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Market data fall into two categories, reasons and excuses. This ignores, of course, both the excusable over-reactions and the reasonable excuses for action, but those are higher-order effects. The monthly release of retail sales data and of various consumer sentiment surveys tends to fall into the excuse category. The only plausible reason why anyone should care about sentiment surveys is if they led retail sales, and the only reason anyone should care about retail sales is if they could be demonstrated to be a leading indicator of other markets. While we are at it, let's see if financial markets, stocks in particular, feed back into either consumer confidence or retail sales.
First, there is a major difference between attitude and behavior. Attitude is what you think, while behavior is what you do. Confidence surveys, no matter how well constructed--and both the Michigan and Conference Board polls are crafted carefully and consistently--cannot measure behavior. No product of the human mind peers deeper and more honestly into the soul than the cash register. This suggests that both the level and the growth trend of retail sales should be the key behavioral yardstick.
The retail sales series is quite noisy even after the Commerce Department's seasonal adjustment. We can smooth it. The method used here is the percentage change in sales for the current three-month period over those for the current 12-month period.
The smoothing process employed should give concurrent consumer confidence a head start in leading the retail sales series, but this does not appear to be the case. If anything, retail sales appear to lead the confidence numbers; this certainly was the case during the early 1980s on the way up and again during both the late 1980s and early part of this decade on the way down. Only once, during the very end of the 1970s, did consumer confidence lead retail sales.
Moreover, consumer confidence and retail sales can diverge, as they have since the start of 2004, a period highlighted in "Retail sales hold," (right). Many Americans consider the economy to be weak, fragile and subjected to all manner of untoward influences, yet they are not deterred from spending. This divergence between attitude and behavior is reflected in the burgeoning levels of consumer debt, a growth enabled by historically low interest rates, an assertion for which there is evidence.
But let's pause first and introduce a subject to which we shall return shortly, the wealth effect. The stock market bubble of the 1990s was feared by some, including the Federal Reserve, as an inflation precursor; the logic was investors would increase their spending without a concomitant increase in the supply of goods and services. An elasticity number of 4% would be gained through currency. That is, investors would increase their spending by 4% of their unrealized gains.
As we should expect by now, that 4% number had little, if any, origin in fact. The past three decades shows a diminishing response in personal outlays relative to stock market gains. Investors realize, prudently, the principle of easy come, easy go and spend an ever-decreasing percentage of their stock market wealth.
We can see this in the highlighted and below trend outlays of the late 1990s. The same can't be said for the present bubble in residential real estate: Personal outlays have increased more rapidly in response to the combined effects of cash-out refinancing of homes and the higher nominal wealth capitalized into those homes by low interest rates (see "Bonds begin at home," August 2003). The present level of personal outlays in the current environment is above the long-term trend indicated by stock market levels (see "Home-fueled spending," right). People appear to trust the ephemeral gains from their illiquid homes more than they do for their liquid stocks.