the impending — and sure to be ugly — tax debate into their forecasts, were much more pessimistic about the future. The Business Roundtable’s third-quarter CEO Economic Outlook Survey, released this week, declined from 89.1 in the second quarter to 66.0 in the third. The downshift, according to Roundtable Chairman Jim McNerney, partly reflects uncertainty surrounding the fiscal cliff. Consumers, who aren’t yet pondering taxmaggedon, have higher hopes for the future: The Conference Board’s expectations index climbed from 71.1 in August to 83.7 in September.
Economists track the confidence numbers, and the expectations index in particular, for signs of whether consumers are likely to open their wallets and help power the economy or stash their money away. Where they disagree is how accurate those numbers are as gauges of future spending.
Marta Lachowska, an economist at the W.E. Upjohn Institute for Employment Research in Kalamazoo, Mich., wrote a paper last summer asking, “What Do Indexes of Consumer Confidence Tell Us?” She concluded that confidence likely does forecast changes in consumer spending by bringing together information that matters to consumers but isn’t independently observable by economists.
DeVol says he has seen the predictive power of the indexes decline over time. Quirks in how the surveys are put together have caused them to weight middle- and lower-income households more heavily in proportion to the broader population. But he still finds it useful to look at consumer responses to questions about whether they will buy big-ticket items such as cars and appliances. “I think those are better indicators of what consumers are going to do than overall weighting all the various factors,” he said.
CEPR’s Baker, however, says that the gauges are more useful as a snapshot of attitudes today than what will happen next month. Both the Conference Board and the Thomson Reuters/University of Michigan indexes have three components: a headline composite number — the one that the press focuses on each month — and measures of consumer attitudes about current economic conditions as well as their future expectations.
“Current conditions tend to be [a] reasonably good … indicator of what’s going on today,” Baker said. Future expectations, on the other hand, are more volatile, even though actual consumption tends to be stable, suggesting that the measures of expectations are not the best gauge of what’s to come, he said.
Today, the Conference Board’s composite confidence reading is 70.3, well below 90, the level associated with a healthy economy. And it’s far below 111.9, the peak reached in the summer of 2007. With threats looming at home and abroad, that sky-high level of exuberance isn’t likely to return anytime soon.