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Consumers' Irrational Exuberance?

Posted by: Ben Steverman on May 26, 2009

Stocks rallied on May 26, and a surprising jump in consumer confidence is getting the credit.

The May consumer confidence reading hit 54.9, quite a jump from 40.8 in April. It’s another data point that suggests the economy is stabilizing a bit.

But, it’s troubling that the report’s optimism contradicts other economic indicators.

1. Slightly more people said jobs were plentiful (though still just 5.7% of those surveyed), and slightly fewer said jobs were hard to get. This despite the fact that more than 600,000 Americans continue to file initial jobless claims each week, and many economists expect the unemployment rate to rise from 8.9% in April to 9.2% in May.

Nick Kalivas of MF Global Research suggests both can’t be right:

It is either signaling that the labor market is stabilizing or Conference Board [consumer confidence] data will display weakness in the coming months.

2. Inflation expectations fell in the report, from 5.9% in April to 5.6% in May. That’s a surprise given the rising price of gasoline. The price of fuel for Memorial Day travel was 30 cents per gallon higher than just a month ago.

Still, consumer attitudes actually are consistent with the talk lately from some economists, politicians and especially investors. The S&P 500 is up 21% from Mar. 9, reflecting hopes that the economy is stabilizing and may recover later this year.

Clearly, some consumers have gotten this hopeful message. Their retirement accounts are fatter than two months ago, but they also believe the current momentum will continue.

Expectations for more jobs in six months jumped from 14.2% in April to 20% in May. Expectations for increased income moved from 8.3% to 10.2%

Unfortunately, these raised expectations could be dashed.

Ryan Sweet of Moody’s summarizes the problem:

The surge in expectations corresponds with a rebound in stock prices. […] However, a major concern is that if the economy does not improve as expected, consumers might react to the disappointment by cutting spending even more, which would delay the recovery.

Even if job losses slow, new hiring could take longer to materialize. Trends in the automotive sector — including worries about General Motors (GM) — could exacerbate the situation.

As Deutsche Bank (DB) chief U.S. economist Joseph LaVorgna noted last week:

While we are optimistic that the labor market’s rate of decline is poised to slow, any significant turnaround could be stymied by further pain in the auto sector.

Since the beginning of the recession, the economy has lost 5.7 million jobs, a number that could hit 7 million by the end of the year. That’s the most of any downturn since World War II, LaVorgna says.

Meanwhile, many Americans might not fully realize how much the dismal housing market is hurting their net worth. The latest S&P/Case-Shiller Home Price index, released May 26 and based on March 2009 data, shows prices continue to plunge.

And Felix Salmon notes:

The length and severity of the drop in house prices is still just a fraction of what we saw on the way up: we had a ten-year boom from 1997 to 2007, and there’s no particular reason why the bust should last just as long — especially given the natural stickiness of house prices on the way down.

Consumers may be feeling a bit better these days. That’s a good sign for retailers in the short term. But the fundamentals don’t yet support optimism about Americans’ buying power over the long term.

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Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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