Tepid consumer sentiment remains hurdle for economy

It was a pretty good week for the U.S. economy: initial reports on third quarter corporate earnings were mostly satisfactory, jobless claims continued to decline, and factory production increased. One metric that underperformed, however, was consumer sentiment, which fell unexpectedly.

The Reuters/University of Michigan Surveys of Consumers said its consumer sentiment index for October (preliminary) fell to 69.4 from 73.5 in September, Reuters reported Friday. The index was at 65.7 in August. The index hit a cycle low of 55.3 in November 2008; its record low of 51.7 was set in May 1980.

Economists surveyed by Bloomberg News had expected the index to total 74.0 in September (preliminary).
Investors should pay attention to consumer sentiment because it usually precedes consumer decisions to buy (rising sentiment) or hold off purchases (falling sentiment) -- and historically consumer spending has accounted for the bulk (60-65 percent) of U.S. GDP.

Further, Friday's preliminary September data will undoubtedly provide fodder for those who argue the nation does not have all foundations in place for a sustained recovery.

The consensus view, or the majority of economists, expect the U.S. economy to record GDP growth by Q4, possibly as early as Q3, arguing that recent data showing housing sector stabilization and manufacturing output increases point to an expansion. Further, these economic bulls say factories and businesses have cut inventories so much, due to the pronounced recession, that they'll likely rebuild inventories, in order to avoid being "product short" when demand picks up, moving forward, and that replacement process will help move the GDP needle in a positive direction. Any tailwind from better-than-expected exports stemming from the weaker dollar would be a bonus.

Conversely, the minority view, the economic bears, argue the signs of recovery are not as strong. They say the U.S. retail sector's doldrums and consumer hesitancy -- the U.S.'s new "frugal consumer" era -- are likely to keep U.S. GDP growth well below potential. The specter of continued monthly job losses through Q2 2010, and rising oil prices will further hurt both U.S. disposable income and conditions for commerce, the bears say. An additional decline in disposable income would quickly cause a retrenchment in consumer sentiment, they say, leading to a very weak recovery, and, quite possibly, a double-dip recession.

The University of Michigan's Consumer Survey Center questions 500 households each month on their financial conditions and attitudes about the economy.

Economic Analysis: The September decline in consumer sentiment to 69.4 was unexpected, but again, it's not that unusual to see fits-and-starts with consumer sentiment during the initial stage of an economic expansion. The reason typically relates to unemployment being a lag indicator: it tends to start to recover much later -- or months after the actual recovery is underway, and the lack of jobs is often expressed as concern by consumers about their job security, financial status, and outlook for the next six months.

To be sure, if consumer sentiment continues to decline in subsequent readings, that would be a cause for concern, but as of now, the bigger picture for the United States reveals an economy that's starting to expand, with increased industrial output, rising exports, and a decline in lay-offs.
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