Does the Consumer Confidence Indicator Point Towards Better Times?

The Consumer Confidence Survey released April 28, 2009 shows an increase in confidence — up to 39.2, an increase from 26.9 in March. The reading in April is the highest of this year and experts believe that this is primarily due to a significant improvement in the short-term economic outlook. The CCI is defined by the degree of optimism about the economy, which is expressed through savings and spending. It was first developed by the Conference Board in 1985 and the index was arbitrarily set at 100, which represents its benchmark. The value is adjusted monthly on the basis of a survey of 5000 households, where consumers give their opinions on current economic conditions and their future expectations. Opinions on current conditions make up 40% while future expectations comprise the remaining 60%.

The survey consists of five questions that ask about:

• Current business conditions

• Business conditions for the next six months

• Current employment conditions

• Employment conditions for the next six months

• Total family income for the next six months.

The index evaluates consumers’ views and then categorizes their opinions on both the present and their expectations of the future.

View of the Present Situation

The consumers’ appraisal of present day conditions improved and the Present Situation Index increased to 23.7% in April, up from 21.9% in March. This moderate gain is another sign that people believe things may improve a bit in the next quarter.

The Expectations Index

The Expectations Index rose to 49.5% in April, up from 30.2% in March. This sharp increase suggests that consumers believe the economy is nearing bottom. Be cautious though, as this index is still well below levels that are associated with strong economic growth.

The Short Term Outlook

The consumer short term outlook improved significantly in April and the percentage of those surveyed who anticipated worsening business conditions declined to 25.3% from 37.8% in March. Those expecting things to improve rose to 16.6%, up from 9.6% in March.

Economists closely monitor consumer expectations about the economy because consumer spending accounts for more than two-thirds of the nation’s economic activity, or the gross domestic product (GDP).

The Consumer Confidence Report is considered to be a lagging indicator by economists, which means it is a response based on changes that have already been taking place. For instance, the CCI showed an increase in consumer confidence when it came out in early May. Then, the latest retail sales reports appeared May 13, showing a 0.4% decline in retail sales, following a 1.3% drop in March. This raised doubts about a swift recovery from the recession, dampening the optimism raised by the improved CCI of just a few days ago.

It is helpful to remember that as a lagging indicator, the CCI responds only after the overall economy has already undergone some changes. The importance of a lagging indicator is that it confirms a pattern that has already occurred. This current optimistic report on Consumer Confidence is reflected in the increased consumer spending of January and February, when retail sales finally posted gains after falling for six straight months.

The Retail Sales Report is also an important economic indicator. It gets a lot of press and the results can cause stock market volatility. This was evident recently in May when the market dropped after the sales report was released. The problems compounded when it was followed by a worse than expected unemployment report.

These two recent reports, one optimistic, one negative, sent the market upward then rapidly heading downhill. These market gyrations and sustained volatility drive investor fear and continue the cycle of volatility. Developing a basic understanding of these economic indicators and what they mean can help you avoid a knee jerk reaction and develop a wiser, long range plan for your investments.

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.