It's no surprise that the recent stock-market gyrations have reduced investor confidence. After all, investors hate volatility, and hate it even more when Wall Street's darlings du jour -- in this case, Internet and other technology stocks -- take it on the chin and get dropped to the canvas.
What is surprising, though, is that investor optimism remains as high as it is, even after an April 14 sell-off that sent the Dow Jones industrial average and the Nasdaq composite index into their biggest point drops ever. This confidence among investors -- who are also consumers -- is likely part of the reason that the U.S. economy continues to be strong, despite entering its record 10th-straight year of growth.
But with stocks expected to continue their wild swings in the months to come, could that optimism ebb, sapping consumer confidence enough to slow the U.S. economic juggernaut?
"Absolutely," says Pradeep Ganguly, director of the Office of Business and Economic Research for the Maryland Department of Business and Economic Development. "People have more of a stake in the stock market now than ever before. ... What happens in the market will have a significant impact on people -- not only wealthy people, but also the average individual."
Ganguly and other economists argue that the "wealth effect" has risen in importance in terms of the impact it has on the economy.
The wealth-effect theory holds that stock-market gains augment our wages and savings, giving us more to spend -- or at least imbue us with the confidence to spend more of what we make, since rising stock prices make us feel flush.
Stock ownership is increasing. About half of U.S. households right now own stocks in some form -- either directly, in brokerage accounts, or indirectly through mutual funds, stock options or 401(k) retirement accounts, according to the Federal Reserve.
Little wonder, then, that sagging stock prices have investors starting to sulk. The Index of Investor Optimism, a measure of investor sentiment reported monthly by brokerage house PaineWebber Inc., declined about 7 percent this month. Optimism specifically regarding stocks dropped more steeply: Fifty-one percent of investors said they were optimistic about stocks this month, down from 63 percent last month. And investors have lowered their expectations, too, though perhaps not enough.
The PaineWebber index, done in conjunction with the Gallup Organization, the noted pollster, each month surveys more than 1,000 investors, each of whom must have savings and investments of $10,000 or more to be included.
Investor optimism isn't nearly as crucial a measurement as consumer optimism -- followed closely through the Conference Board's Consumer Confidence Index -- since consumer spending accounts for two-thirds of the nation's economic activity.
But thanks to the long-running bull market of recent years, many U.S. consumers feel wealthier. That translates into consumer confidence, which has fueled the record boom. So expect the two measures to move more in tandem, underscoring how deeply Americans have thrown in their lot with the stock market.
The Index of Investor Optimism rose to a record in January, slipped slightly in February, then dropped about 15 percent in March, before sliding again this month. The Consumer Confidence Index, which hit a record high in January, fell in February and dropped again in March.
In their attempt to explain the recent declines in consumer confidence, economists initially blamed spiraling oil prices and rising interest rates. That's clearly part of it. But, as economists like Ganguly believe, the other reason is a simple one -- stock prices.
Blue-chip stocks started their descent right after hitting an all-time high Jan. 14, and consumer confidence declined in February. The Dow recovered some of its ground, but then technology stocks went into a slide from which they have yet to recover. Consumer confidence hasn't recovered either.
Sentiment among consumers "definitely seems to have changed," said Lyle K. Benson, president of L. K. Benson & Co., a Towson financial planning firm. "I've seen a lot of people -- not necessarily clients, but people I see around -- who had never considered the risk that the market carried."
There's evidence that investors don't fully understand that risk: When quizzed about the rate of return they expected to earn on their investments, the least-experienced investors polled by PaineWebber said 20 percent -- a rate that's nearly double the historical norm for stocks, and which demands an incredible level of risk to achieve. In reaching for risk, those investors could be badly burned by a bear market, perhaps incinerating consumer confidence and capping spending for some time.