Some economic indicators are subtle, nuanced or otherwise difficult to grasp straight off the page. Not so for consumer confidence. While economists and investors can debate just how significant this indicator is, most at least grudgingly agree that how consumers feel about the economy (and their personal financial situation) can be a self-fulfilling prophecy. Accordingly, investors should at least consider the trend of this indicator when it comes to investment decisions. This is particularly important for investors who rely on a robust consumer spending environment. (For more on the Index, read Understanding The Consumer Confidence Index.)
TUTORIAL: Economic Indicators
What is Consumer Confidence?
Broadly speaking, consumer confidence numbers measure the degree of optimism that consumers feel in regards to the economy and their personal financial situations. There are two major indexes for investors to consider - the Consumer Confidence Index and the University of Michigan Consumer Sentiment Index.
The Consumer Confidence Index is a product of the Conference Board, which relies on Neilsen Company to conduct a five-question survey of 5,000 households every month. This survey (conducted since 1967) asks for opinions regarding current business conditions and current employment conditions, as well as expectations for business, employment and family income for the next six months.
The University of Michigan produces a rival index called the Consumer Sentiment Index. This index is based upon a monthly survey, but the sample size is smaller and the questionnaire is longer. Those interested in the details can actually go to a website hosted by the University of Michigan and review the questions there. Much like the Consumer Confidence Index, the questions largely revolve about responders' feelings about the economy, job market and their family's financial outlook. The Consumer Sentiment Index goes into much more detail. For example, the index lists the outlook for gasoline prices.
Where the Numbers Are Going
For indexes that are based largely upon how people feel about their financial circumstances, it is no great surprise that the numbers have not been strong lately.
In fact, numbers in the Consumer Confidence Index declined sharply in August, hitting a two-year low and dropping 15 points from July (from 59.2 to 44.5). Keep in mind, this survey was performed against a backdrop of the S&P downgrade of U.S. debt, the wrangling over the debt limit and a near-constant drumbeat regarding the poor current economic conditions. It is also worth noting that the "Expectations Index" dropped from 74.9 to 51.9 - suggesting that people who often tend to be optimistic about their economic future are feeling increasingly uneasy.
Investors should remember that these numbers are only a snapshot in time and perceptions can change relatively quickly - particularly in a presidential election year. Studies have also shown that people tend to respond in line with how they think they are supposed to. If the news on the economy is consistently negative, people will respond to surveys negatively even if their personal situation is not bad. With that in mind, it is also worth wondering to what extent these numbers can be manipulated or "jaw-boned".
Can politicians and commentators effectively talk people into feeling better (or worse) about their economic well-being than the data would support? (For indicators that do have an effect on the market, check out 4 Key Indicators That Move The Markets.)
What Does Consumer Confidence Mean For An Investor?
Consumer confidence numbers are considered a leading economic indicator, and they have historically been good predictors of consumer spending for the next three to six months. As consumer spending is roughly 70% of the U.S. economy, that is no trivial matter.
Consumer confidence numbers can also have significant implications for major spending decisions. Companies will adjust their production schedules in reaction to these numbers, particularly for big-ticket items like cars, appliances and so on. To an extent, it can be a self-perpetuating statistic. If consumers are nervous, companies will cut back on production, hours and hiring. Consumers will then see those cutbacks and become even more nervous.
By the same token, this phenomenon works in reverse and can accelerate a recovery/expansion.
Investors should be careful in how they translate consumer confidence numbers into investment actions. For starters, there are a lot of factors that impact consumer confidence beyond their actual economic significance. In addition to the aforementioned news environment, gasoline prices seem to impact consumer behavior disproportionately to their economic impact. Likewise, there is evidence that a sour housing market can worsen economic outlooks even for those not intending to sell their house or worried about refinancing their mortgage.
Historically, the release of these numbers has made relatively small impacts on the stock and currency markets. As might be expected, it is significant counter-trend moves that have the most impact (that is, major reversals either up or down). Still, there are consumer sectors where sentiment seems to affect stocks more than others - automobile stocks often track these numbers and so do stocks of appliance manufacturers, retailers, consumer discretionary manufacturers and big-ticket entertainment providers.
Investors looking to purchase the stocks of cruise line operators, jewelry retailers and so on would do well to notice the trend in consumer sentiment, or at least have a valid thesis and plan for why counter-trending makes sense.
The Bottom Line
Confidence is a strange thing. A lack of confidence can ensure that the dreaded declines actually come, while steadfast optimism can actually lead to a better environment (or at least so long as businesses share in that optimism). By the same token, the data from the consumer confidence surveys are rarely surprising. Though these are considered leading indicators, the tenor of economic news and media coverage often points at least towards the direction that the confidence numbers will take. As investors look to find a bottom in the current economic malaise, it is worth watching these surveys for signs of bottoming out - often it is the point where optimism washes out that a recovery begins. (For more read Leading Economic Indicators Predict Market Trends.)