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US consumer confidence is through the roof and seems slightly out of touch with reality. Or is there something else going on?
Last week I received this graph from Peter van der Welle, a senior strategist on my team. It shows the relationship between consumer confidence (the turquoise line) and the year-on-year change in real wages (orange line) in the US. Roughly speaking, these key indicators seem to move in tandem, though clearly that is not a hard and fast rule. For example, consumer confidence levels were a lot higher for much of the 1980s than you would expect based on real wage growth and during the 2008-2009 recession, deflation caused the two variables to even move temporarily in opposite directions.
That said, there is fairly strong relationship. What surprised my colleague most was the part circled in red: why did consumer confidence go through the roof while real wages were actually falling? Puzzling that US consumers have been so optimistic...
Puzzling? There is at least one person who probably was not at all surprised. As early as last December, ‘the Donald’ was all too eager to take credit for the fact that consumer confidence was on the up and up. Wages weren't responsible for providing a lasting boost, it was Trump. Who else? So since the Donald will be with us for the next four years, this should mean we can expect consumer confidence levels to remain high. Guess what? I don't totally buy it.
Fortunately, there is an indicator that correlates much more reliably with consumer confidence. True to the motto ‘know your classics', I've included the following graph, which shows the relationship between unemployment and consumer confidence. Unemployment is plotted on the right-hand axis; note that the axis is reversed, so the orange line goes down as unemployment goes up. The correlation is not perfect, either, but this orange line seems to suggest a better fit than in the case of the first graph: for instance, the second peak in confidence levels during the 1980s clearly coincides with a lower unemployment rate and during the latest recession, the relationship also appears to be strong. Moreover, this graph does not have a ‘gap’: consumer confidence consistently rises as the unemployment rate drops.
The lesson seems simple: the level of consumer confidence relates more to the unemployment rate than to wages. That's not to say wages are insignificant, but they clearly seem to be of secondary importance. Once you have a job, your wage will also impact your confidence, but having or not having a job will affect you a lot more. And so for Trump to pat himself on the back in December was, to say the least, premature: he wasn't going to be sworn in until January, so at that stage, any impact he could have on unemployment was negligible.
Although this graph seems to do away with the ‘gap’, it's actually not the end of the story. The graph below, which was compiled by analysts at Deutsche Bank, compares (an aspect of) consumer confidence (shown in blue) with real consumer spending (shown in red). These two variables also appear to be quite closely related, but notice again that they move in opposite directions at the end of the period. So the current optimism does not seem to be translating into any significant increase in real consumer spending.
Perhaps this can easily be explained by the fact that the first graph does not show evidence of any real wage growth. However, it didn't show any in the 1980s, either, while real consumer spending and consumer confidence (second graph) were then both on the rise. This time around, people are clearly keeping a tight grip on the purse strings.
So then that gap eventually reappears, after all. And it's not exactly narrow. An optimist would say that spending, as shown in red, will soon bounce back. According to that scenario, the US economy is about to undergo a largely consumption-driven recovery, which would suggest that the stock markets will continue to respond favorably, as well. A pessimist, however, would expect the exact opposite. In this scenario, consumer confidence has gone too far and, as was the case in 2002 and 1992, for instance, will quickly drop back down.
I suspect that ultimately, a lot will depend on what Trump gets done in terms of tax reforms. If he manages to push through cuts, that will promote optimism and spending (at least temporarily). Conversely, if those plans fail, it will dampen sentiment.
So ultimately it is, in fact, all about the Donald...