Beware Over-Exuberant Reactions to this Week’s Economic News

Morris Segall      consumer sentiment, economic

This week the Conference Board Consumer Confidence Index for the month of May came in at an impressive 54.9, a surprisingly strong increase over the rise in the index in the month of April. The strong increases in the Conference Board’s and Michigan Consumer Sentiment Surveys in April and May we believe are largely due to the continued strong gains in U.S. stock prices since mid March.

Indeed, we mentioned in our Economic Update of May 1, 2009 that the March reading in this index in the mid 30s would likely be the low point for consumer sentiment in the current cycle. The news of the cycle results and its  attribution to perceived improved labor conditions, mentioned in the  survey, were the catalysts for the recent strong stock market rally.

What Does it REALLY Mean?

There has always been a strong correlation between strong stock markets and rising levels of consumer sentiment. We, along with many other market analysts,  are skeptical of the intermediate and long term predictive value of consumer sentiment surveys. One of the unexpected measurements of  strength in the survey was a perceived improvement in job availability  among consumers to 44.7 from 46.6. Such a slight statistical  improvement is not a convincing improvement in trend particularly when one notes the absolute high level (approximately 45%) of respondents reporting “jobs are hard to get” versus the level of approximately 6% reporting “jobs are plentiful”.

We stated further in our May 1 Economic Update that consumer sentiment surveys can be fickle and inaccurate as a predictor of actual consumer spending trends. To be sure, we believe the just concluded Memorial Day holiday will show a strong increase in consumer spending as more Americans hit the road for vacation travel. We are expecting strong retail spending numbers for the first holiday weekend of summer. Our concern is that the current depressed economic environment may become one of a “sawtooth” pattern of economic activities. One month of increased retail sales and factory orders and industrial production followed by a retrenchment due to the continued  high levels of unemployment and weak consumer and business demand.

In short, we do not believe there is sufficient strength in consumer finances and psychology to sustain a consistent rise in consumer spending in the near term.

Take a Look at the Hard News

Conversely, the news coming into the Memorial Day holiday was far more disturbing for the following reasons:

1. Rising Interest Rates

The yield on the U.S. 10-year Treasury Note rose on Friday to nearly 3.5%, up from 3.17% since the middle of May and 2.53% since the middle of March. This is the highest yield on 10-year U.S. Treasury securities since last November. We have warned in previous blog and website articles the massive negative impact on longer term U.S. economic growth from rising interest rates and a large decline in the U.S. Dollar. Both of these developments are occurring now despite the action of the FED to buy Treasures to keep interest rates low.

2. Federal Budget Deficits

Coincident with the dramatic rise in intermediate and long term U.S.  Treasury interest rates have been equally dramatic increases in the projected Federal budget deficits for fiscal 2009 and 2010 and the chronic increase in the government’s national debt. This deterioration in the U.S. financial condition is causing alarm among national and world investors, including foreign governments and world banking institutions that the U.S. credit rating would be downgraded like that of Great Britain last week.

3. Credit Crunch on Farmers

Deteriorating credit availability for farmers which may affect the procurement of fertilizer, seeds, animal feed and farm equipment. The credit crunch on farmers could negatively impact upcoming harvests and thus cause a rise in food prices next winter.

4. The State of California

The continuing chronic fiscal woes of the State of California whose  budget deficits are projected to rise to more than $40 billion in fiscal 2010. We fear the Federal government will have to bail out the state within the next two-three years to avert a major state default and cutbacks to state services that would be injurious to the public wellbeing. A federal “bailout” of California would rank among the largest and most expensive and long lasting in this current financial crisis. It would certainly add to the deterioration of the Federal balance sheet and pressure our credit rating and currency. It would also lead to further  demands from severely depressed states for increased Federal assistance.

Reality Check

We continue to be wary of over-exuberant stock market reactions to encouraging news du jour which needs to be confirmed by improved and sustained underlying improvement in unemployment, a bottoming in residential housing and a peaking in bank loan losses.

Until we see that, we maintain that we have hit a DEMAND bottom at the end of the first quarter but not a recession bottom. The second and third quarters of  this year will be “less worse” than the first but not an end to the  recession. We might see some slight improvement in GDP in this year’s  fourth quarter but more likely we will have to wait until 2010 for gradual economic recovery. Bullish reactions to this week’s economic news is  premature.