With consumers becoming more confident, is it time for a positive feedback loop?

Last week I highlighted the positive implications of a stronger real estate market.  Confirming this view are reports this week showing that residential construction rose smartly in September, by 2.8% and average home prices by 2% compared to last year[1].  Residential real estate improvement implies the positive spillover effects of increased durable consumption (think washing machines, refrigerators etc.,).  It is time for a positive feedback loop – that is consumers spend more, demand increases , businesses hire and the economy grows!  Consumers are feeling better off and more confident now that their net worth has increased.  Could this positive sentiment translate to a stronger economy and stock market?

Here are the economic positives:

• Today the Labor department reported that payrolls increased better than forecast with 171,000 jobs added in October.
• On Nov. 1,  ADP reported that 150,000 jobs, also better than expected, were created in the private sector.[2]
• Also on Nov. 1, unemployment claims were lower than predicted at 363,000
• Consumer sentiment is the highest since September 2007 when the recession started. (See chart below)
• Oil prices are receding putting more discretionary spending in consumers’ pockets.
• Consumer debt has decreased after several years of paying down debt.[3]  So consumers are starting to spend and as a consequence, retail sales are up more than 5% versus a year ago.[4]
• Household net worth is up more than 17% compared to a low in 2008.
• Economy is growing at a moderate 2% pace.

Could these positives affect future stock market performance?

Assuming a snap back to historical averages, the market is poised to go higher once investors return to owning stock ownership at their usual 60% allocation (instead of the current 50% levels).  Currently both individual and institutional investors shun stocks and prefer bonds.  According to ICI, the Investment Company Institute, investors have withdrawn money out of equity funds four years in a row with $100 billion pulled out in 2011, for example.  This year through September, investors have sold $83 billion of equity funds and channeled roughly 3x that amount into bond funds over the same period.[5]  It appears that investors are preparing for the last Global Financial Crisis instead of a future bull equity market!

Additional supportive factors for stock ownership are low inflation (with the Federal Reserve promising to keep interest rates low for the foreseeable future), decent profits reported this earnings season (despite some challenged revenues for multinational companies), and increased productivity at American companies.  All of these factors argue for a higher stock market once some of the uncertainties are cleared away such as the election and fiscal cliff.

Caveat:  Hurricane Sandy’s destruction is a big negative whose effects and costs are still being measured.  In fact, your author is writing these words at her New York gym due to Sandy’s effects!  Long term, nevertheless, it looks like consumers are getting ready to spend, demonstrating their dominant portion (about 70%) of the gross domestic product.

Chart Source: St. Louis Federal Reserve