Why Is Investor Optimism So Volatile?

GALLUP NEWS SERVICE

PRINCETON, NJ -- During July, investor optimism continued its highly volatile pattern of the past several months as the Index of Investor Optimism -- a joint effort of UBS and The Gallup Organization -- retreated significantly, losing two-thirds of its June gain. The Index declined along both its Personal and Economic Dimensions. Investor optimism fell among both substantial and average investors and among both men and women.

The July loss of upward momentum in investor optimism appears to parallel a similar -- if less substantial -- loss of momentum in consumer confidence. Gallup's latest consumer confidence data (July 7-9) show that 26% of the public rates current economic conditions as "poor" while 24% rate them as "good" or "excellent." At the same time, 47% of the public tells Gallup that economic conditions are "getting worse" compared to 43% who say things are "getting better." Both of these consumer confidence measures suggest that American consumers are less optimistic about the nation's near-term economic prospects in July than they were a month ago.

Investor Optimism Declines in July

Over the past four months, investor optimism has continued to show extreme volatility, and in July, it has dashed the hopes of many that the June surge in optimism would build significant momentum as the summer progressed. During the first half of March, investor optimism fell to 5 -- the lowest point in the Index's six-year history. In April, there was a record surge in the Index, bringing it to 66. But in May, the Index plunged, falling back to 42. In June, the Index surged upward once more, reaching 77, but then it fell 23 points in July to 54. The overall Index now stands almost exactly where it did just about a year ago, in August 2002.

The Personal Dimension of the Index has shown similar volatility over recent months. It fell 13 points in July, offsetting about two-thirds of the 19-point increase in this dimension in June. The Personal Dimension now stands at 48. This places investors' assessments of their personal situations above where they have been much of this year but without any signs that the Dimension is building positive momentum.

The Economic Dimension of the Index also declined in July, falling from June's double-digit optimism level of 16 to a more modest optimism position of 6. This suggests that investors have lost about two-thirds of their June optimism about the economic outlook for the next 12 months.

Index of Investor Optimism – U.S. January 2000 – July 2003

Optimism Among Substantial/Average Investors Declines

The Index of Investor Optimism among substantial investors fell 30 points in July, offsetting nearly all of its 34-point gain from June. This breaks a pattern of three consecutive monthly gains in substantial investor optimism and what appeared to be a trend implying good upward momentum. Substantial investor optimism remains above where it has been during most of 2003 but is still slightly below where it was last August (71).

The Index among other, or "average," investors also decreased in July, falling 19 points to 47. This puts average investor optimism above where it has been during much of 2003 and somewhat above where it was last August (41). While the decline in average investor optimism was not as great as that among substantial investors, average investor optimism remains well below that of substantial investors.

Index of Investor Optimism – U.S. January 2000 – July 2003 By Type of Investor

Optimism Among Male/Female Investors Declines

The Index of Investor Optimism among male investors fell 21 points to 70 in July, eliminating all but one point of its June gain. Investor optimism among men remains above where it was during the first quarter of 2003 but shows no signs of gaining upward momentum. It is also above where it was last August (61).

The Index fell about the same amount (22 points) among female investors as it did among their male counterparts during July. This puts investor optimism among women at 35, far above where it was in February and March, when female investors were pessimistic overall. Still, their optimism remains below its August 2002 level (42). Investor optimism among women is also at only half the level of male investors' optimism.

Index of Investor Optimism – U.S. January 2000 – July 2003 By Gender

Why the High Volatility?

Most economic prognosticators believe that today's highly stimulative fiscal and monetary policies will lead to a significant economic recovery later this year and into early 2004. Given this uniformity of opinion and the roaring equity markets of the second quarter, it is not surprising that investors -- and consumers -- want to be optimistic about the economic outlook for the months ahead.

Still, every time their optimism seems to surge, they are brought back down to economic reality as they perceive little improvement in the jobs outlook and local business conditions in their communities. In this context, one of the reasons for the extreme volatility in investor and consumer perceptions of the economy may have to do with expectations that significantly differ from what is actually happening.

A significant lag effect occurs between the time when efforts are made to stimulate the economy and the time when those efforts actually impact the average American investor/consumer. The equity markets and economic policymakers tend to look three to six months ahead and talk about improvements they expect to see in the economy later this year. Some investors and consumers may not be thinking so far ahead, and as a result, may be disappointed when things don't seem to be improving immediately. This can create very volatile investor/consumer expectations, which increase based on hope and are then dashed by reality.

This volatility is likely to continue during the next few months. Over the next three weeks, 25 million Americans will receive checks from the IRS. Millions of Americans will also see their federal income tax withholding reduced. In the immediate term, this could mean another surge in investor/consumer optimism and a reasonably good "back-to-school" sales season. The key question is whether this tax-cut effect will start a process that builds momentum in investor optimism and consumer confidence, or simply leads to continued volatility.

Survey Methods

Results for the "Index of Investor Optimism -- U.S." are based on telephone interviews with a randomly selected U.S. sample of 805 adult investors, 18 years and older, with at least $10,000 of investable assets, conducted July 1-17, 2003. For results based on these samples, one can say with 95 percent confidence that the maximum error attributable to sampling and other random effects is ±4 percentage points. In addition to sampling error, question wording and practical difficulties in conducting surveys can introduce error or bias into the findings of public opinion polls.