University of Michigan Consumer Sentiment drops slightly, are interest rates starting to bite?

Consumer SentimentEnlarge GraphThe Thomson Reuters/University of Michigan Consumer Confidence Index is a leading indicator for the U.S. economy

The Thomson Reuters/University of Michigan Consumer Confidence Index is an important indicator of the consumer’s perception of the U.S. economy. Similar to other consumer confidence measures, it asks consumers about their views on the current economic conditions, and their expectations for six months out. It is one of the oldest consumer surveys, originally started in 1964.

Consumption is the major driver of the U.S. economy and accounts for 70% of GDP. Consumption has been relatively subdued since the recession began as Americans have boosted their savings rate and spent only on essentials. The real estate bubble drove consumption in the mid ’00′s as people took out cash refinances and spent the extracted home equity. This had the effect of increasing the cost basis for many people’s homes and left them vulnerable when house prices collapsed. As a result, they have focused more on paying down debt than spending.

Highlights from the report

The Consumer Sentiment Index rose to 84.1 in June, down from 84.5 in May. (Consumer confidence in 1964 = 100). The Bloomberg survey consensus was 75.1. The Current Conditions Index fell to 93.8 from 98 in April, and the Expectations Index rose to 77.8 from 76.7 last month. Given that an index value of 90 is more or less the average over the past 50 years, consumer confidence is still on the weak side. The index can vary widely – in January of 2000, it was 112 and in November of 2008, it bottomed at 55.3.

One theory that has been thrown out is that consumers are starting to pick up on the improvement in the real estate market and that is driving consumer confidence. As we have seen from the real estate indices, unless you live in San Francisco, Phoenix, Las Vegas, or a few other places, you haven’t really been experiencing a major increase in home prices. It may be that the headline numbers are enough to make people feel better even if prices aren’t rising that dramatically where they live.

Implications for the homebuilders

KB Home CEO Jeffrey Metzger said on their earnings conference call last week that consumer confidence was more important to their business than the level of interest rates. Buying a new home is such a commitment that buyers require certainty about their job prospects and the economy before they will entertain such a purchase.

KB and Lennar both noted that the first time homebuyer was returning to the market and that household formation appeared to be increasing again. There is a lot of pent-up demand from young adults and once that is unleashed, it should drive business for homebuilders at lower price points like Lennar (LEN), KB Home (KBH), Ryland (RYL), and Meritage (MTH).