MARKET WATCH: What’s Happening? Since the Presidential Election, “soft” economic indicators like consumer confidence have soared and have surprised the consensus on the upside. “Hard” indicators of actual economic activity, by contrast, are exhibiting no such growth—and are surprising on the downside.
Our Take: While the post-election surge in soft indicators is normal, the partisan forces influencing these data points are not. Republicans have been reporting much higher levels of consumer confidence than Democrats—creating an unprecedented gap in consumer sentiment by party affiliation. Bottom line: While soft indicators backtest well as leading indicators, investors this time should be especially cautious about betting on them without more corroboration from hard numbers.
In March, U.S. consumer confidence as measured by the Conference Board rose to 125.6, the highest level seen in 16 years. This data series is just one of many so-called “soft” indicators intended to gauge consumers’ feelings on the future. Consumer confidence indexes like those provided by the Conference Board and the University of Michigan are surveys that ask people their opinions on their present and future spending habits and optimism.
Diffusion indexes, another type of “soft” indicator, reflect whether purchasing and supply executives say their businesses are expanding or contracting or if orders are up or down. Major diffusion indexes include those produced by Markit Economics and the Institute of Supply Management (ISM).
What are these indicators showing? Very clearly, Americans have grown bullish since the election. The Conference Board’s Consumer Confidence Index and the New York Empire Index for Current Conditions each shot up more than 10 percentage points from November 2016 to February 2017.
“Hard” indicators, on the other hand, are an entirely different story. These are quantitative estimates of actual economic activity provided by government agencies like the Bureau of Labor Statistics and the Bureau of Economic Analysis. Hard indicators include everything from median payroll to housing starts to PCE.
Over the same period that soft indicators have been surging, hard indicators that track overall economic activity, like real average hourly earnings and aggregate weekly hours, have continued to report steadily weaker YoY growth rates. The January and February real PCE numbers—showing the first back-to-back negative sequential growth rates in over five years—can only be described as a big disappointment. Yes, there is one good hard-data news headline recently: the rising trend in corporate earnings. But it's being generated by rising profit margins (which are now moving back toward their 2014 historical high), not by faster economic growth. That may or may not be a sustainable trend.
The recent surge in consumer sentiment has shocked even professional forecasters. Since November, soft indicators have been surprising largely on the upside, which means that they have come in above consensus estimates. Hard indicators, by contrast, have been surprising on the downside. In February, the gap between Bloomberg’s soft data and hard data surprise indexes hit 1.88—a 17-year high. And in March, the difference between hard and soft data surprises remained high at 1.85.
The timing of this sentiment boost is nothing new. Over the past 50 years, the election of a new first-term president has repeatedly led to higher soft data readouts. Political scientists and economists are well aware that most new presidents are afforded a “honeymoon period” that usually lasts no longer than 100 days. (This boost, however, seldom extends beyond 100 days unless some positive economic results appear.) Even after tightly contested elections, the positive impact of rising sentiment on the winning side typically outweighs the negative impact of falling sentiment on the losing side. (In effect, even the losing side says, "Hey, maybe we should give this new leader a shot.")
What’s also typical is that the euphoric rise in soft indicators is mostly powered by future expectations—not current conditions. Overall, the Conference Board’s Consumer Confidence Index reported a 14-point increase from 101 in October to 115 in February. While consumers’ confidence in their present situation increased by only 8 points (from 123 to 133), their confidence in future expectations rose 19 points (86 to 102). And this makes sense. A new president brings expectational hopes—not yet actual results. Along the usual life cycle of an economic recovery, expectations start higher than current confidence (in youth); this pattern gradually reverses to current confidence higher than expectations (in old age). In this sense, the Trump victory has to some extent "rejuvenated" our (now) elderly recovery.
SO WHAT MAKES THIS TIME DIFFERENT?
There are, however, many things about what’s going on today that are atypical from previous election cycles.
An unprecedented partisan swing in soft indicators. For one, changes in soft indicators since the election varied hugely by party affiliation. According to the University of Michigan’s Surveys of Consumers, the Index of Consumer Sentiment went up 40 points (from 83 to 123) for self-identified Republicans and fell 13 points (from 101 to 88) for self-identified Democrats from June 2016 to December 2016. The Index of Current Economic Conditions experienced a similar partisan divide—with Republicans up 24 points and Democrats up by only 5 points. Most notably, the Index of Consumer Expectations soared 51 points for Republicans and tanked 24 points for Democrats—a whopping 75-point divide.
This election cycle has given us an extreme example of asymmetry between popular opinion and sentiment indicators. A majority of voters didn’t cast their ballots for Trump, and negativity toward his election resulted in a historic low postelection approval rating. Yet the Trump enthusiasts are more than compensating for this negativity.
But don’t we see the same partisan swing after all elections? Not nearly to this extent. In fact, today’s divide in consumer expectations is almost five times the size of the partisan gap after Reagan’s election in 1980 (17 points) and Obama’s election in 2008 (17 points).
