There are literally hundreds of economic reports issued every week relating to everything from new and used home sales to consumer and producer prices, employment numbers and trade surpluses, GDP, PMI, ADP – the  list goes on.  But what’s relevant?

Amid the numerical swamp are several items worth watching, particularly now as we pull ourselves out of a calamitous six months and begin to look forward to better days.  And they all relate to confidence.

As one, old-time market commentator reported in his blog last week:

“There’s a tremendous horde of cash sitting on the sidelines, waiting, waiting…  What it will take to get this money into play is anyone’s guess.  But it’s there.  The mutual funds are sitting on a horde.  The pension funds and Insurance funds, too.  Even the consumer is not so bad off.  And the banks?  They’ve been rained on – with money, that is.  And there’s just one thing holding them all back from opening up their wallets and spending.  Fear.  They fear that the worst is not yet behind us.”

Of course it doesn’t help matters to hear the IMF’s chief economist say there’s a good chance “there will be major crises in a number of emerging economies” this year.  Nor that there’s been: “a striking … drop in consumer confidence and business confidence in all the countries of the world,” which is to blame for the current seizure in global economic activity.

It just doesn’t get you feeling rosy.

So, too, when the Governor of the Bank of Spain says:

“The lack of confidence is total.  The inter-bank (lending) market is not functioning and this is generating vicious cycles: consumers are not consuming, businessmen are not taking on workers, investors are not investing and the banks are not lending.  There is an almost total paralysis from which no-one is escaping.”

He then goes on to comment that the world faces “’total’ financial meltdown” unless confidence returns.  These things just don’t get people out of their homes and into the malls to buy.

Consumer Spending and Consumer Confidence

A picture is worth a thousand words, so let’s have a look at this:

What you’re looking at is monthly readings of the Conference Board’s Consumer Confidence Index for the last thirty years.  The grey bars represent recessions.  What’s notable about the current recession – which began at this time last year – is that it marks the lowest point of consumer confidence in over a quarter century.

No one wants to spend.  And the outlook regarding what’s ahead is bleak enough that they won’t be doing any major spending for the foreseeable future, either.

Mark Vitner, economist at Wachovia Group securities points out that: “Consumers typically have to have a job if they are going to buy a home or automobile. And even if consumers have a job, they are less likely to borrow and spend if they feel their job is at risk or their income could take a hit.”  And that’s where we are now.

“So what,” you may ask.  “How much of a difference can some economist’s poll make to my business and investments?”  And the question is a fair one.  Remember, consumer confidence is a leading economic indicator.  That is, it has some valid, predictable prognosticating power and can be relied upon to indicate broad spending patterns for months to come.

But know, too, that this latest reading is also a snapshot.  It describes a mood from a particular point in time, and as such, it’s subject to all the vagaries and vicissitudes of the participants at the time the survey was taken.  Consumer Confidence is a fickle indicator in that regard.  It’s as apt to spike or swoon over fleeting economic, political or social events that either lifts people’s spirits – or get them temporarily despairingly down.

A Snapshot in Time – And What a time!

Much of the gloom in the latest readings is attributable to their being taken during a holiday season when consumers had more time to digest the losses to their investment portfolios and home values – and to mull over their job security.

Vitner continues: “the record low in the overall index is due mostly to consumers’ extremely pessimistic view of future economic conditions” [my italics].  This can be read in two categorically opposite directions, depending on whether that pessimism turns out to be warranted or not.

Should their negative expectations not be realized, and an upturn in the economy ensues, the lift in sentiment will be dramatic, as it was directly after the devastating recession of 1982 (seen on the chart, above).

That said, we are coming out of one of the worst consumer spending holiday seasons on record.  Retail sales contracted by 5.5% in November and 8% in December through Christmas Eve, according to MasterCard’s SpendingPulse statistics.

Concurrent Conflicting Confidences?

So, while it may be true, on the one hand, that extreme lows in consumer confidence have generally produced up markets in the following twelve months, the same cannot be said for investor confidence, as measured weekly by Investors Intelligence and the American Association of Individual Investors (AAII).  A chart of the two sentiment readings against the S&P 500 is shown below.

It’s clear from the charts that investor confidence has grown in recent weeks, breaking the last several months’ downtrend.  And while these readings are generally only useful at the extremes – and then only as contrarian indicators – we believe they are speaking volumes at present.

Given where we’re coming from, and the speed with which we’ve returned to confidence levels normally reserved for comfortably ensconced bull markets, we would prefer to stay away from equities at this point.

Unless you are a trader or are shorting the broad market indexes (not a bad move for the risk-takers out there – and for the real gamblers there’s always puts on the ultra-leveraged 3x funds from Direxion), we say stay in cash.  Short term pressure is decidedly down.  And until investors get a little more fear in ‘em – perhaps way down.

“Don’t fill up on bread!”

Matt McAbby
Analyst, Oxbury Research