Recently there have been significant drops in the two main surveys on consumer confidence. While a drop in consumer confidence sometimes foreshadows weak consumer spending, I do not believe this decline will be permanent.
Until recently consumer confidence levels had recovered to their best readings in 5 years. What has essentially changed is the media attention regarding the fiscal cliff, which has now been averted.
Probably the most important factor that drives consumer confidence is the job market. While the employment situation is still relatively weak, it has improved somewhat over the course of the past year. That explains why consumer confidence had been improving until just recently.
Other factors that determine consumer confidence , include gasoline prices and household wealth. Gasoline prices have been trending down recently, which is a positive. The stock market has risen this past year and real estate has modestly increased in most markets, so many consumers have seen an increase in their net worth.
It is always interesting to see if the surveys on consumer confidence correspond to people’s spending patterns. Expenditures on big ticket items, such as cars, are much improved compared to the past several years. However, this year’s holiday spending was a little disappointing, with only a slight increase over last year. This implies that the falloff in consumer confidence in December did dampen spending at retailers.
Given that the underlying trends that determine consumer confidence have been favorable, I would expect consumer confidence to improve with the fiscal cliff behind us. This increase will likely be tempered by Social Security taxes reverting back to their old level. While income taxes will increase for only a small number of people, Social Security taxes will increase 2% for most workers. Thus someone earning $50,000 per year will see their take home pay drop about $20 per week.
The recent compromise to avoid the fiscal cliff did very little to avoid our long term budgetary problems. Virtually nothing was done on the spending side, and the increases in revenue will not be that significant. In addition our tax system remains as complex as ever, which results in an additional drag on the economy.
The stock market did rally when the fiscal cliff was averted. Part of the rally was just to get this issue behind us, but also the increase in taxes for high income people with respect to capital gains and dividends was not as bad as originally feared. Therefore, investment spending should not be impacted in a significant manner.
Budgetary issues will be back at the forefront again in two months, when Congress will need to increase our debt ceiling again. It will be interesting to see if legislation will be passed that will have a more significant impact on our budget deficit.
Since I expect to see some recovery in consumer confidence, our economy should still continue to have modest growth. This should allow for a decent environment for the stock market, as corporate earnings should still continue to expand moderately. However, with the stock market near its highs for the past 12 months, I would not necessarily add to positions unless you are under invested in stocks.
