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Confidence Abounds


After the war in Iraq drew to a close, there was little doubt that confidence would rebound. On Monday, the UBS Index of Investor Confidence soared 61 points to 66. This was the largest one month gain since the index was created six years ago and the highest level since June of 2002. The biggest increase came from the component that measures investor's perception about the economy. The economic component increased a whopping 39 points, while the personal index rose a still robust 22 points.

On Tuesday, the Conference Board index of consumer confidence jumped almost 20 points to 81, well ahead of the 71 that economists expected. Not only was this the first increase in four months, but it was the largest one-month gain since March 1991. Most of the gain was attributed to an increase in expectations as that component rose 23.4 points to 84.8, the highest level this year. The present situation index rose almost 14 points to 75.3, the highest since January. Business conditions improved to the best levels since September. But before anyone gets too excited, it remains at only 16.2 versus over 40 during the bubble years. Conversely, those that thought business conditions were bad fell over six points to 23.7, but remain three times the lowest levels of 2000. The interesting item was the plans to buy component, which actually show a slight decline. Only 5.9% plan on purchasing an automobile, the lowest level since October 1998. Those planning on buying a house or a major appliance increased slightly, 0.1 to 3.3 and 0.3 to 28.5 respectively.

On Wednesday, investors were treated to the third confidence survey of the week. The ABCNews/Money Magazine consumer comfort poll showed weakness this week. After four weeks of increasing confidence, the relief from the end of the war seems to be stalling. Similar to the Conference Board survey, consumers indicated that the buying climate is not optimum. The index measuring how consumers feel about making purchases dipped two points to -28. This biggest drop came regarding personal finances. The index measuring how consumers feel about their own personal financial affairs bounced 14 points to 20 during the stock market rally. The latest result dropped eight points. The weakness in the index is probably greater than on the surface. This index is a four-week moving average and the results that fell off helped contribute to a -26 level.

We thought the end of the war would provide investors an impetus to get back in the market. We also thought as the stock market rose so would confidence. This combination coupled with very easy credit conditions could boost consumer spending in the second quarter. Retail sales did post a good rebound according to the Bank of Tokyo - Mitsubishi. While retail sales fell 1.6% during the most recent week, it followed two weeks of very strong weekly sales, 1.3% and 1.9% respectively as measured by the Bank of Tokyo - Mitsubishi. With Easter falling in April this year compared to March last year, April year-over-year comparisons will not provide good data. Barring any outside shock, May should be a good month to gauge the strength of the consumer.

First quarter GDP growth was much slower than economists forecasted. Instead of growing at a respectable 2.4% as economists predicted, the economy hobbled along at 1.6% annual rate. It should come to no surprise that residential construction posted the strongest growth, increasing at 12% annualize rate and accounted for one-third of the total increase in GDP.

Personal consumption rose only 1.4%. There has not been a quarter with slower growth since the first quarter of 1993. There have been two other quarters since than that has matched the 1.4% growth rate, second quarter 2001 and third quarter 1995. As anemic as personal consumption was, it still was the largest contributor to GDP growth, accounting for about 60% of overall growth.

Spending on durable goods fell 1.1%, which should not be a surprise after reading first quarter earnings announcements. This was the first back-to-back declined in durable goods since the first quarter of 1991. Nondurable accounted for virtually all the strength in personal consumption. Sales of nondurable goods increased 4.2%, half of the dollar increase came from food purchases. No more hot dogs and french fries, surf and turf for all. Service expenditures increased only 0.5%. The increase in medical spending was almost double the increase in the entire service sector, as almost every other category showed weakness, save housing.

Nondefense government spending was another area of double digit growth, up 10.5%. Also contributing to GDP growth was a reduction in net imports, obviously due to the lackluster economy. Additionally, there has yet to be a pick up in fixed investment. Even with residential housing boosting gross private investment, it still declined 2.5%. Nonresidential construction fell 3.4% marking the sixth consecutive quarter of falling commercial construction. Equipment and software fell 4.4%, throwing cold water on the apparent recovery from last year.

We continue to think companies will have a hard time justifying additional capital spending. The wildcard is the flood of liquidity coming to market, but a significant amount of this is being used to refinance existing debt. It is not being used to build factories or buy equipment. Without end demand increasing companies have little incentive to expand capacity. Plus, companies are still focused on cutting costs.

During their conference calls, several companies mentioned that employee costs are crimping margins, especially increases in health insurance. We have also reported anecdotal evidence for some time that painted the same picture. This week, the Employment Cost Index, published by the Bureau of Labor, jumped 1.4% during the first quarter. This was the largest quarterly increase since the first quarter of 1991. Pundits quickly spun this into a good development since it gives consumers more money. However, the jump was led by a surge of 2.2% in the cost of benefits, which was the biggest increase since first quarter of 1988. Wages and salaries did increase a healthy 1.0%, but that is inline with the 2000 and 2001 increases. These increases will make it difficult for companies to add workers to their payrolls.

The relief rally in the stock market did boost consumer confidence, and we will have to see if consumers whip out their pocketbooks. With personal consumption accounting for almost 70% of the economy, the consumer remains the key to any meaningful recovery. Business spending on equipment and software is only about 10% of the economy, so it would take one heck of an increase by business to make up for a meaningful slowdown in personal consumption. While predicting a fall in consumer spending as caused more than one economists to throw away his crystal ball, I could see spending starting to fall in the third quarter this year.

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