Why We Need To See Some Real Consumer Confidence For Green Shoots To Flower

The “green shoots” debate is getting more and more interesting as the days go by.

This week is as full of as much good news as the last one was bad news. In fact, it’s fair to say that there’s now some compelling evidence that some sort of economic recovery is getting underway. On the path to recovery however, there are still some hefty roadblocks standing in the way.

The Conference Board announced Tuesday that consumer confidence jumped to its highest reading since September, a trend that in part prompted economists surveyed by the National Association for Business Economics to call for an end to the recession as early as the second half this year.

GDP growth in 2010 is expected to return to a historical trend of 2.7%, followed by a mild rise in the third and fourth quarter this year, according to NABE’s latest report.

But on closer analysis, it is investment funds and shares in general which seem to have picked up the brunt of consumer confidence. Barclays Capital and Investment Company Institute said that long-term mutual funds — which are closely tied to equity market performance — have seen $16.2 billion in inflows over the last nine weeks. The Dow Jones Industrial Index has risen similarly, by around 29% since its March 9 lows.

That’s in contrast to retail sales, which declined more than expected in April. The problem with consumer confidence inflating asset prices, rather than being channeled into purchasing consumer goods, is that it doesn’t do much for companies’ earnings results. Eventually, that leads to a reduction in asset prices and a return to lower consumer confidence as companies’ earnings fail to keep up with the rise in their valuations.

In order for the green shoots to sprout into full-blown plants, therefore, a significant increase in retail sales in May and June will be required.

There’s some evidence that one may be coming. U.S. existing home sales rose 2.9% in April, even as S&P’s Case-Shiller index showed a rapid decline in home prices Tuesday. Then again, as I pointed out yesterday, as long as price drops are playing catch-up with demand — and not the other way round — the situation looks tenable for at least the medium-term.

In the financial services sector, while big banks are picking up a bit, local banks are still suffering. Indeed, private equity capital may be their only salvation, as America’s thirty sixth bank filed for bankruptcy protection Friday.

Some sort of beginning of an end to the leakage of small bank bankruptcies and home foreclosures would be an encouraging catalyst of economic re-growth. Right now, that appears somewhat further away on the horizon than the second half of last year.

In the last few months, investors have thrown some of their previous caution to the wind. The real test in the next few months will be whether consumers follow suit.

Related Reading at BNET Finance:

• Are We In An Economic Recovery Yet?: Analyzing The “Green Shoots” Debate