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. and most highly industrialized nations, this percentage is about 65% of total spending. 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.
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 on a monthly basis.
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. 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 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. Acknowledging 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, or the progression can hit a general plateau, which sometimes happens when the economy shifts from 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: Improvements can be foreseen as a leading indicator for things to come. On the flip side, cutbacks in corporate capital spending are indeed 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: There is a concrete threshold level 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 utilized as a simple benchmark to assess corporate activity. In good times, the index is roaring in the high 50s, while in slow times the index can fall towards 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, a savvy investor should keep an eye out for companies within these industries and how they are performing.
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 more freely with disposable income.
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.