U.S. business confidence has improved far more than consumer confidence

Two of the best indicators with respect to the U.S. economy are the Index of Consumer Confidence posted by The Conference Board and the Purchasing Managers Index (PMI) of the Institute of Supply Management (ISM). The latter has improved far more than the former.

Consumer confidence still waffles

While it is true that U.S. consumer confidence in January 2010 (55.9) was a lot higher than at the same time a year ago (25.3), it still falls well short of the 100.0 level that occurred from the start of 2004 and persisted until the mid-point of 2007. Consumers remain wary about the outlook. They will continue to hold this stance until job prospects pick up in a more meaningful way.

Furthermore, there are plenty of potential workers who have given up on the idea of finding a job at all for the moment. As a result, the unemployment rate is likely to stay near 10.0% all year, even as the number of new jobs and re-hires increases. This is the discouraged worker effect.

A second major factor holding back consumer confidence is the state of new and existing housing markets. People derive much of their sense of wealth and well-being from their homes. Until new and resale house prices stabilize, confidence will be shaky. The December incomes report contained good news, however. Inflation-adjusted personal disposable income was ahead 0.3% month to month in December, a good rate of growth. And the personal savings rate was 4.8%. Such strong savings are helping individuals and families restore their budget balances.

Business is feeling more confident

At the same time as consumers waffle, firms are feeling more confident. One reason is the rise in the PMI to 58.4% in January 2010, its highest level since mid-2004. Third-quarter 2009 profits (+10.8%) returned to a solid growth path. Inventories have been reduced to where they are now consistent with sales levels. To maintain stocks moving forward, new orders will have to be met by a one-to-one increase in production. Gains in sales will warrant adding to stocks in inventory.

There are several corollaries that go along with the massive job cutting that has been seen over the past two years. The job cuts inevitably bring big increases in productivity during the recovery phase, as firms find a means to fulfill orders with fewer workers in the short term. Coming out of recession, there is also an incentive to purchase new machinery and equipment to increase competitiveness. The software-and-equipment investment component of GDP advanced 13.3% annualized in fourth-quarter 2009 versus the third quarter, according to the latest report.

A capacity reduction effect

Finally, one other factor comes into play. The massive decline in the capacity utilization rate in the nation’s industrial sector to less than 70% has also led to one other phenomenon: cutbacks in available capacity to save on costs. That’s fine, until output levels have to be ramped up again. At such a time, the need to add capacity can lead to a quick turnaround in capital investment in some key sectors. That is what some analysts are counting on. As a final word, the ISM says that a PMI of 58.4% is consistent with real GDP growth of 5.5%, based on historical modeling.