The very real effects of consumers’ hopes
Investors and economists know that consumer sentiment surveys are a leading indicator for future consumption. However, the headline figure is a mix of assessments about personal financial situation, the economy, the job market, etc., which is why it isn’t always helpful to look at that number. My personal favourite is the question whether it is a good time to make major purchases, which seems to be a better predictor of future consumption. But a new study from Australia has created two intriguing new indicators about consumers’ optimism that I may use instead going forward.
Edda Claus and Viet Hoang Nguyen looked at three specific questions in the consumer confidence survey in Australia: The current assessment of family finances, the expected change in family finances in the next 12 months, and the expected change in the economy in the next 12 months.
As you can see from the US and UK data below, consumers have a tendency to be overly optimistic about their prospects. Their assessment of their future family finances is typically better than their assessment of the future situation in the economy overall. This is nothing new, we all are overoptimistic about our abilities and our prospects. It’s the famous statistic that more than 50% of people think they are better than average drivers.
Expectation for personal financial situation and the economy in the US (left) and the UK (right)
Source: Liberum, Bloomberg
But if we plot the difference between the expectation for family finances and the economy in a year’s time, we see that the degree of overoptimism changes over time (and sometimes turns negative). It is this measure of ‘ex ante optimism’ that the research says has predictive power for future consumption growth. In the case of Australia, they find that a 1% increase in ex ante optimism leads to an increase in consumption growth of 0.13 percentage points in the following year. If similar results hold in the US and the UK (which is something you should check if you are a professional, as will I in the next couple of weeks), then the 25% drop in ex ante optimism in the US in February might indicate a pretty steep drop in consumption in 2024.
Ex ante optimism seems particularly influential for future consumption because if consumers become more optimistic, they tend to increase their spending and their use of debt in the hope that they will pay for all that debt with future wage increases or lower interest rates on debt.
Ex ante optimism (left) and ex post optimism (right) in the US and UK
Source: Claus and Nguyen (2024), Bloomberg, Liberum
But the authors of the study construct another measure of consumer optimism, one they call ‘ex post optimism’. This measure compares consumers’ assessment of their current family finances with their expectations a year earlier. And this ex post optimism is what drives savings ratios, it seems. If consumers are persistently disappointed about how their personal finances developed compared to their expectations, they start increasing their savings ratio to have more of a safety net and they start cutting back on using credit anticipating that they will not have the means to service their debt.
And looking at the chart of ex post optimism in the US and UK above, I would say that the situation is still ok, but slowly getting worse, which means we should expect consumers to increase their savings ratio in 2024.