The last decade has seen significant changes in media and communication. In a world where there is an ever louder cacophony of news sources competing for our attention, any one particular story has to be communicated at a particularly high volume if it is to attract notice. UBS' Paul Donovan warns that this perhaps gives a tendency to sensationalism. For financial markets, Donovan notes, there is a risk that these changes in the world of media will impinge on the calm and reflective world of economics. Economists rely on sentiment data as a leading indicator for future economic trends. If individuals are overreacting to events relative to the past, however, sentiment may not be as useful as a barometer of future economic activity. In the US a certain economic hysteria seems to be developing, amongst consumers in particular (especially compared to Europe) and Donovan suggests investors would be wise to treat US sentiment data (particularly consumer sentiment data) with some caution as American investors appear to react more strongly to the underlying economic events.
Via Paul Donovan, UBS,
If individuals are overreacting to events relative to the past, however, sentiment may not be as useful as a barometer of future economic activity. At the very least there is a risk that sentiment will mislead investors as to the scale of likely moves in underlying economic fundamentals if there is a tendency on the part of individuals to overreact to the news flow.
To monitor this, we use our blasé barometer. This simply compares the volatility of sentiment with the volatility of the pertinent underlying economic data. If the barometer is rising it suggests that sentiment is more inclined to overreact. If the barometer is falling, then sentiment is blasé about the economic news flow. The indices are based so that the average reading in 2000 is equal to one.
In the US a certain economic hysteria seems to be developing, amongst consumers in particular. The volatility of sentiment has been rising sharply relative to the volatility of the underlying economic data.
The causes are slightly different depending on the sector. For the consumer, the shift is due to rising volatility in sentiment and falling volatility in retail sales coming together simultaneously. For the manufacturing sector however, the rise is due to the fact that the volatility of manufacturing production has been declining faster than the volatility of ISM sentiment.
The trends in the US are particularly interesting when compared to what is happening in Europe. Europeans are becoming especially blasé in their outlook (perhaps “resigned to their fate” would be a better way of characterizing it given the economic weakness of the data).
Consumers in Germany have been less inclined to overreact, at least relative to the norms of the period of the Euro crisis. Consumer confidence has been less volatile of late, and the barometer has fallen. Corporate sentiment has been marginally more volatile in a relative sense this year – perhaps reflecting concerns about the consequences of the Euro crisis – but it is not a significant shift.
The French consumer, meanwhile, has reached new lows in their reactivity to economic circumstances: the volatility of consumer sentiment is almost at its all time low.
The British data show consumers and corporates that are relatively indifferent to the swings of underlying economic data. This is entirely due to declining volatility of sentiment – in the case of the manufacturing sector the underlying data has in fact become slightly more volatile in recent months.
Those excitable Americans
What this suggests is that investors would be wise to treat US sentiment data (particularly consumer sentiment data) with some caution. There is clearly a tendency to react more strongly to the underlying economic events in the United States. European sentiment data, on the other hand, seems to be more reliable as an indication of where things are likely to go. The blasé barometers can not, of course, tell us anything about the direction of data. It may well be that the correct interpretation of these numbers is that Euro area consumers and corporates are dependably pessimistic in their economic views.