Consumer confidence hit a five year high this month, the headlines blared in response to the release of the most recent University of Michigan Consumer Sentiment Index. The positive spin was that rising house prices and declining unemployment have made consumers upbeat, causing the index to clock in at its highest level since before the Great Recession began.
Despite the happy news, consumers aren't that optimistic. Not only are the consumer sentiment numbers weaker than the headlines suggest, but also small-business owners are likely to infect consumers with their more downbeat views.
The headlines are deceiving. Consumers aren't confident about the future. The sentiment index is composed of two parts: consumers' views of current economic conditions and their expectations about future conditions. While consumers were more positive about current economic conditions this month than last month, their expectations about the future were actually more pessimistic, the University of Michigan data reveals.
Moreover, the current level of consumer sentiment isn't particularly strong when compared with historical standards. Advisor Perspectives notes that the November figure lies below both the index's average since 1978 and its average for years when the economy was expanding.
Further, consumer sentiment tends to track small-business confidence, and small-business owners aren't all that positive right now. Despite rising 0.3 points last month, the National Federation of Independent Business Small Business Optimism Index remains below its pre-recession average, mired in what the association's economists call its "recession range."
Small-business owners are worried that employee health-care costs will rise substantially as the Affordable Care Act is implemented, and that Congress and the President won't agree on taxes and spending, sending the country over the fiscal cliff into a recession in 2013. A recent survey of small-business owners conducted for the U.S. Chamber of Commerce by Harris Interactive reported an 11 percentage point rise in the last year in the number of owners who are unsure of whether their business will be better off in the future than it has been in the past.
Small-business owners remain much worse off financially than they were before the Great Recession because they suffered a particularly deep drop in income during the economic downturn. The Federal Reserve Survey of Consumer Finances shows that the median income of households headed by a self-employed person dropped 19 percent between 2007 and 2010 -- far more than the 6 percent decline for households led by someone working for a salary or wage. Similarly, Census Bureau figures show that the income of the typical wage-earning household fell only 1.3 percent between 2006 and 2010 when measured in inflation-adjusted terms, but plummeted 17.4 percent for the median self-employed household.
The more sanguine small-business confidence numbers are more likely to predict future economic conditions than the more optimistic consumer-sentiment figures. To start with, the NFIB's measure is a better predictor of future economic growth than the University of Michigan's indicator.
Moreover, small-business owners' pessimism will likely be a drag on the economy. Business owners' downbeat expectations will lead them to refrain from investment and hiring. Because half of private-sector employment and gross domestic product are accounted for by small businesses, lack of activity among small businesses will keep GDP and employment from growing much. Faced with stagnant employment and wages, the sentiment of consumers, many of whom also work at small companies, will turn negative.
Sorry for the out-of-the-holiday-spirit message, but economics is the dismal science, after all.