TCS Daily


Will Sentiment Catch Up With Reality?

By Kevin Hassett - April 2, 2001 12:00 AM

Markets soared last week when the Conference Board reported that their survey of consumer confidence showed a marked up tick. The overall index dropped between September of last year and February of this year from a very healthy level of about 140 to a recessionary level of about 110. All the while, the hard economic data stayed fairly strong. Why did people get so depressed, and what happened in March to lighten the load?

A look at the details of the report suggests that something truly strange has been going on. The overall consumer confidence index combines responses of 5,000 consumers to questions about how they think they are currently doing, and how they think they will be doing six months from now. Lately, there has been a fascinating divergence of attitudes towards these two different horizons. When asked how they are doing right now, consumers have continued to say "great!" Indeed, attitudes toward the present situation are still about as positive as they have ever been in U.S. economic history. On the flip side, people have become positively paranoid about the future, with consumer expectations of future conditions dropping just about as steeply as they have ever dropped from September to February, all the way down to a level consistent with a deep recession.

It is fairly unusual for the attitudes about the present and the future to diverge so much. A couple of years ago during the Asian crisis, we saw a similar pattern. Back then, panics hammered the financial markets of developing nations, especially those in the Far East. Many analysts predicted that the "Asian flu" would spread to the United States, driving us into a steep recession. At the time, stock markets in the United States plunged, and attitudes about the future turned very sour. Since the flu had yet to strike, however, consumers continued to answer (truthfully) that current conditions were fine.

When consumers are down in the dumps, consumer spending tanks, and the economy goes with it. This didn't happen back then, however, because consumers were conflicted. Despite being fearful of the future, the present still looked pretty good. Then a funny thing happened on the way to recession. The hard data kept showing a healthy U.S. economy, and expectations about the future improved. The economy dodged a bullet.

Are we about to go through the same thing all over again?

Since attitudes have run so far ahead of the data, we may be. If we keep receiving solid economic reports, then consumers will have to change their minds about the future. This is certainly what happened in March. Going forward, however, there are a couple of big differences this time around.

First, to some extent the "flu" has hit the U.S. already, whereas it existed only in concept back then. There is no question that growth has slowed substantially over the past six months.

Secondly, this slower growth has fed through to corporate profits. In the aggregate, these dropped sharply in the fourth quarter of last year, from a third quarter level of about $970 billion to a fourth quarter level of about $914 billion. Such a big drop in profits will undoubtedly continue to depress business spending, which will be a drag on overall economic growth.

Those negative profits came because there were some segments of the business sector --the Internet comes to mind -- where capital spending ran ahead of consumer demand, and then the demand was never realized. When the dry-well drilling companies pared back their spending, capital goods suppliers suffered as well.

For them. the suffering is not over. But for me, the good news about sentiment is that the conflict between current feelings and future expectations has been sharp enough that negative sentiment has not crushed consumer spending. If spending is still high now, it will likely stay there, foregoing a recession. As for firms, since consumers are still buying, many companies are still selling, and profits should recover after an adjustment period. It may take awhile for broadband investment to recover, but Johnson & Johnson is still selling baby shampoo.

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