Fundamentals Still Sound,
Consumers Still Optimistic

The problem for inflation fighters (and consequently equity owners) is that the U.S. economy has remained on a much stronger growth track than nearly everybody expected. Real consumer spending through the first quarter was still on a 5-6% growth track. Construction was rebounding at a double-digit annual rate, broadly spread across home building, nonresidential and public sectors. Real capital spending also surged ahead during January and February. Labor market data show no weakening in demand. Hours worked are rising at a 3 to 3.5% annual rate.

The latest available readings of consumer confidence were taken before the market sell-off in mid-April, but showed that confidence remained near an all-time record high. Various events (rising oil prices, volatile stock prices, continued interest rate hikes) have tested consumer confidence since January, but strength persists. The University of Michigan's Index of Consumer Sentiment fell to 107.1 in the March, 2000 survey from 111.3 in February and the all-time peak of 112 in January, but remained higher than the average level recorded for any year in nearly 50 years.

Richard Curtin, Director of the Michigan Survey, said that the March loss resulted from declining expectations about future economic prospects as consumers said they expected higher interest rates to slow growth. Events of recent days suggest this expectation is likely right on the mark. Remarkably, although buying attitudes have cooled somewhat the declines were mostly due to consumers' dissatisfaction with market prices, and not because of the cost of credit or uncertainty about future job or income prospects. In fact, Curtin notes a phenomenon reminiscent of the old "buy-in-advance" inflation psychology of the 1970s. The recent increases in interest rates have had less impact on spending than might have been anticipated. "Consumers have temporarily reacted in the opposite direction than anticipated with regard to the housing market: the expected increases in mortgage rates have prompted an increasing number of consumers to borrow in advance of the anticipated increases in rates."

Again, we should emphasize that the confidence readings were taken prior to the precipitous drop in equity values. However, consumers had already experienced strong doses of market volatility as of the March surveys and remained remarkably optimistic in spite of it. Richard Curtin puts the March decline in perspective: "The recent falloff in optimism about the outlook for the national economy is easily misjudged by comparison to the all-time records in the prior two months. Other than for the recent records, consumers' judgments about prospects for the national economy have rarely been more favorable during the past 50 years. Indeed, even after setting the record for the longest expansion in U.S. history, consumers still expect the expansion to continue to at least the middle of the upcoming decade. Not since the 1960s have consumer viewed future economic prospects as favorably as at present." Why? Despite expecting slower growth in the year ahead, consumers see no change in their own job prospects or heightened risk to job security. Moreover, among all households, 44 percent reported income gains in March, just two percentage points below the highest level recorded since the 1960s.