This special guest commentary was written by Peter Atwater of Financial Insyghts. This piece was originally published on March 22, 2017.
Throughout the past eight years, Federal Reserve chairs Janet Yellen and Ben Bernanke have lamented the prolonged disconnect between consumers’ mood and both the rising stock market and objective economic measures, like declining unemployment.
The two chairs, along with others on the Federal Reserve Board, have been frustrated that consumers have experienced neither the much-touted "wealth effect" arising from higher financial asset prices, nor the typical consumption enthusiasm generated by increasing employment and higher wages.
Until very recently, outside of the extreme high end, consumers haven’t felt materially better than they did during the banking crisis. If there was a recovery, you sure didn’t see it in most sentiment indicators or at the mall. Negative mood was impacting spending decisions far more than positive markets or improving job prospects.
Last week, though, with confidence measures soaring - with some, like the University of Michigan consumer sentiment index, now at sixteen year highs - Dr. Yellen suggested that mood doesn’t matter today, either. During last week’s post-rate hike press conference, Dr. Yellen offered these thoughts when discussing whether the “animal spirits” currently on vivid display in the stock market were flowing through to the U.S. economy:
“It is uncertain just how much sentiment actually impacts spending decisions; and I won’t say at this point that I have seen hard evidence of any change in spending decisions based on expectations of the future.”
I don’t mean to call Dr. Yellen out on this, but she can't have it both ways.
You can’t tell people that low sentiment is getting in the way of economic growth one moment and then tell them that high sentiment doesn't contribute to growth the next. Either mood impacts consumers’ decisions or it doesn’t.
To be clear, as a researcher, I think it does matter – big time. How we feel impacts our preferences, decisions, and actions – whether the choice be economic, financial, political, social, or even cultural. While Dr. Yellen now seems to feel otherwise, confidence is a critical input to what we do.
Sadly, most economic models don’t consider sentiment as an input. Principles, like the "wealth effect," for example, tend to look at confidence only as a consequence. The possibility that higher confidence leads to higher prices is never even acknowledged. Nor, sadly, is the fact that in periods of low sentiment, unnaturally inflated financial asset prices don’t boost confidence either. Confidence comes from the Latin word – confidere meaning ‘have full trust.’
Back in 2013, I wrote an essay for the New America Foundation in which I challenged economists' thinking, encouraging policymakers to focus on how confidence alters consumers' thinking and why initiatives focused on supporting the "income effect" should be prioritized over those aimed at generating a "wealth effect."
When confidence is low, "me here now" thinking dominates. Perceptions of "permanence" - what transform "high asset prices" to trustworthy "wealth" - are all but impossible when we perceive high uncertainty and a lack of control.
Understanding how confidence serves as a a filter and as an input to our perceptions and actions really matters.
This weekend, New York Times economics columnist Neil Irwin suggested that maybe we ought to turn more economic policy over to sociologists - social scientists whose research, for example, "shows how tied up work is with a sense of purpose and identity." Those folks, to paraphrase Mr. Irwin, seem to better understand how people really behave and, more importantly, why.
Reshaping the Economic Dialogue
As a socionomist – someone who looks at how changes in social mood impact behavior – I was thrilled to see Mr. Irwin challenge the status quo. Not only would more interdisciplinary thinking benefit most social scientists, but it would change the conversation, too.
I can tell you from experience, it is remarkable how people on the left and right can come together when issues are re-framed as being driven by high or low confidence, rather than by Democrat or Republican ideology.
When we position issues by how people feel, rather than by people’s political party, cultural identity, or ethnicity, we can better understand choices and actions. When you can look at the opioid epidemic, for example, and appreciate that it is the natural consequence of chronic under-confidence, you reshape strategies and solutions, too.
(And for those who missed it, I recently wrote about the hidden role of chronic underconfidence behind the new administration's immigration policy. Link here)
As much as many of my economist brethren want to ignore mood, confidence matters. It is the "invisible hand." With chronic underconfidence now at epidemic levels in many parts of America, the sooner we factor mood in to our fiscal and monetary policymaking efforts, the sooner we will be able to tackle the challenges at hand.
EDITOR'S NOTE
This is a Hedgeye Guest Contributor note written by Peter Atwater, founder and president of Financial Insyghts. He previously ran JPMorgan’s asset-backed securities business. He is also the author of the book Moods and Markets (FT Press, 2012) which details how investors can improve returns by using non-market indicators of confidence. This piece does not necessarily reflect the opinion of Hedgeye.
