By Chris Stone
The opinions of companies' chief executive officers on the state of the economy can provide a valuable benchmark for traders and economists. In 1976, the Conference Board (CB), in an attempt to capture the CEO's perspective, began to survey chief executives in a variety of industries. The CB called the study the "Business Expectations Survey", but later changed it to the CEO Confidence Survey. Here we look at how it is constructed, what it communicates and how the trader can interpret it.
The CEO's Insight
From their corner offices, CEOs have a comprehensive view of not only their own company but also their industry, the nation's economy and even the global economy. CEOs have access to detailed information on new orders, inventory, customers, prices, suppliers and what kind of financing is available to businesses. They network with leaders in business, academia, politics and media, allowing them a unique perspective into the condition of other businesses. Often CEOs attend conferences to speak with investors, analysts and bankers to find out what kind of investment capital is available and what kind of opportunities investors are looking for.
The Survey Structure
Today, 100 CEOs are involved in the report, representing 10 industries (five service industries and five manufacturing industries). The 10 industries break down into the following categories:
- food, textiles, apparel
- paper, printing, publishing
- chemicals, petroleum, rubber
- wholesale and retail trade
- banking and financing
- business services
- How are the current economic conditions compared to six months ago?
- What are your expectations for the economy six months ahead?
- What are your expectations for your own industry six months ahead?
- What are the current conditions in your own industry compared to six months ago?
- substantially better = 100
- moderately better = 75
- same = 50
- moderately worse = 25
- substantially worse = 0
The survey also includes two supplementary questions, which are totaled, averaged and reported as a separate headline number. Separate averages are also calculated and reported for each industry. Below are the two supplementary questions, with their respective choice of answers:
- What are your firm's profit expectations for the next 12 months? Answer choices:
- increase substantially
- increase moderately
- remain the same
- If you expect profits to increase, which do you foresee as the prime source of improvement? Answer choices:
- market/demand growth
- cost reduction
- price increase
- new technology
Historical Results: CEO Confidence and Other Economic Measures
The CEO Confidence Survey tends to lead a number of other economic indicators. One such indicator is the U.S. gross domestic product (GDP). When CEOs foresee an increase in business conditions, that outlook usually translates into higher production, which contributes to GDP. Of course, it goes both ways: negative CEO sentiment can indicate future weakness in GDP figures. The chart below - showing CEO Confidence Survey data (blue line) together with the chart of the percentage change in real GDP from Sept 30, 2000 to Mar 31, 2005 - demonstrates the correlation. (Though historical data for the CEO Confidence Survey is difficult to come by (a full historical report in spreadsheet format costs $1,395), we've patched together recent data from various news sources to create the chart you see below.)
In the chart, you can see that the peaks and troughs of the blue line form about six to nine months ahead of the yellow line. Put another way, if you were to pick up the yellow line and shift it six to nine months to the right on the chart, it would roughly match the blue line's peaks and troughs. When viewed from this perspective, the CEO survey appears to be a leading indicator of GDP.
Another economic factor that the CEO Confidence Survey tends to lead is interest rates. CEOs are asked in the survey if increased profits will come from an increase in prices, and their answers may therefore indicate something about future inflation and, in turn, interest rates. When inflation rises, interest rates also tend to rise because consumers, anticipating higher prices in the future, require a higher interest to save their money - they would rather spend it now since items will be cheaper today than tomorrow.
Two economists from the Harvard Institute of Economic Research (HIER), James Medoff and Ronald Sellers, have a theory about the relationship between the CEO Confidence Survey and interest rates. In their discussion paper, Labor's Capital, Business Confidence, and the Market for Loanable Funds (Oct 2004). Medoff and Sellers make the case that CEOs' business expectations contribute to real interest rates.
"...as CEO sentiment (as captured by the measure of business confidence) increases, real interest rates also increase. From the standpoint of the market for loanable funds, this result may be understood as follows: a fundamental increase in CEO sentiment shifts out the demand for loanable funds, increasing the total quantity of investment and raising the real interest rate."Insight for Traders
Taking into consideration the value of an accurate predictor for GDP and interest rates, the CEO Confidence Survey proves to be a rich resource for the trader. With sentiment readings for both service and manufacturing industries, the CEO Confidence Survey allows traders to target their investment research into areas with higher readings.
High confidence among service industry executives indicates that money can be more confidently invested in the service-industry businesses. The same is true for the manufacturing sector.
Perhaps another benefit of the CEO Confidence Survey is that it is less widely followed by the general masses of investors and traders, giving shrewd traders a leg up on forecasting future economic conditions. For these reasons, traders should be on the lookout for this quarterly release, and heed its message.
Because their businesses depend on them to have a deep understanding of current industry and economic conditions, CEO confidence is a valuable indicator of the business conditions. But CEOs are not only observers of the market and economy - they are players. Furthermore, their outlook has a real economic impact; historical data shows there is a strong relationship between CEO confidence and GDP and interest rates. Because of the window it provides into the economy and markets, the CEO Confidence Survey serves as a useful tool for traders.
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