Consumer spending is the key to any market economy. On the airwaves, there's never a shortage of data, analysis, and cable commentary regarding consumer behavior. So what are the key fundamental consumption indicators in a good economy? How about in a bad economy? There is no doubt that consumer spending is the most vital component of any economy. Why? Depending on the economy's sheer breadth, consumer spending can range anywhere from 50% to 75% of gross domestic product (GDP).
In the U.S. this percentage is about 65% of total GDP. The first part of measuring total consumption is measuring consumer sentiment, which is derived completely from a consumer's standpoint. This article will recap the vital economic indicators of overall consumption, outlining what trends to look for and when to look for them.
- Measuring consumer sentiment is the first step in measuring total consumption.
- The Consumer Confidence Index (CCI) and the Consumer Sentiment Index are indices used to measure consumer sentiment.
- Business capital spending is also a consumption indicator—where corporate spending could be a sign of economic growth, and cutbacks can be a sign of an economic downturn.
- Measuring the consumption of durable goods—such as appliances, furniture, and electronics—and automobiles also serves as an indicator of consumer spending.
- Corporations that predict a depressed economy may reduce spending on auxiliary services, such as advertising and marketing.
The two numbers expressing consumers' feelings about the economy and their subsequent plans to make purchases are the Consumer Confidence Index (CCI), prepared by the Conference Board, and the Consumer Sentiment Index, prepared by the University of Michigan. Both indexes are based on a household survey and are reported monthly.
To measure consumer sentiment, the Conference Board sends out surveys to approximately 5,000 homes monthly.
In analyzing any consumer sentiment index, it is most important to determine the trend of the index over several months. Simply put, the trend graphed out over four or five months is critical. More data points will give the investor a better gauge of this very important measure. Keeping this in mind, you need to remain astute and block out news bits, such as "the index is at 80 so things look gloomy" or "the level of consumer sentiment is up slightly from last month."
The trend over several months—not a comparison of a month-to-month figure or this month to the same month last year—is the undeniable benchmark. Commentary that focuses only on the single monthly figures, without looking at the developing trend, is misleading.
For many, the importance of the trends of consumer sentiment rests in the fact that the consumer sentiment index originated in the middle of the 20th century when the concept of the "typical" consumer was more homogeneous. Considering this historical fact, as well as potential sampling bias and possible subjectivity across regions, the safe bet is to focus on trends forming some sort of linear progression, whether upward or downward. Otherwise, the progression can hit a general plateau, which sometimes happens when the economy shifts through the various stages in the business cycle.
Business Spending as Leading Indicator
Though not as powerful an indicator as consumer spending, business capital spending can be a killer statistic—since things can get ugly in a hurry when overall business investment precipitously cuts back. The impact on the economy can be felt at an even faster pace than if the cut occurred purely along consumer lines. The rationale is that today's sophisticated and large inventory-lean corporations often can gauge future demand before policymakers can implement changes, which often take months to kick in due to embedded policy lags.
Corporate spending is therefore very similar today to the role the stock market has played in most recoveries, and dramatic changes can be seen as a leading indicator for things to come. A rise in business spending could augur economic growth, while cutbacks in corporate capital spending can be viewed as an ominous indicator. The Purchasing Managers Index (PMI), is a representation of the progress in corporate spending.
For analyzing consumer spending, ascertainable trends are more telling than actual figures. The opposite is true for analyzing corporate spending through the PMI, where there is a concrete threshold for analyzing corporate investment spending and subsequent production. A PMI below 50 designates a contracting manufacturing sector, while a number above 50 highlights expansion across corporate spending and investment. Obviously, clear awareness of the current trend analysis is always better than a stand-alone result. Nevertheless, the 50 threshold can be used as a simple benchmark to assess corporate activity.
Historically, the range has been between 40 to 60. In good times, the index is roaring in the high 50s, while in slow times the index can fall to the low 40s.
Other Spending Items
There are other spending indicators, such as purchases of durable goods orders and overall auto sales. However, in terms of aggregating the data, these metrics are narrowly defined extensions of overall individual consumption. Trends across personal consumption will usually be reflected and correlated across these two metrics, as well as others.
For instance, during the end of 2001, while the world economy was suffering on many fronts, steady consumer spending helped fuel auto sales that originated from generous financing from Detroit. This stimulus ultimately helped erode the three-quarter recession that had developed from the beginning of the year. Awareness of these symbols of consumption can give you more insight into exactly why and how consumption is impacting the economy. This awareness will help you judge the sustainability of these trends.
From a pure corporate standpoint, auxiliary spending—besides durable orders and big-ticket items, such as auto purchases—can often indicate a great deal about overall corporate sentiment. Recall from above that the PMI for corporate spending is a definite quantitative measure and the consumer sentiment index is a qualitative metric. In the eyes of large corporations, and from a sheer qualitative standpoint, auxiliary spending on services, such as advertising, consulting, and information technology may reveal information about attitude and sentiment, just like the consumer sentiment indices reveal information about personal and individual consumption.
Just as a murky outlook will depress consumer sentiment, a weak forecast for the demand for goods and services will sidetrack corporate spending on auxiliary measures that can be budgeted away if necessary. The end victims are advertising/marketing, media campaigns, consulting fees, and information technology overhauls. When the headlines indicate that layoffs and slowdowns are rampant in any of these fields, it can be safe to bet that corporate appetite for auxiliary spending is weak. The performance of these industries is largely tied to the level of corporate sentiment, and it would be to the benefit of an investor to keep an eye out for companies within these industries and how they are performing.
Consumer Confidence FAQs
How Does the Consumer Confidence Index Impact Elections?
Consumer confidence usually increases right before an election and drops by about the same amount directly after. The drop after the election is due to the political environment, rather than the condition of the economy.
What Does Increasing Consumer Confidence Do?
Increasing consumer confidence increases consumer spending. The aggregate demand curve shifts to the right, indicating an increase in demand for goods and services. In response to increased consumer spending, manufacturers can increase production, banks can extend more credit, and the real estate market can anticipate an increase in home sales.
What Are the Best Ways to Increase Consumer Confidence?
Many factors that influence consumer confidence are outside of our control. However, companies can take steps to increase consumer confidence. They can strengthen their brand, building a loyal customer base. Remaining honest, transparent, and consistent can help build a strong reputation. They can also strive to produce quality products and services that fulfill consumers' needs, as well as advertise in meaningful ways that communicate value.
What Determines Consumer Confidence?
The state of the economy and what's reported in the news help shape consumer confidence. Several factors affecting consumer confidence include changes in house prices, unemployment rates, and inflation. Falling house prices compromise wealth accumulation and erode consumer confidence. Increased unemployment rates also negatively affect consumers' confidence in the state of the economy. Inflation is an indicator of too much economic growth, and the rise in prices can reduce consumers' purchasing power and confidence.
The Bottom Line
Consumption is ultimately the stimulant behind almost every fundamental aspect of the worldwide economy. In sophisticated economies, the impact of consumption may be less than in emerging economies that are largely import-export driven, but the consumption magnitude is even more pronounced due to both a greater wealth effect and standard of living that enable individuals to spend their disposable income more freely.
The data for analyzing overall consumption contains many underlying factors. To scrutinize the daily volumes of indicators, focus on the indicators according to the above ranking system. This will help you capture the main elements and the interaction between the various areas of spending.