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While the market has continued to be resilient into year-end (largely based on the belief that the Government is going to prime the consumer spending pump well into 2011), we continue to believe that the average American remains liquidity-impaired and the consumer cannonball thesis still holds (although it is clear we were early).

Over the past two days the incremental news on the consumer and consumer confidence (notwithstanding the hype over the holiday season) has been less than inspiring.  As it relates to the Holiday season, Hedgeye Retail Analyst Brian McGough had the following thoughts:  “Were the brick and mortar retailers good performers?  Yes!  But what we don’t know is the extent to which discounting activity gave the top line a shot in the arm.  Think about it… As a retailer, would you rather have 2% growth at full price or 5% growth because merchandise is 25-50% off?  I’d likely prefer the latter.”

“I think the key is that people will want to show that they own the companies putting up the best comps during the holidays so they can show how smart they are.  But as people begin to focus on margin come earnings season in Jan/Feb, we’ll see how much discounting is happening.  Then we REALLY start to see cost inflation in 2Q-4Q. That’s going to be when the other shoe drops.”

On the backdrop of these thoughts, the Consumer Discretionary index (XLY) is only one of two sectors that are down month-to-date in December.

Yesterday, the Conference Board’s reported consumer confidence index dropped unexpectedly in December, following an improvement in November.  In December, the index fell 1.8 points, to 52.5, from November's upwardly revised 54.3 (originally 54.1).  The decline stemmed from a slip in both expectations and assessments of the present situation. The expectations component fell 1.7 points, to 71.9, while the present situation component lost 1.9 points, to 23.5.

Confirming the Conference Board reading, the ABC News/Washington Post consumer confidence index showed sentiment dropped 3 points, to -44 for the week ended December 26. The decline pushes the index back into the middle of its range for the year, one week after reaching its June high.

Since May of 2009, confidence has been essentially flat and remains 53% below the peak set back in July 2007.  Although there are signs that the Government-sponsored recovery is gaining momentum, the reality is that the average consumer remains uncertain about the future.  The largest drag on consumer confidence is still poor interpretations of current conditions; consumers want to believe but nothing has materialized.

Two critical factors in moving confidence higher are an improvement in the job picture and increased home prices, and, on both of these fronts, the situation is not improving.  As our Financial Analyst Josh Steiner put it yesterday, “It’s official: home prices have resumed their downtrend.  Six markets are now at new post-bubble lows: Miami, Tampa, Atlanta, Charlotte, Portland and Seattle.  For reference, all 20 major cities lost value month-over-month in October.”

That being said, there is support for the bullish consumer thesis as incomes and the stock market are rising and many households have made significant progress in easing their debt burdens.

Ultimately, I still come out on the side of caution rather than enthusiasm regarding my outlook on consumer spending as we head into the New Year.