Profits? It’s All About Confidence.

The extraordinary bull market of the late 1990s resulted in intense optimism and growth in the North American economy. The past year has painted a dramatically different picture. A major driving force of economic growth is the behaviors and actions of consumers – their confidence tends to mirror the cyclical trends of the marketplace.

What is Consumer Confidence?

The idea behind consumer confidence is that when the economy warrants more jobs, increased wages, and lower interest rates, it increases our spending power and confidence. As there has been a huge influx of people starting to invest recently our confidence has relied more and more on the performance of the financial markets, this is otherwise known as the Wealth Effect. This means shoppers’ confidence is increasingly affected by financial devices such as the value of the currency and the direction of various stock market indices.

Keep in mind that confidence is a two-way street, consumers look to businesses for growth and increasing employment while businesses develop their strategy around consumer spending patterns. Because of the strong correlation between consumer spending and confidence, financial markets interpret rising consumer confidence as a precursor to higher consumer spending.

A huge factor in consumer spending and confidence is their buying power – the assets we have to purchase things. Buying power is created by increases in jobs, wages, wealth, and investments. Interest rates have a similar effect on consumers, low interest rates make it easier to borrow which ultimately supports consumer spending. Keep in mind though that lowering interest rates is not an instantaneous confidence booster, it can take 6-8 months for rate cuts to work their way into the economy.

Another factor that causes an increase in consumer confidence is the different seasons of the year. Certain times can place limits on the buying power a consumer has, thus affecting confidence. Post Christmas is a time of the year when the weather isn’t particularly great and people are debt-ridden. This paints a somewhat gloomy picture on most people’s personal finances. Conversely, the spring and summer are traditionally easy on most consumers, people look forward to warmer weather and families plan their summer vacation. As a result confidence is high at this time.

Finally, perhaps the most powerful force that affects consumers today is the media. Newspapers, magazines, television, and radio inform and influence us on almost every aspect and decision in the economy. For example, if the headline of the Wall Street Journal was “Economic Outlook Is Bright”, then society’s trust in our economy would most likely increase. On the other hand, magazines picturing “Bears” on their covers undermines our confidence.


How do we determine consumer confidence?

The CCI performance over the past year
One of the most recognized indicators for detecting consumer confidence is the “Consumer Confidence Index (CCI)” put out by the Consumer Confidence Board. (There are others such as the Michigan Sentiment Index which is put out monthly by the University of Michigan). The Consumer Confidence Survey is based on a sample of 5,000 U.S. households and is considered one of the most accurate indicators of confidence. It even goes as far as calculating the number of “help wanted” ads in newspapers to detect how tight the job market is.

Here are some things to watch for when the Consumer Confidence Index comes out

Dramatic changes in expectations for the next six months.
Look for changes in trend, many people use the moving average (3-6 months), should the index move above or below the moving average it is usually a good indication that consumer confidence is significant.
Month to month changes are not considered to have as great an impact as the overall trend.
If more and more consumers expect rising wages it is an indication that the labor market is getting tighter.
Pay close attention to differences among various regions, this might not be indicative of the overall US economy but differences in consumer confidence according to areas has implications on residential real estate markets.

The ups and downs of the business cycle play an active role in every consumer’s life. Since consumer confidence is the leading indicator of future spending it affects the direction of the economy and ultimately the stock market. Consumers are the final determinants of growth in the economy, an increase in their confidence can be the difference between recession and prosperity.