From Invesco: Last week the Conference Board’s Consumer Confidence Index was released, showing that consumer confidence is at a 16-year high.

We saw slightly less effusive but similarly positive attitudes from the University of Michigan’s Consumer Sentiment Index. (It is worth noting that the former was conducted before the failure of the health care bill while the latter was conducted after.)

Digging down into the consumer confidence report, we see that consumers today are much more positive about their current situation as well as their expectations for the near future. Not only do consumers expect more jobs to become available in coming months, they also expect their incomes to increase.

It’s no surprise that consumers feel this way, given that incomes have already started to rise. February’s Personal Income and Outlays report showed that there was a very significant growth of 0.5% in the wages and salaries component of income.¹ The problem is that it hasn’t translated into an increase in consumer spending, which rose just 0.1% in February.¹ Despite positive sentiment about their current situation and their future, it turns out consumers are saving more. And that’s not just in February — consumers had also increased their savings in January.

So what is happening? It seems clear that there is a divergence between sentiment and actual activity when it comes to both companies and individuals. The question is: How can we reconcile the two?

Two theories about consumer activity

One theory is that sentiment is a leading indicator, and that actions will follow. That is certainly a “best case” scenario and one that finds some support from historical data. We can certainly hope that economic activity will increase and at some point closely match sentiment; that is perhaps the more likely theory, in my view. However, we need to be cognizant of other possible scenarios.

Another theory is that consumers are not being truthful. Think of the polling results that preceded Brexit and the US elections last year, which both proved to be inaccurate. Individuals have a habit of refraining from sharing views with pollsters if they believe their answers will be perceived as unpopular. There is actually a term for it — social desirability bias. And it has manifested itself in a variety of different polls over time:

• Consider the California gubernatorial race of 1982. Los Angeles Mayor Tom Bradley, an African-American, led in the polls up until election day but lost the actual election. Some theorized that California voters did not want to appear racist, so they indicated support for Mayor Bradley when polled, but not in the privacy of the election booth. This theory became known as the “Bradley Effect.”
• This phenomenon is of course not limited to the US. In the United Kingdom in the past several decades, the Conservative party (the Tories) performed surprisingly better in elections than their polling numbers suggested in advance of the elections, leading to a similar theory termed the “Shy Tory Factor.”

Social desirability could be the reason consumer sentiment is so high right now. In an environment in which “America First” has become a common slogan, and many are talking about a return to Reaganesque economic growth, it may seem unpatriotic to question the strength of the US economy. So consumers may just be hedging their bets — hoping for the best but planning for less.

In short, there could certainly be other reasons for the divergence, which we can explore in future commentaries. However, this disparity between consumer sentiment and economic activity is worthy of note. In my view, this mismatch suggests that investors should exert caution with their exposure to retail stocks in particular. I believe this is an environment in which there are likely to be significant distinctions among individual retail stocks — if consumer spending isn’t enough to boost the sector as a whole, then company fundamentals become more critical. Selectivity and scrutiny should be critical in evaluating opportunities in this sector.

The SPDR S&P Retail ETF (NYSE:XRT) fell $0.10 (-0.24%) in premarket trading Tuesday. Year-to-date, XRT has declined -5.60%, versus a 5.28% rise in the benchmark S&P 500 index during the same period.

XRT currently has an ETF Daily News SMART Grade of B (Buy), and is ranked #33 of 45 ETFs in the Consumer-Focused ETFs category.

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1 Source: Bureau of Economic Analysis, data as of March 31, 2017

Important information

Blog header image: zhu difeng/Shutterstock.com

The Conference Board’s Consumer Confidence Index® is published monthly, based on a survey of US consumers’ buying attitudes and buying intentions.

The University of Michigan’s Consumer Sentiment Index is published monthly, based on a telephone survey designed to assess US consumer expectations for the economy and their personal spending.

The opinions referenced above are those of Kristina Hooper as of April 3, 2017. These comments should not be construed as recommendations, but as an illustration of broader themes. Forward-looking statements are not guarantees of future results. They involve risks, uncertainties and assumptions; there can be no assurance that actual results will not differ materially from expectations.

This article is brought to you courtesy of Invesco.

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