Consumer Confidence or Irrational Exuberance?

By the time an economic expansion becomes as long-in-the-tooth as the current one (9 years as of February, 2000), nagging signs that the end is near have usually appeared. However, no such pessimism prevails with U.S. consumers. In its January, 2000 survey, the University of Michigan’s Index of Consumer Sentiment hit the highest level recorded in its 50-year history. Moreover, the January index registered it largest month-to-month gain in nearly 6 years.

Interestingly, the last time the index registered such a large increase was in January, 1994, just prior to a series of rate hikes by the Federal Reserve Board. All indications from the Fed and from professional forecasters are that similar hikes are coming. Consumers expect it but do not fear it:  in the January survey 73 percent of all consumers expected interest rates to increase during the coming year, the largest consensus ever recorded on the question. Home buying attitudes have cooled markedly since mid-1999.  During the past 12 months the proportion of consumers who thought that mortgage rates were attractively low fell from 72% to 38%, again mirroring the experience in the rising rate environment of 1994-95. 

Despite the widespread expectation of higher rates, a stunning 90 percent of consumers thought the national economy would not weaken during the year ahead. Consumers viewed both near-term and longer-term prospects for the national economy more favorably in January than in any survey in the past 50 years. The same can be said for their expectations for their own personal finances. Just 3 percent of all households in the January, 2000 survey expected their financial position to worsen during the year ahead, the lowest proportion ever recorded. On average, household incomes were expected to rise by 3.2% during the year, the highest expectation in a decade.

Richard Curtin, Director of the University of Michigan Consumer Surveys offers some interesting commentary on the surge in confidence. Based on responses to specific questions in the December, 1999 survey on potential Y2K impact, he believes the uneventful turn of the millennium prompted much of the upwelling in confidence. In his summary of the January, 2000 survey, he writes “The more lasting and perhaps troublesome impact may be that it further kindles the view among consumers that the economic expansion is invincible, replacing any faint traces of caution with an unbounded sense of confidence not seen since the mid-1960s. Although the data provide no compelling evidence that consumers are now less resistant to price increases or more insistent in their demand for higher wages, the ongoing changes in consumer expectations are the same as those that preceded such developments in the past.” Of course, this is what worries the inflation fighters at the Fed.

Some of the post-Y2K ebullience may already be dissipating. As we go to press results are just becoming available from February consumer confidence surveys. The Conference Board reported that its index of consumer confidence retreated slightly in February for the first time in four months, but still recorded the third highest level ever.   Consumers apparently have noticed the impact of higher oil prices and increased volatility in the stock market. Still, in the Conference Board survey, the proportion of people indicating they would buy a home or major appliance in the next 6 months actually rose. Auto purchase plans for the next 6 months dipped slightly. However, actual auto sales in February set records for most manufacturers. General Motors had its best February since 1988 with a 16% gain in year-over-year sales. For the entire market, sales of cars and light trucks rose 11.3% in February compared to one year earlier.

One reason that consumers seem relatively unconcerned about rising interest rates, at least in the new auto market, is that manufacturers have insulated their customers from most of these rate increases to preserve market share. Michael E. Maroone, president of AutoNation told The Wall Street Journal, “Our business is super. With the amount of interest-rate subsidies the manufacturers have out, the impact on customers of the higher cost of money hasn’t been felt.” The accompanying chart confirms that auto finance companies have drastically slashed their interest rates since 1996, and have kept them low relative to their commercial bank competitors. Paul Ballew, GM’s general director of industry and market analysis told The Wall Street Journal that “the combination of pricing restraint and rising incomes means the average new vehicle is more affordable today than at any time since the early 1960s. The average monthly payment is currently about 7% of average monthly income, down from about 10% in the 1980s.

Much of the pressure on manufacturers to keep prices down to preserve market share is coming from an influx of supply from foreign automakers who have hungrily eyed the buoyant U.S. consumer market. The share of the U.S. market held by the Big 3 domestic automakers slipped from 71% in February, 1999 to 69.4% in Feb, 2000.