Understanding the Impact of Consumer Confidence on the Markets

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Understanding the Impact of Consumer Confidence on the Markets Consumer confidence has not returned to pre-financial crisis levels. Since consumer spending makes up about two-thirds of overall spending, consumer attitudes are an important part of our economic outlook. When consumers are confident about the future, they are prone to continue spending and make long-term financial commitments. Conversely, if they are not confident about the future, they are likely to hold back on major purchases.

Consumer confidence is generally reflective of the economic environment, not necessarily predictive of the future. Former Federal Reserve Chairman Alan Greenspan said “if I could figure out a way to determine whether or not people are more fearful or changing to euphoric… I don’t need any of this other stuff (referring to economic data). I could forecast the economy better than any way I know.”

But consumers don’t always walk their talk, although the idea behind confidence surveys is sound. The consumers may say they are fearful about the economic future and then go out and buy a car.

Credit: http://www.fuelsnews.com/wp-content/uploads/2012/06/Consumer-Confidence-graph.gif

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Despite the intuitive sense that a slowing or dropping level of consumer confidence should lead to a drop in retail sales, that doesn’t always happen. Consumer confidence dropped sharply in the third quarter of 2011 as a result of deepening problems in Europe and down grading the US Government’s credit rating. This led to a sharp sell-off in the stock market but not a drop in retail sales. Despite wars, pestilence, stock market bubbles, a dearth of capital spending by business, corporate governance scandals, slipping consumer confidence—you name it—consumers often continue to spend.

Consumer attitudes are an important part of the investment landscape. Throughout most of 2012, figures published by the Consumer Confidence Board and the University of Michigan showed steady improvement. This data may not be relevant at all when it comes to measuring consumers’ propensity to spend but the stock market improved right along with consumer confidence.

Credit: http://www.marketobservation.com/blogs/media/blogs/Statistics/StockMarketConsumer.jpg
Source: MarketObservation.com

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A better way to understand consumer behavior might be to look at long-term trends in consumer spending patterns. Students of consumer behavior point out the simple fact that consumer spending has more to do with the age of the consumer than the condition of the economy. A younger population in their late 20s and early 30s are more likely to spend on family formation goods and services as they have babies, buy their first homes and begin raising families. As they age, they trade in smaller homes for bigger homes. Eventually, they sell their big homes and move to retirement communities. Throughout their lives, their spending patterns change in a very predictable fashion.

Researchers argue that peak spending per household occurs when the head of the household is age 46-47. If we accept this and go back 46 years, we see that we have passed the peak birth year of the baby boom generation (1961). The good news is the baby boom spenders may not have hit their peak. If business spending recovers, the outlook for the next 6 to 8 years is positive.

The bad news—when baby boomers have bought their last big homes and spent all they’re going to spend on furnishings and toys, our economy is likely to come up short. At that time, consumer confidence levels are likely to be high, reflective of the good life, not necessarily reflective of their future spending patterns. That’s when we have to be careful.

Rick’s Insights

  • Consumer confidence is still well below the levels seen before the financial panic of 2008.
  • Consumer spending does not always follow consumer confidence.
  • Consumer spending may have more to do with their age then with their confidence in the economy.

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