The Independent Market Observer

Consumers and Business Head Confidently into New Year

Posted by Brad McMillan, CFA®, CFP®

Find me on:

This entry was posted on Jan 3, 2017 3:55:00 PM

and tagged Politics and the Economy

Leave a comment

confidenceLooking ahead into 2017, one big theme that will carry over from last year is the positive change in confidence. Consumer confidence has increased dramatically, especially since the election, and just spiked to a point last seen in 2001. Business confidence continues to rise and is now at a level not seen since 2007.

Higher confidence could bode well for growth

Clearly, if confidence is any indication, we are in a boom time, and 2017 should be a good year. But is confidence a reliable guide to the future?

The chart below compares consumer confidence with economic growth, with growth shown at a two-quarter lag. The idea is, what happens with consumer confidence should show up six months later in the growth figures.

confidence_1.jpg

As you can see in the chart, it largely does. A decline in consumer confidence predicted the drop from 2007 through 2009, and the recovery showed growth was coming back as well. Now, the rise in consumer confidence suggests faster economic growth should continue for at least the next six months.

This makes sense, given that consumer spending represents more than two-thirds of the economy. If people feel good, they will spend more, and the economy will grow faster. But there’s a real difference between being willing to spend and actually spending, and this difference has shown up in the past month, with spending below expectations even as confidence rose. So, before we get too excited about the rise in confidence, we need to examine whether consumers are likely to actually spend.

The savings rate. One way to do that is to consider income growth, but that has been discussed a great deal, and we know that income growth can support faster spending. Another way, more directly related to confidence, is to look at the savings rate. The more people spend, the less they save, and the better they feel, the less they save. If income growth shows they can spend, could confidence predict lower savings?

As you can see below, higher confidence does seem to lead to lower savings—and thus higher spending—over a period of about six months (the lag shown in the chart).

confidence _2.jpg

This is consistent with the time frame in the economic growth chart, suggesting that the causal link is real. With the recent spike in confidence, we can reasonably expect savings rates to drop and spending to go up during that time frame, which would be positive for growth.

Business confidence. Consumers don’t drive all of the economy, though. We also need to consider business, particularly capital investment, one of the weakest areas of the current recovery. In this case, we’ll use the ISM Manufacturing Index as the confidence index and compare it with total private business investment, as shown in the following chart.

confidence_3.jpg

Here, again, you can see both the two-quarter lag and a recent improvement in confidence that should produce higher business investment. This would be a significant boost to growth, as well as a potential start of the kind of virtuous economic circle the U.S. hasn’t seen for more than a decade.

Where's all the positive sentiment coming from?

The sea change in confidence happened right after the election, so the reason, for better or worse, appears to be largely political. And if the new administration and Congress make real progress in delivering on their pledges, that confidence could grow even further. On the other hand, if they don’t follow through, most of the recent gains could disappear as quickly as they came.

In many ways, the story of 2017 is shaping up to be all about politics. The difference this time is that we have much more solid fundamentals, giving politics the chance to accelerate growth rather than simply slow its decline.

Happy New Year!

  Subscribe to the Independent Market Observer

Subscribe via Email

Crash-Test Investing

Hot Topics



New Call-to-action

Conversations

Archives

see all

Subscribe


Disclosure

The information on this website is intended for informational/educational purposes only and should not be construed as investment advice, a solicitation, or a recommendation to buy or sell any security or investment product. Please contact your financial professional for more information specific to your situation.

Certain sections of this commentary contain forward-looking statements that are based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets.

The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. All indices are unmanaged and investors cannot invest directly in an index.

The MSCI EAFE (Europe, Australia, Far East) Index is a free float‐adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the U.S. and Canada. The MSCI EAFE Index consists of 21 developed market country indices.

One basis point (bp) is equal to 1/100th of 1 percent, or 0.01 percent.

The VIX (CBOE Volatility Index) measures the market’s expectation of 30-day volatility across a wide range of S&P 500 options.

The forward price-to-earnings (P/E) ratio divides the current share price of the index by its estimated future earnings.

Third-party links are provided to you as a courtesy. We make no representation as to the completeness or accuracy of information provided on these websites. Information on such sites, including third-party links contained within, should not be construed as an endorsement or adoption by Commonwealth of any kind. You should consult with a financial advisor regarding your specific situation.

Member FINRASIPC

Please review our Terms of Use

Commonwealth Financial Network®