Confidence Wanes; Pessimism Stays High Analysis By Michelle Lirtzman

July 17, 2007

Americans’ ratings of their personal finances hit a nine-month low this week, pushing confidence back down after a recent rally. Pessimism for the future of the economy stayed high for the third month straight in the ABC News/Washington Post consumer confidence survey.

The ABC/Post Consumer Comfort Index, -7 two weeks ago, now stands at -11 on its scale of +100 to -100, back within sight of its 2007 low of -15 on June 3.

The index is calculated according to ratings of personal finances, the national economy and the buying climate. In a separate measure on expectations, a majority (now 51 percent) said for the third month straight that the economy is getting worse. Just 12 percent said it’s improving.

These results suggest that gas prices, plus the public’s generally foul mood, linked to the unpopular war in Iraq, carry more weight than recent gains in the stock market, where the Dow touched 14,000 Tuesday. Gas climbed 7 cents to $3.05 in this week’s U.S. Department of Energy survey, the first significant increase since prices began to ease in late May.

That makes sense: Many people are indirect, buy-and-hold investors, not directly touched by the market’s ups and downs; but for most, gas prices hit home every day.

INDEX — While positive ratings of personal finances and of the buying climate have lost ground, overall views of the economy continue a gradual month-long climb.

Ratings of personal finances, 55 percent positive, have dropped by 10 points since May and six points over the past three weeks. Ratings of the buying climate, after hugging 40 percent for two weeks, are back in the mid-30s, where they spent most of spring.

However, 42 percent rate the overall economy positively, up from 37 percent in June.

EXPECTATIONS — As noted, for the third consecutive month, a majority said the economy is getting worse. The most recent previous majority was last summer, when consumers were also hit with a spike in gas prices.

Only 12 percent said the economy is getting better, down from a 2007 high of 18 percent in January before gas headed north.

Pessimism is now 12 points higher than its long-term average in polls since March 1981 and 17 points higher than its 2007 low. It is, however, considerably lower than its all-time high of 77 in November and October of 1990.

TREND — The CCI is five points below its 2007 average, -6, and 13 points from its high for the year, +2 on March 11. Its averaged -9 in weekly polls since December 1985, ranging from a high of +38 in January 2000 to a low of -50 in February 1992.

GROUPS — As usual, confidence is higher among better-off Americans. The index is +36 among higher-income people, while -53 among those with the lowest incomes, +5 among those who’ve been to college while -40 among high school dropouts and -9 among whites but -33 among blacks. It’s -12 among men compared with -10 among women, an unusually narrow gap for the second week in a row.

Big partisan differences remain: The CCI is +23 among Republicans, but -14 among independents and -28 among Democrats. Still, the 51-point gap between Democrats and Republicans has been bigger, peaking at 90 in July of 2004.

Here’s a closer look at the three components of the ABC/Post CCI:

NATIONAL ECONOMY — Forty-two percent of Americans rate the economy as excellent or good; it was 40 percent last week. The highest was 80 percent on Jan. 16, 2000. The lowest was 7 percent in late 1991 and early 1992.

PERSONAL FINANCES — Fifty-five percent said their own finances are excellent or good; it was 58 percent last week. The highest was 70 percent last reached in January 2000. The lowest was 42 percent on March 14, 1993.

BUYING CLIMATE — Thirty-six percent said it’s an excellent or good time to buy things; it was 39 percent last week. The highest was 57 percent on Jan. 16, 2000. The lowest was 20 percent in fall 1990.

METHODOLOGY — Interviews for the ABC News/Washington Post Consumer Comfort Index are reported in a four-week rolling average. This week’s results are based on telephone interviews among a random national sample of 1,000 adults in the four weeks ending July 15, 2007. The results have a three-point error margin. The expectations question was asked of 500 respondents July 5-15; that result has a 4.5-point margin of error. Field work by ICR-International Communications Research of Media, Pa.

The index is derived by subtracting the negative response to each index question from the positive response to that question. The three resulting numbers are added and divided by three. The index can range from +100 (everyone positive on all three measures) to -100 (all negative on all three measures). The survey began in December 1985.

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Everyone from Hong Kong billionaire deal maker Li Ka-shing to former Fed chairman Alan Greenspan and http://investing.businessweek.com/research/stocks/snapshot/snapshot.asp?capId=7923985 Governor Zhou Xiaochuan have been warning for weeks that the levitation act at China’s domestic bourses in Shanghai and Shenzhen wouldn’t last forever. Beijing financial mandarins have also sounded the alarm and followed up with interest rate moves and other tightening measures.

Nobody knows for sure, but the mother of all stock rallies in China that has seen the benchmark CSI 300 Index nearly double this year and inspired millions of new investors to open up trading accounts may finally be reaching a turning point. On May 30, the CSI 300 Index which tracks the most important “A shares” traded on the Shanghai and Shenzhen markets tumbled 6.8%. That’s the most precipitous fall since a 9%-plus blowout on Feb.26 that rattled markets worldwide.

