GALLUP NEWS SERVICE
PRINCETON, NJ -- In sharp contrast to Wall Street's exuberance last month, the April 2006 UBS/Gallup Index of Investor Optimism then showed investor optimism continuing to tumble from its January high. Over the past week, the equity markets have taken a plunge while investor optimism stabilized during May -- although it did so at a six-month low.
Does the leveling of investor optimism this month suggest that the equity markets will soon follow suit? And, what does today's low level of investor optimism imply for the course of the economy during the months ahead?
Investor Optimism Stabilizes in May
Investor optimism remains at it lowest point since November 2005. The Index of Investor Optimism now stands at 64, essentially the same as the 63 of April 2006. The Index is down 29 points from January's 93, falling 13 points in February and 16 points in May. The Index had a baseline score of 124 when it was launched in October 1996.
The Personal Dimension that assesses investor perceptions of their own portfolios is unchanged from April, remaining at 56 in May. The Economic Dimension that measures investor perceptions of the economy stands at 8 in May -- essentially the same as the 7 for April.
Energy Remains Top Investor Concern
Nine in 10 investors (92%) say the price of energy including gas and oil is hurting the investment climate a lot (73%) or a little (19%). While a number of experts argue that high gas prices are not doing great damage to the economy, 8 in 10 investors (81%) are so concerned that they say the federal government should do more to address the high price of gasoline.
In part, this desire for government action is explained by investor perceptions of the forces influencing today's gas prices. A majority (55%) say they believe that high gasoline prices are the result of both free market forces and price gouging. Another 18% attribute today's high gas prices largely to price gouging by the big oil companies, while only 17% believe they are totally the result of free market forces in the global oil markets.
Investors are evenly split over the idea of temporarily suspending all federal, state, and local gas taxes until the price of gas falls below $2.50 per gallon including taxes. Fifty-one percent favor this proposal, and 47% opposed.
Many Other Investor Concerns
Second among investor concerns is the outsourcing of jobs to foreign countries (80%). This is followed by worries about the federal budget deficit (77%), the current situation in Iraq (75%), questionable accounting practices (71%), and worries about inflation (70%).
One reason that concerns about potential inflation ranks a somewhat surprising sixth in the survey may be that it was conducted over the period of May 1-14, 2006 -- and thus was completed prior to last week's release of new data on the raising inflation fears on Wall Street. The same may hold true for the value of the dollar (63%) as it ranked seventh. Interest rates (47%) ranked last in the 11 items included in the investor survey.
On the other hand, the comparatively low level of the Index of Investor Optimism implies that the average investor remains more concerned about the overall strength of the U.S. economy than is the case among many pundits on Wall Street. In turn, this could lead investors to rank inflation and interest rates lower than some other potential worries. Further, the overall percentages show many investors are worried about inflation, the value of the dollar and interest rates.
Both current Fed Chairman Ben Bernanke and former Chairman Alan Greenspan talked about the slowing housing market last week. Timing of the survey may also account for this issue ranking eighth among investor concerns. However, it may also indicate that many investors agree with these policy makers that the housing market is in for something of a "soft-landing."
Testing New Fed Chairman Bernanke
The steady decline in investor optimism since January implies a weakening U.S. economy and therefore is consistent with the forecasts of most economists. It is also consistent with the recent declines in the equity markets. Of course, the real question is not whether the U.S. economy is slowing, but how far the slowdown will go.
In this regard, it appears as though the markets are going to be testing new Fed Chairman Bernanke over the weeks and months ahead. At its last meeting, the Federal Open Market Committee (FOMC) abandoned the Greenspan language on interest rates and the relative predictability they have provided during recent years. This has created increased market volatility as the markets place bets on the future direction of interest rates.
Given declining investor and consumer optimism, gasoline prices around the $3 tipping point, and the slowing housing market, a good argument can be made for the FOMC taking at least a pause as it considers further interest rate increases. Ironically, however, such a pause could create a significantly steeper yield curve -- the gap between short-term rates and long-term rates widens -- as the international money markets respond to such a policy. The higher long-term interest rates that result could intensify the current housing downturn.
On the other hand, the FOMC could continue increasing interest rates based on the recent indications of continued economic momentum and the signs that inflation may be gaining some momentum of its own. This might produce the "soft-landing" in housing the Fed is suggesting, but also intensify the slowing of the economy later this year.
Given the uncertainty surrounding the new "Bernanke Fed," the interest rate policy conundrum it faces, and the likelihood of a pullback in consumer spending barring a sharp drop in gas prices at the pump, investor optimism may well continue to decline in the months ahead.
Survey Methods
Results from the Index of Investor Optimism poll are based on telephone interviews with 803 investors, aged 18 and older, conducted May 1-14, 2006. For results based on the total sample of investors, one can say with 95% confidence that the margin of sampling error is ±4 percentage points.
