Consumer Still Holds the Key

Jobs data suggest the consumer's surprising strength could be short-lived, however.
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An unexpected drop in consumer confidence has laid investors low. Stocks fell sharply after the Conference Board said its Consumer Confidence Index slipped to 114.3 in August from July's 116.3.

Economists had thought the index would improve for the month, pointing to government tax rebates, lower energy costs, housing-sector strength and interest-rate weakness. But softness in the job market was apparently enough to trump all the positives.

Those surveyed saw a sharp deterioration in current economic conditions. Those saying jobs are hard to come by climbed to 15.9% of the sample from 14.1% -- the biggest jump this year. The portion of those who believe jobs are plentiful slipped to 33.4% from 35.6%.

"The negative weight on sentiment here is the eroding job market," says Morgan Stanley senior economist Bill Sullivan. "We run the risk that households become more cautious and cut back on spending."

Throughout the downturn consumer spending has held up well, helping mitigate the effects of a deep recession in manufacturing and preventing the overall economy from slipping into the red. This has been surprising for many economists. Unemployment went from 3.9% last October to 4.5% in July; in the past such a large rise has inevitably led to recession.

That consumers haven't retrenched has bolstered the argument for the economy getting back on track by the end of the year. This has been especially true given recent reports showing the manufacturing economy beginning to stabilize. Industrial production, for instance, was flat in July, ending 10 months of declines, and in many areas of manufacturing inventories appear to have been brought in line. But if consumers pull their heads in, manufacturing's toehold on recovery could fall away. The many investors who are banking on a rebound by the end of the year could be sorely disappointed.

"The stock market is hopeful that economic activity has reached a bottom," says J.P. Morgan Chase chief market analyst Don Fine. "The number this morning suggests that may not have happened."

But Salomon Smith Barney economist Chris Wiegand points out that there were competing reports this morning that suggested the consumer isn't going away just yet. The chain store sales index put out by Bank of Tokyo-Mitsubishi and the Redbook retail average both put on gains for the week ended Aug. 25. That suggests that regardless of how they feel, people are still plunking down their money at stores.

Wiegand also notes that since the employment situation is such a big part of it, the drop in the confidence index may not augur further deterioration in the economy. Because companies continue to be cautious going into a recovery, unemployment tends to rise even when the economy rebounds. Yet Wiegand does admit that, with economic growth teetering on the flatline, if unemployment rises sharply in the coming months, all recovery bets are off.