Leading Market Indicators: The Consumer Confidence Index

Economic indicators can have a significant impact on the stock market, so knowing how to interpret and analyze them is important for you as an investor. Just like a temperature graph and a vital signs record, these indicators can provide meaningful information about the health of the economy.

The Consumer Confidence Index (CCI)

This monthly report is released by the Consumer Confidence Board, and its latest, out April 28, 2009, shows considerable improvement from March, indicating that consumer confidence is gaining strength. This unique survey is based on the information gathered from more than 5000 households and is designed to gauge the average consumer’s:

• Relative financial health

• Individual spending power

• His individual confidence

This report is designed to show:

• How people currently feel about the economy (This is the Index of Consumer Sentiment).

• How people feel the general economy is going (Index of Current Economic Conditions).

• How consumers see the economy in six month’s time (Index of Consumer Expectations).

The Consumer Sentiment Index is a component of this indicator and over its time of use has actually tracked the business cycle well. Some investors average this report with the University of Michigan Sentiment Report.

A strong consumer confidence report can actually move the stock market by making investors more willing to purchase equities. The idea behind this is that a happy consumer who feels his standard of living is increasing is likely to spend more and make large purchases, such as a new home or car. This is a highly subjective survey and you should remember that some people’s entire opinion of the economy may be influenced by one or two things, like the price of gas. This may sour their whole outlook resulting in a negative review of the economy.

Due to this factor and the small sample size, many economists take a look at the moving averages, which is a way of smoothing a time series to reduce the effects of random variations to reveal underlying trends. They analyze three to six months of consumer confidence figures before making any predictions of major changes in sentiment. Some economists feel that index level changes of at least five points are necessary before they can even note the reversal of an existing trend.

Usually, rising consumer confidence goes hand in hand with rising retail sales, an increase in personal consumption, and expenditures, which are all consumer driven indicators related to spending patterns. These numbers can be broken down by regions, and, when combined with housing starts and existing home sales, can be useful factors in the real estate market.

Strengths of this Indicator

• This is one of the few indicators that evaluates the outlook of average households.

• Historically, this has been a good predictor of consumer spending and its effects upon the gross domestic product (GDP). Consumer spending actually makes up more than two-thirds of the real GDP.

Weaknesses of this Indicator

• This is a subjective survey with no physical data sets.

• The sample size of 5000 households is relatively small.

• The survey results may contradict others indicators, such as the GDP and The Labor Report.

The optimism and spending ability of Joe Consumer is an important factor in determining the direction of the economy so sentiment indicators do carry a lot of weight. There are very few that are standardized like the Consumer Confidence Index so it should not be overlooked or ignored.

Michael Doran is Managing Director of the long/short equity fund, Emerald Bay Partners LP. Mr. Doran can be reached at (530) 677-1635 or sierracap@directcon.net.