By Chris Stone Contact Chris
A consumer's decision of whether to buy that new TV for the family room this weekend or at a later date is driven by a number of economic factors. These include concerns about job security (unemployment), credit card bills (interest rates), personal accounts (equities markets) and prices. Since the confidence consumers have in the economy is sensitive to these factors, consumers' outlook provides insight into the direction of the overall economy. After all, consumers represent two-thirds of all domestic spending in the United States. For these reasons, measuring consumers' opinions plays an important role for economists in their attempt to gauge the future spending of consumers, and measure economic conditions.
By far, the most widely reported confidence measure is the Consumer Confidence Index (CCI), which has been published by the Conference Board (CB) on the last Tuesday of each month since 1967. But the CCI presents a challenge to economists, sparking debate over whether it is a lagging or leading indicator. So, when using the CCI for evaluating their positions, traders must decide for themselves what it is telling them about future economic conditions. Here we give some background that might help.
Though it's called an index, the report is actually a poll done through the mail of around 5,000 households (only about 3,500 respond), which change each month. The participants are asked to respond to five questions, which have remained consistent over the life of the survey. The questions ask the respondents to give their appraisal or expectations about the following:
- current business conditions
- business conditions six months hence
- the current employment conditions
- employment conditions in the next six months
- their own total family income in the next six months
(For more details on this, see this explanation on the CB website.)
The CCI Subindexes
In addition to the headline number, the Conference Board reports the results for two subindexes. The Current Situation Index is the average response to questions 1 and 3, and represents consumers' opinions on the current economic situation. The average of the responses to the remaining three questions (2, 4 and 5) is reported as the Expectations Index. The Expectations Index represents consumers' feelings about the future of the economy.
As these subindexes break the consumers' confidence down into future expectations and feelings toward current conditions, traders should follow these subindexes, which give insight into the overall economy and markets respond to the release. Many economists and traders believe that high, increasing confidence in the future of the economy will translate into large consumer purchases.
While the main numbers are widely reported in the media, a more detailed, subscriber-only report of the survey results is published by the Conference Board.
Distinguishing the CCI from the University of Michigan Consumer Sentiment Index
It is important for us to note that the University of Michigan Consumer Sentiment Index (MCSI) is sometimes confused with the Consumer Confidence Index. The University of Michigan releases its own telephone poll results each month, also attempting to measure consumers' opinions on the economy.
The two surveys are quite similar, but they have two important differences traders should be aware of. The MCSI survey asks one less question about employment. This fact makes the Conference Board survey a better indicator of consumers' expectations about employment. But the look-ahead period of the MCSI survey is longer: one year instead of six months. The Michigan survey therefore attempts to predict economic conditions a full year into the future.
There is debate over the implications of these differences, and also on the ability of these surveys to forecast the future at all.
In a study released in 1998 by the Federal Reserve Bank of New York, economists Jason Bram and Sydney Ludvigson compare the two surveys (the study is entitled Does Consumer Confidence Forecast Household Expenditure? A Sentiment Index Horse Race). Here's what they have to say:
"We find that lagged values of the Conference Board Consumer Confidence Index provide information about the future path of spending that is not captured by laggedThe findings of Bram and Ludvigson in this report state that the CB's CCI gives a better forecast of consumer spending. Still, many economists are divided on whether surveys on consumers' opinions lead or lag other factors of the economy, such as unemployment and interest rates. Forbes writer Dan Ackman, in his article "Confident But Wrong: False Notes On Confidence" (Sept 25, 2001), assets the importance of the difference between consumer confidence itself and the surveys that try to measure it:
values of the Michigan Index of Consumer Sentiment, labor income, stock prices, interest rates, or the spending category itself."
"That consumer confidence itself is important has been beyond dispute for generations. A consumer confident about his prospects will spend more, especially on big-ticket items. Thus confidence, what John Maynard Keynes called 'animal spirits', drives both spending and investment. "But there is no evidence that surveys of consumer confidence are good predictors of actual consumer behavior - and this is where the link between confidence indexes and the economy breaks down almost completely. The best that consumer confidence surveys can provide is to "predict" the recent past - and they do only a fair job of even that."The Trader's Decision
As we mentioned at the beginning of this page, while the debate rages on, traders must make up their own mind on whether consumer expectations lead or lag other economic indicators. It may help to know that for its' part, the Conference Board is confident enough in its survey to include it in the Composite Index of Leading Indicators (discussed in chapter 3).
Furthermore, despite the disagreement about leading/lagging characteristics of the CCI, there is evidence that the Consumer Confidence Index has the power to move financial markets upon its release. In separate research from the Federal Reserve Bank of New York, economists Michael J. Fleming and Eli M. Remolona - in their report What Moves The Bond Market? (1997) - ranked economic releases on their ability to move bond market prices. According to their results, the CCI is the ninth most important announcement affecting bond market prices. This is a strong vote of confidence for the survey, considering that interest rates and market pricing are the ultimate judge of the economy.
Still keeping the debate in mind, traders are nevertheless wise to pay close attention to the direction and rate of change of the Consumer Confidence Index. It is undoubtedly one of the strongest forces on market prices when it is released.
The power of the consumer has been heralded since the early days of our free-market economy. The ability for people to go out and buy stuff (and their willingness to do so) is what ultimately drives financial markets. And, the Consumer Confidence Index is an elite measure for traders to gauge consumers' opinions on the economy. Despite disagreements among economists, there is no doubt the CCI moves markets. Therefore, traders should study the results and anticipate the markets' reaction with assurance, according to the index's direction and rate of change.
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