A Matter of Trust

The widely-followed Reuters/University of Michigan index of consumer sentiment dropped to 69.6% in February 2008 from 78.4% in January — the lowest reading on consumer sentiment since February 1992.

I started writing in 2006 about how the contraction in the U.S. housing market would be followed by a similar contraction in consumer spending. In particular, I was recommending that investors stay away from the large American retail stocks.

Day in and day out now, the media is reporting how poorly the U.S. economy is faring. We have the Federal Reserve jumping in and reducing interest rates at a blistering pace…we have President Bush signing an historic economic bailout package for consumers. We have economists coming out of the woodwork and saying we are going to have a recession. (Where were these guys last year?) How can the typical consumer feel good about the economy?

As investors, we must remember that consumers as a group operate with the “herd mentality.” When housing prices are booming and consumers should not be buying homes, that is when they are jumping in. When housing prices are collapsing and good deals could be in reach, they are staying away instead of negotiating a bargain.

Consumer confidence, or should I say a lack of consumer confidence, is a huge problem for the U.S. economy at this juncture. In my opinion, consumers are now in that “let’s wait and see” mode, where they will defer major purchases pending the “feeling” they have about the economy. Of course, this makes it worse for the economy.

There two types of consumers in the U.S. marketplace right now. The first got caught in the real estate boom and are paying the price today, trying to cope with higher monthly mortgage installments as their ARMs reset. These people are not spending simply because they don’t have anything to spend. Their monthly payments on mortgages and car loans, coupled with maxed-out credit cards, have placed this first group in a cash crunch.

The second group may not have gotten caught in the U.S. real estate boom frenzy. But they are watching what is happening in the U.S. economy and simply deferring their purchases to see “what happens next.” The more negative economic news that comes out, the less they spend.

Consumer confidence does not change overnight. In the U.S., 70% of GDP is based on consumer spending. And in my life, all the recessions I have seen or studied have only come to an end when consumers started spending. With consumer sentiment getting worse, and with the U.S. personal savings rate at near record lows, it may take two or three years for consumers to start spending again.