2007Jan Consumer Sentiment vs Spending

2007Jan Consumer Sentiment vs Spending

Judging by the reaction of equity markets and news media to the monthly release of consumer sentiment measures, you have to conclude that economists and stock traders haven’t learned the basic lesson of watching people’s actions, not listening to their words. Each month the University of Michigan (UofM) conducts a survey asking individual households how they view their personal finances, business conditions and buying conditions. UofM calculates the consumer sentiment index, which many investors and financial analysts use to gauge the strength of the economy and the markets.

The belief is that when people are feeling bad about the economy they will cut their spending to reflect their weariness about the future. Because consumer spending represents a full 70% of all economic activity, forecasting consumer behavior by this or any other measure should provide a forecast of changes in the economy and stock market. While forecasting consumer behavior is the key economic variable, we find absolutely no support for the notion that sentiment surveys help in estimating what consumers will do next.

By comparing almost thirty years of monthly returns for the UofM Consumer Sentiment Survey index with the S&P 500, there is no evidence of a relationship that, according to many economists, should exist. The News: Changes in the Consumer Sentiment Index and the S&P 500 are effectively uncorrelated.

Another index used to measure consumer sentiment is the RBC CASH Index, and it is no better a gauge of consumer behavior than the UofM measure. (Call me if you really want to see the correlation charts).

The evidence illustrates that Americans don’t change their spending habits based on how they feel in any given month. Why? Americans are more concerned about maintaining their standard of living than worrying about the ‘what if’s’ of tomorrow’s economy. As demographic research has revealed for years, age and stage of life are the best predictors of spending, not surveys. As people age, they move through very predictable productivity, earnings and spending patterns.

The consumer life cycle affects everything from the demand of potato chips to cycles of innovation and economic growth. Dad may gripe about interest rates or the price of oil, but that doesn’t stop him from buying Junior a new bike. And it certainly doesn’t affect his regular monthly payments on things like the mortgage, the car, or cable TV.

This month’s message is to ignore the hype about consumer sentiment. Go back to living your life and have a Happy New Year.