Friday, September 11, 2009

The Importance of Rising Consumer Sentiment

Normally, the various Consumer Sentiment/Confidence indicators are viewed as "soft" barometers of economic activity, as they involve largely perceptions and are heavy on psychology as opposed to "hard" evidence regarding the performance of a particular segment of the economy. As such, their true significance, and despite the prominence that sometimes the media give them, is relatively limited. As sometimes the joke goes "one cannot spend confidence".

Today's sharp rebound in the University of Michigan Consumer Sentiment index for early September to 70.2 from 65.7 in August deserves a little more attention for two reasons:

a) It fits nicely in to a pattern of steadily better looking economic data in the last couple of months, suggesting that a broad number of pieces are slowly coming together to suggest that an upturn in economic activity is in the offing. To be sure, the Consumer Sentiment series is quite volatile and the early September number simply recouped some ground that the series lost in July and August, after it had reached 70.8 in June. But it does confirm that this measure of consumer attitudes has rebounded convincingly from its 55 to 60 range late last year and early 2009.

b) While it is true that one cannot spend confidence (income growth is needed for that), one can certainly spend savings. If consumers start feeling steadily more upbeat (as the solid increase in both the current conditions and expectations components of the index showed today), they may become more inclined to let the recently elevated savings rate drift lower in the next few quarters, therefore leading to a moderate pick up in spending.


The dollar, Treasuries, and a Reassessment of Risk Tolerance

Over the past week or so, many stories have focused on the falling dollar. Some of the stories are legitimate threats to the dollar, such as China beginning to assert itself by issuing yuan-denominated debt to Hong Kong (, and others merely make headlines, like the UN declaring the need for a new reserve currency (

Both stories are the type of news that would normally cause traders to react by sounding the alarms of a dollar crisis, and the dollar has indeed made new lows for the year. However, there is no evidence of any kind yet that the dollar weakness is causing foreign investors to become apprehensive toward the U.S Treasury market. The Treasury held three successful auctions for 3- and 10-year notes as well as 30-year bonds, all of which produced strong bid-to-cover ratios and showed evidence of solid foreign participation. The question of whether or not bond investors have a great fear of oversupply (due to tge deficit) or inflation, seems to have been answered- at least for now. The current environment is one within which investors of various degrees of risk tolerance feel increasingly confident seeking opportunities.

Does this mean that U.S. bonds are decoupling from the declining dollar? Maybe not, completely, but it does demonstrate a conviction that there is no significant risk of interest rate increases in the foreseeable future. Ben Bernanke has been adamant about deflation prevention since the onset of the crisis and his words have assured markets that the Fed remains committed to facilitating a sustainable economic recovery. As a result, the prevailing view seems to be that the fed funds rate will remain trapped against the zero lower bound for some time, therefore helping prevent any major back-up in Treasury yields. As such, the strong bonds bids this week do not reflect a flight to safety, but a legitimate investment opportunity sprung out of the strong appeal of such securities on a carry basis.

In addition to U.S. debt, and further along the risk spectrum, many other asset classes, including gold, SPX, most currencies vs. USD, and global equities have risen, indicating a reflation of sorts. This makes sense, given the cautiously optimistic economic numbers overseas, particularly among emerging markets. It has been made apparent that the U.S. will not lead out of this downturn and, as such, it makes limited sense to pile cash in money markets when more attractive returns are available in most asset classes across the board. Some of the most rich investment opportunities are to be found in the places that have already begun traveling the road to recovery, or better yet, don't have much recovering to do, and recent price action indicates that the markets seem to be recognizing that fact.

Chris Hodge
Analyst, Pharo Management