How Important Is the American Consumer?

Earlier this week, big news hit the airwaves that consumer confidence dropped to its lowest level in two years! The Conference Board’s index printed at 44.5, which was a drastic drop from July’s score of 59.2.

To put this into perspective, the index was as high as 70.4 in February earlier this year, a level it hadn’t reached since before the Great Recession in 2008. Apparently, one of the major reasons for the decline in consumer sentiment was due to on-going debt deal problems over the past few months.

For those of you who normally overlook the report, you should know that this report is actually a leading indicator of consumer spending. Considering that consumer spending accounts for up to 70% of the U.S.’ GDP, I believe that the recent decline in the index is something that we should pay more attention to.

After all, if the average Joe is less confident about the state of the economy, chances are that he won’t be dropping a couple of Franklins on a brand new iPhone or a pair of leather boat shoes. Instead, Joe is more likely to stash his money and keep it for a rainy day.

While it is good to be prudent and to save, a major decline in spending on the macro level would lead to a dip in activity. Less activity could lead to pay cuts or worse, layoffs, which would make Joe even less likely to spend his money. Yes, it’s a vicious cycle and we all know what this could lead to – that’s right, a double dip recession.

Some of you might be thinking that I’m getting ahead of myself, but after looking at the last time the consumer confidence index dropped so much, I’m afraid to say that the numbers aren’t encouraging at all.

Consumer Confidence Index vs. GDP q/q

Over the past four years, we can see that there has been a positive correlation between consumer sentiment and quarterly GDP figures. After chilling above the 100 mark in early 2007, the index dropped quickly throughout 2008, before finally bottoming out at 25.0 the following year.

At the same time, we see that GDP growth soon followed, falling as much as 6.20% during the last quarter of 2008.

Once consumer sentiment started to pick up in 2009, we saw that GDP growth resumed as well, as consumers were probably more willing to spend.

While the correlation isn’t perfect, it does highlight that consumer confidence can be a predictive factor in whether or not the economy is about to enter a recession.

Unfortunately, not only are consumers bearish about the economy, but this sentiment is shared by economists, some of whom are predicting that a fear that a double dip is just around the corner.

“Mr. Gump, is a double dip recession really in the cards?

Now, I’m no fortune teller like Pipstradamus, but I think we should keep paying attention to the Conference Board’s index. If we see the index continuously head lower and hit below the 30.0 mark, it could be a signal that GDP figures are about to follow suit.

If this does happen, we may see safe haven currencies like the franc, yen, and maybe even the dollar rally. Yes, the dollar has taken some hits recently, as speculation is rising that the Fed will in fact introduce some form of QE3 in the markets. At the end of the day though, the dollar is still the world’s reserve currency and people still believe in it. Don’t be surprised if we see risk aversion keeps the dollar afloat.

For now, all we can do is wait and see how this all plays out. Just make sure to keep an eye out for those consumer confidence reports to help you gauge what direction the economy will be headed over the next few months!