Consumer Confidence a Key Indicator of Future Economic Prosperity (published in October of 2009 in the SB News Press)

As many of you know, my “day job” is running my investment management company, Montecito Private Asset Management.  In this capacity, one of my primary duties is to stay on top of what is happening with the economy, since economic activity drives the performance of investments.  One of the most important economic indicators that I watch is the Consumer Confidence Index. 

Consumer Confidence measures how optimistic or pessimistic consumers are about the future prospects for the economy and their financial situation.  Since about 70 percent of all U.S. economic activity is driven by consumer spending, the attitudes and expectations of consumers is of the utmost importance to people like me trying to make good investment decisions.  From a stock market perspective, consumer spending drives corporate profits, which in turn drive stock prices, so it is imperative that I keep a close eye on what consumers are thinking and feeling.
The Consumer Confidence Index is calculated and reported to the public each month by the Conference Board.  For over 90 years, The Conference Board has created and disseminated knowledge about management and the marketplace to help businesses strengthen their performance and better serve society.  The Consumer Confidence Index has been released each month since 1967. 
The Consumer Confidence Survey is based on a representative sample of 5,000 U.S. households. The CCI is designed to assess the overall confidence, relative financial health and spending power of the average U.S. consumer.  The data is calculated for the United States as a whole and for each of the country’s nine census regions. The survey consists of five questions on the following topics: i) current business conditions, ii) business conditions for the next six months, iii) current employment conditions, iv) employment conditions for the next six months, v) total family income for the next six months. After all surveys are collected, each question’s positive responses are divided by the sum of its positive and negative responses. The resulting relative value is then used as an “index value” and compared against each respective monthly value for 1985. That year was chosen as a benchmark year because it was neither a peak nor trough in the business cycle. The index values for all five questions are averaged together to produce the CCI.
So how can we use this index to learn something about the economy or investing? 
Looking only at one month’s index value really doesn’t tell you much.  If the value is moving higher, consumers on average are more optimistic than pessimistic, and the higher it moves, the more optimistic they are.  Of course, the opposite is true—if the value is trending lower, it means the average consumer is pessimistic, and the lower the value is below 50, the more pessimistic consumers feel. 
The best way to use the CCI is to look for trends over a period of several months or more.  Consumer Confidence is considered a lagging indicator, meaning that the index tends to keep moving up even as the economy is turning down into recession, and tends to keep moving down as the economy is moving from recession to recovery.  (The opposite would be true of a leading indicator—it turns positive first and the improvement in the economy follows.)  Even though the CCI is a lagging indicator, we can use it to gauge consumer’s attitudes towards the economy, and to confirm if a turn in the economy can be expected to “have legs” (last for a good while).
We can see how dependable the CCI is at confirming economic changes by comparing the trends in the CCI with previous periods of economic change—recessions and recoveries.  The typical definition of a recession is at least two quarters of negative GDP (Gross Domestic Product) in a row.
Since the Great Depression, we have had thirteen recessions.  (We’ve had 47 since 1790.)  Boom and bust cycles are common, as you can see.  We will focus on the last few, since we only have data going back to 1967 on the CCI.  The last really bad recession we had was from July 1981 through November 1982 (one year and four months).  Peak unemployment hit 10.8 percent (we are at 9.8 percent today, and climbing).  High oil prices resulting from the Iranian revolution helped push inflation up, forcing the Fed to follow a tight money policy, which, in turn, crushed our economy.  (Sound similar to what is happening now?) 
The CCI hit its low for this recession in October 1982, the month before the recession ended, and began steadily trending higher, hitting a peak of 106.1 in April of 1984.  Although the CCI did not turn positive a long time prior to the recession ending, it had been trending consistently lower since mid-1981, from index values in the mid-80s. 
We did not see another recession until the early 1990’s—from July 1990 through March 1991.  During the seven years between the early 80’s recession and the early 90’s recession, the CCI maintained a very high level, moving as high as 120.7 in February of 1989, and holding above 85 for the entire period, up until July of 1990 (the month the recession started).   The next month, in August of 1990, the CCI dropped from 101.7 in July 1990 to 84.7 and fell as low as 55.1 by January 1991, only five months later. 
Following this major downtrend, the CCI reversed up and began trending higher in February 1991.  By March 1991, when the recession ended, the CCI had already registered its second positive monthly value, and had risen from the January low of 55.1 to 81.1, confirming that the recovery had commenced.
The next recession was a mild one that lasted only eight months, from March through November of 2001, which followed the tech bubble bursting the prior year and included the September 11th attacks.  The CCI hit a high of 144.7 in May of 2000, and had declined as low as 109.2 in February of 2001, the month before the recession officially started.  In this case, the CCI was actually a good predictor of the recession.  The CCI fell as low as 84.9 in November 2001, the month that the recession ended, and began trending higher, starting in December 2001. 
Our current recession officially starting in December of 2007.  The CCI reached a peak of 111.9 in July of 2007, five month before the start of the recession, and had fallen to 87.8 by November 2007, just before the recession started.  The CCI fell as low as 25.3 in February of 2009, the lowest reading in more than 40 years, since the Conference Board has been measuring consumer confidence.  Since February, the CCI has been trending higher, and now stands at 47.7 (as of October).  Because the current recession has been so long in duration—December 2007 until this month, or 23 months, the CCI is acting more as a leading indicator than a lagging one, as consumers seem to be tired of being negative. 
Just this week, third quarter GDP was announced to have grown at an annualized rate of 3.5 percent, indicating that the recession has ended.  While we will get a few revisions to this number, it is clear that the economy is improving. 
In conclusion, what we can learn from watching consumer confidence can help us understand when the economy may change directions.  While this is certainly useful for investment managers like me, and for investors in general, it is also a great tool for all of us to use when we want to better understand what to expect with regard to the economy, the companies we work for, our 401(k)’s, interest rates, and the list goes on.  The CCI is certainly not the only important economic indicator, but it is clear from our little exercise that it can be helpful in confirming the direction of the economy, and sometimes even predicting it, so it is certainly worthwhile to pay a little attention when this index is reported each month. 
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