The trigger for the sell-off was a move by the Chinese government to triple the stamp tax—a fee on trades—from 0.1% to 0.3%. Although the absolute impact of the increase alone is hardly enough to dampen investor enthusiasm for markets that have been on a tear for the past two years, the move could signal that the government is deadly serious about guiding the market down with even stronger measures if need be. Herald of Tougher Measures?

“This is very symbolic and a signal that the government is using targeted means to dampen irrational exuberance in the A-share markets,” says Jing Ulrich, chairman of China equities at JP Morgan Chase (http://www.businessweek.com/ticker/). Ulrich points out that while the latest stamp duty adjustment in itself will have “a very limited impact,” it’s important to view it historically. Since the Shanghai market opened in 1991 the government has cut the stamp duty six times from an initial 0.6% rate, each time in an attempt to shore up sagging prices.

This small tax increase could herald a more profound move, such as the creation of a capital gains levy on stock transactions. Market rumors that Beijing was considering such a levy helped touch off the fall back in February.

This latest development also follows moves by China’s central bank to steadily tighten credit conditions on the mainland, though they remain lax for an economy that grew 11.1% during the first quarter. The People’s Bank of China has steadily hiked the reserve requirements for cash the banks must maintain at the central bank, and on May 18 hiked the interest rate on one-year loans to 6.57% from 6.39%, the fourth such increase since the spring of 2006 (see BusinessWeek.com, 5/18/07, ). Market Sentiment Shifting

Chinese financial authorities have also slowly twisted the tourniquet on liquidity and tried to dampen the speculative fever at domestic bourses in other areas. Beijing this year has introduced limits on allowing mutual fund companies to raise money from investors by launching new funds; has stepped up probes into insider trading and stock market manipulation; and has urged brokerages to make better attempts to educate retail investors about the risks of investing.

Only two trading days ago, on May 28, the CSI 300 Index touched a record high, but now market sentiment may be shifting as evidence grows that the government will keep up its “death by a thousands cuts” strategy to bring stock prices to more reasonable levels.

“The thousand cuts sound like they are now biting,” says Stephen Green, the Shanghai-based senior economist for Standard Chartered.

The big question is whether this administrative measure portends something more Draconian in the future. It didn’t take long for the Shanghai and Shenzhen markets to recoup declines in February and resume their moon-shot trajectory. And even with May 30’s haircut, the Shanghai Stock Exchange Composite Index is up 51% on the year and shares traded on the smaller Shenzhen bourse have delivered returns of 117%.

Consumers boosted their spending in May as their incomes grew solidly, an encouraging sign that high gasoline prices haven’t killed people’s appetite to buy. Inflation moderated.

It was the second month in a row that consumer spending went up by 0.5 percent, the Commerce Department reported on Friday.

Incomes, the fuel for future spending, rebounded in May, growing by 0.4 percent. That was an improvement from the 0.2 percent drop reported for April.

The latest snapshot of consumer behavior was a bit weaker than economists were expecting. They were forecasting consumer spending to rise by 0.7 percent and for incomes to grow by 0.6 percent in May. The spending and income figures aren’t adjusted for inflation.

Consumer spending plays a major role in shaping overall economic activity. In the first three months of this year, it was consumers’ brisk spending that kept the national economy from stalling.

The economy barely moved in the first quarter, growing at a pace of just 0.7 percent, the weakest in more than four years. A rebound in the April-to-June quarter is anticipated, with growth coming in anywhere from a 2.3 percent pace to topping 3 percent. A few believe it could clock in around 4 percent.

In deciding to hold interest rates steady on Thursday, Federal Reserve Chairman Ben Bernanke and his central bank colleagues also stuck to their forecast that economic activity would bounce back modestly in the coming quarters. The Fed’s key rate has stood at 5.25 percent since last June, giving borrowers a yearlong period of rate stability. Rate predictability can be helpful when mapping out big-ticket purchases and investment decisions.

An inflation measure tied to the income and spending report showed “core” prices — excluding food and energy — moderated. These prices rose 1.9 percent over the last 12 months ending in May. That was the best annual showing since the spring of 2004.

Even so, Bernanke and his colleagues made clear Thursday that they are not ready to declare victory against inflation and will be watching for sustained improvements. The biggest risk to the economy, they said, is if inflation fails to recede as they anticipate.

In May, consumers rediscovered their appetite to spend on big-ticket durable goods, such as cars and appliances. This spending rose by 0.4 percent, compared with a 0.6 percent decline in April. Spending on nondurables, such as food and clothes, went up a brisk 1.4 percent in May, up from a 0.5 percent gain in April. Spending on services edged up 0.1 percent in May, down from a 0.8 percent rise in the prior month.

With spending outpacing income growth, Americans’ personal savings rate — savings as a percentage of after-tax income — fell to negative 1.4 percent in May, the worst showing since August 2006.

Economists, however, caution that the picture of savings isn’t as bad as it looks. The savings rate doesn’t provide a complete picture of household finances because it doesn’t capture gains from such things as real estate or financial investments.