A partisan-fueled sentiment shift by age. So strong is this partisan division that it clearly tilts the sentiment data when broken down by age. According to the Conference Board’s Consumer Confidence Index, Americans under age 35, who were more likely to vote for Clinton, experienced a much smaller boost (2 points) in consumer confidence after the election than Americans over age 55, who were more likely to vote for Trump (23 points). In fact, the boost in consumer confidence among the 55+ has narrowed the age gap to a mere 6 points—a figure that has been in the double digits since July 2009.
This inversion of sentiment by age can’t be explained by anything going on in the economy. According to the Atlanta Wage Tracker, there has been very little difference in monthly wage growth in any age bracket over age 25 since the election—and certainly not enough of a difference to explain a confidence convergence of this magnitude.
A partisan-fueled sentiment shift by region. Partisanship is also shaping the changing pattern of consumer confidence by region. Americans in the Pacific, New England, and Middle Atlantic regions (who predominantly voted for Clinton) reported the smallest post-election increases in consumer confidence. Meanwhile, Americans in the East South Central, West South Central, and West North Central regions (who predominantly voted for Trump) reported the largest.
Once again, this divergence can’t be explained by changing economic conditions. A simple linear regression on the difference in consumer confidence before and after the election and change in GDP growth by region shows a weak and slightly negative relationship (-0.2). The difference between consumer confidence and the share of voters who voted for Trump by region shows a strong and positive relationship (+0.6).
An unprecedented partisan swing in “harder” soft indicators. It’s not just consumer sentiment surveys that are being influenced by partisanship. Even the “harder” soft data like business diffusion indexes are being swayed.
When you look at corporate roles across the spectrum, you find that compliance-focused and people-focused professionals (like those in human resources, public relations, and marketing) are more Democrat-leaning overall—while more “nuts and bolts” and bottom line-focused professionals (like plant managers and purchasing agents) are more GOP-leaning. Guess who generally fills out the questionaires for the ISM, Markt, and regional Fed diffusion indexes? That's right, the GOP-leaning purchasing and supply executives.
The same goes for the celebrated NFIB small business confidence index. It’s been soaring since the election, jumping from 94.9 in November to 105.3 in March. (A read-out above 100 indicates strong small business optimism.) Guess where these small business owners align politically? To the surprise of no one, they affiliate strongly with the Republican Party.
A partisan-fueled stock market boost? Beyond pushing up the soft indicators, Trump partisans may also be pushing up the stock market. Since the election, investors have been snapping up ETFs at a record-breaking pace: As of the beginning of March, investors have funneled $124 billion into ETFs in 2017—the strongest start to a year ever recorded.
To be sure, the rising share of all assets held in ETFs is a long-term trend that didn't start last November. But this sudden recent burst points to a strong role now being played by the retail investor. BlackRock’s Martin Small reports that, during the first two months of the year, individual investors accounted for as much as 85% of the inflows of the firm’s popular iShares ETF—far above the normal mark of 50% to 60%. MarketWatch columnist Howard Gold has repeatedly argued that this behavior is largely driven by Trump supporters who “shied away from stocks during the ‘Obama bull market’”—sitting on cash or gold instead—and are now “jumping in with both feet.”
Further evidence that lone Trump bulls have boosted the stock market is the cautious behavior of the big players. Indeed, most large active funds and foreign investors are taking a step back. Many are looking for opportunities to short the market, and thus far have been burned in their attempts (as happened, for example, in the short squeeze following Trump’s joint session with Congress on February 28).
IMPLICATIONS
What does this all mean for the future?
For starters, it’s worth mentioning that political missteps could bring these soft indicators back down. Since Trump’s inauguration, his approval ratings have hit new lows—indeed, his current approval rating in March (42%) is by far the lowest of any president at this stage in their first term going all the way back to Dwight Eisenhower. Clearly, the run-up in soft indicators is increasingly being driven by the optimists, whose impact is outweighing any negativity felt by the general public.
The real danger point will occur if and when Trump’s evidence of political impotence begins to erode support among his steadfast core, the die-hard optimists. And if last week’s botched ACA repeal and subsequent (if brief) stock market tumble is any indication, public confidence in Trump’s leadership abilities—and his odds of succeeding with his next major agenda item, tax reform—has already been shaken. If at some point episodes like these begin to erode large chunks of Trump’s core support, the soft indicators could take a real hit. And maybe the stock market along with it.
Speaking of Trump’s agenda, rising soft indicators could paradoxically make it harder for his administration to get anything done.
Why? A soaring stock market is a problem for Trump because it dissipates any sense of urgency in Congress to take action. When everyone feels fat and happy, it’s hard to get players to make compromises and find a consensus.
By contrast, there’s nothing like a severe market downturn to push power and initiative back to the executive. The market psychology is simple: When there’s fear, people are compelled to fall in line. This worked for Reagan early in his first term in 1981—and for Obama early in his first term in 2009. It is not working for President Trump, at least not thus far.
The bottom line for investors in all of this is to stay grounded when they’re watching soft indicators soar into the stratosphere. These numbers are heavily influenced by emotions and can easily change from one day to the next. (It’s called soft data for a reason.) If hard indicators continue to fall short of today’s high expectations, the possibility that these soft figures are overblown grows stronger—so proceed with caution.
