Decline in Consumer Confidence: It’s About Jobs

The stock market has steadily and strongly advanced for about 10 months on the belief that the U.S. economy is finally recovering. The U.S. economy returned to growth in the third quarter of 2009 after dropping sharply earlier in the year, and economists expect stronger growth in 2010. Equity analysts are predicting a strong rebound in corporate profits in the year ahead, and almost uniformly think that the stock market will go higher. Shoppers returned to the malls (and ecommerce websites) this holiday season for better than expected retail sales. In general, housing prices show stabilization in many areas. These and many other economic indicators have moved beyond “green shoots” and are no firmly trending more positive. So, why does the latest gauge of consumer confidence show one of the largest drops in the last quarter century?

According to ABC News Consumer Confidence Index report, only 9% of those polled see the US Economy positively. On a scale of -100 to 100, the poll fell to -47 this week falling more than 6 points in just one week. The survey covers three areas: personal finances, buying environment, and national economy. Both confidence in personal finances and perception of if this is a good time to buy things matched their greatest declines in the history of the poll. There was not much potential for the third metric to fall as it was already at only 9% seeing a bright future for the US economy.

There is no, one clear explanation for such a marketed decline in confidence, but of course theories abound. First, this decline may correspond with consumers receiving credit card bills after a fairly ebullient holiday shopping season. Perhaps too many shoppers got caught up in the holiday cheer and are now left reeling in trying to pay for their gifts, which would help to explain the decline in personal finance. Similarly, Christmas sales and the sales following the holidays have finished, and now there is less discounting in retail. So, it is logical that buyers are hesitant to rush back to the stores to pay full-price, and helps to explain the drop in purchasing environment. However, these seasonal effects are nothing new to the survey and still this is one of the worst weekly declines ever.

We think a much better explanation is the growing problem of joblessness in America as a primary reason for the horrendous consumer confidence results. Last week, after economists had predicted net job growth in December, the official data showed more than 85,000 jobs were lost in month. That result did not even include the 661,000 “discouraged workers” who are no longer actively seeking employment and thus not considered unemployed. This large number fleeing the workforce allowed the official unemployment rate to stay unchanged at about 10%. Although, that number is more important for economists and traders, but consumers live in the real world. Consumers are seeing the jobs disappearing as well as their discouraged neighbor who no longer “seeks work”, and the U6 rate (which more closely mirrors a consumer’s view) shows more than 17% of the population is unemployed, underemployed, or discouraged. This large swath of the population does not spend discretionarily and discourages confidence in those that still have a job.

There exists a parallel relationship between consumer confidence and our national economy. Consumer confidence had been in a steady uptrend for a few months and was sitting at a 16-month high prior to this week’s drop (sounds similar to the stock market). The US economy is built around consumer spending–for better or worse–and until the economy can start to generate jobs, it will take a toll on the confidence. Can the market and corporate profits continue to rise in the short term in this condition? Surely, short term direction of the market is very fickle and sentiment right now is clearly bullish. However, for long term investors we think it is worth remembering the wise words of Benjamin Graham,

“In the short run the market is a voting machine. In the long run it’s a weighing machine.”

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Ockham Research is an independent equity research provider based in Atlanta, Georgia. Security analysis at Ockham Research is based upon the principle known as Ockham's Razor, named for the 14th- century Franciscan friar, William of Ockham. The principle states that a useful theory should utilize as few elements as possible, because efficiency is valuable. In this spirit, our goal is to make the investing environment as simple and understandable as possible, yet no simpler than is necessary.

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