With the sheer mass of data available to investors, it's no wonder that economic measurements come in all types. For some types of information, like reports on new-home sales and the Producer Price Index, statisticians must collect, compile, and organize data from a large cross-section of the country to gather enough information to make statistically significant conclusions. In many cases, the resulting figures need further interpretation before the average person can understand what the report is saying about the overall economy.
Perhaps in response to the complexity of economic data, some organizations seek metrics that reflect some important aspect of the economy and that even the novice investor can easily understand. One such measure of the economy that has gained recognition is consumer confidence. Two groups look at consumer confidence data: the University of Michigan produces its consumer sentiment index, and the Conference Board collects information to determine its index of consumer confidence. This article takes a closer look at the information that these two organizations use to calculate their respective indices, as well as some of the conclusions that economists draw from the data.
The basic concept
The premise behind the consumer confidence index is that because consumer spending represents such a large fraction of the overall economy, gathering information about consumers' opinions of the economy is important in determining their spending behavior both now and in the near future. If consumers believe that the overall economy is good, then they will be more optimistic about their personal financial situations and therefore be more willing to make purchases. Conversely, if consumers see bad economic conditions, they will take a more defensive posture and defer big purchases until the economy is more favorable.
The simplicity of the methodology at the University of Michigan and the Conference Board is clear to anyone who has ever gotten a phone call asking for a few minutes to answer some questions. Both organizations collect information from ordinary households by conducting surveys; the Conference Board selects a sample of 5,000 households, while the University of Michigan does a minimum of 500 telephone interviews each month. The surveys gather information on a number of different topics that encompass both broad opinions and narrowly specified facts that shed light on consumer behavior. Topics covered by the surveys include opinions about current business conditions and prospects for employment, predictions about future business conditions, job availability, and household income, and forecasts of financial indicators like price inflation, interest rates, and the level of the stock market. While the Conference Board survey restricts the time frame of predictions to six months or a year, the Michigan survey asks respondents to consider future conditions as far as 10 years in the future.
In addition to asking opinions about the overall economy, the surveys also ask people to provide information about their own purchasing behavior. The two surveys include questions about whether people plan to make major purchases over the next six months of a number of high-priced items, including homes, automobiles, carpet, and large appliances like refrigerators, televisions, and washing machines. While the Michigan survey phrases these questions in terms of whether now is generally a good time to buy these items, the Conference Board survey focuses on whether the respondents plan to make these purchases for their own families. Also, the Conference Board asks its respondents whether they are planning on taking a vacation over the next six months, along with details about the trip, such as the destination and whether they are planning to drive, fly, or use another form of transportation.
Once the survey information is collected, both organizations divide their findings into two general categories: one that reflects current economic conditions, and one that reflects expectations of future economic conditions. Results for each category are compiled into an index based on relative conditions as of a particular year, which is used as a benchmark for comparison.
Economic implications
A variety of groups, including the government, businesses, research analysts, and investors, use consumer confidence figures. Consumer confidence is widely believed to be of significant importance to the Federal Reserve in its management of the U.S. economy. In particular, measures of consumer expectations are used as a leading indicator of overall economic activity; the Department of Commerce uses the Michigan consumer expectations index in determining its Leading Indicator Composite Index, while the Conference Board uses its expectations numbers in its own Index of Leading Economic Indicators.
Businesses eagerly await consumer confidence numbers as a way to predict their own future sales. For companies such as appliance manufacturers Whirlpool (NYSE:WHR), Sanyo, and General Electric (NYSE:GE) that sell durable goods that the Conference Board survey measures directly, the specific information about future consumer purchases is valuable as a benchmark of overall sales expectations. Similarly, homebuilders and automobile manufacturers can look at consumer opinions of their respective markets and incorporate them into their own sales tracking data. Investors in such companies can also use the numbers to determine whether expectations of earnings and revenues are realistic -- and make investment decisions accordingly.
One interesting aspect of consumer confidence numbers is that because they incorporate information obtained directly from consumers, they are difficult to predict without conducting similar research. In contrast, many other types of economic data that draw information from publicly available sources can be predicted with a much higher degree of precision. As a result, data releases on consumer confidence will show substantial deviations from economists' expectations more often than releases of other types of data, giving news reports more opportunities to sensationalize the numbers with jubilant or ominous undertones. For instance, today's release by the Conference Board showed marked improvement over last month's readings. However, the Conference Board's own director cautioned against concluding that the number indicated any significant change in the economy.
In summary, the consumer confidence numbers produced by the University of Michigan and the Conference Board provide a direct measurement of the opinions of consumers, whose spending accounts for a large percentage of overall economic activity in the United States. By observing consumer behavior, you can keep your finger on the pulse of the overall economy and see the true effect of government and corporate actions on the average person.
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Fool contributor Dan Caplinger isn't one to turn down a good survey, but he's never been asked by either the Conference Board or the University of Michigan to share his thoughts on the economy. He doesn't hold positions in any of the companies mentioned in this article. You can always have confidence in the Fool's disclosure policy.
