Schwab Guide to Economic Indicators: Consumer Attitude Indexes—Confidence, Sentiment

by the Schwab Center for Financial Research
April 4, 2008

What are they?
A consumer attitude index tracks consumer opinions—typically their present and future views on the economy and their finances. Though several indexes exist, the media tends to highlight two separate reports:

Consumer Confidence from the Conference Board, a not-for-profit business membership and research organization; produced monthly
Consumer Sentiment from the University of Michigan, in partnership with Reuters news and media services; produced twice per month

What is their relative importance?
Medium. Each report is monitored in conjunction with a variety of other economic indicators to help gauge the direction and strength of the economy, and what the Federal Reserve might do with short-term interest rates.

Though these indexes are not as comprehensive and meaningful as the quarterly gross domestic product report, their timeliness can be important. When economic growth is thought to be near a turning point—up or down—this data can provide a heads-up (monthly and semimonthly) while quarterly data is awaited.

What impact do they have on the market?
Rising consumer attitudes depict economic strength; declining consumer attitudes reflect economic weakness.

The overall economic backdrop and expectations of what’s needed from monetary policy and where it's perceived to be headed play a major role with the direction of stock prices.

If the trend in consumer attitudes exceeds forecasts in a way that hints the economy is overheating, bond prices could fall (and yields would rise) on the outlook for greater overall economic demand, potentially higher inflation and an increased chance that the Fed will hike interest rates. Stock prices may also fall.

Why?

A rise in bond yields can eventually make bonds more attractive, once the fall in bond prices settles down. Compared to where the weights of stocks and bonds are in your portfolio, the typical thing to do in response to this change in valuation would be to sell a portion of your stock portfolio and put the proceeds into bonds. Even if corporate profit growth seems supported in this time of upbeat consumer attitudes, the market will likely see it as being short-lived given expectations for impending rate hikes and eventually slower economic growth.

There's a scenario in which stock prices could experience a temporary lift if the economic backdrop is subdued. Suppose consumer attitudes come to life in a manner suggesting that the overall economy could be on the verge of rebounding from a weak period. This could give a boost to stock prices even with an expected rise in bond yields, because the market's expectation of potentially higher profit growth from greater economic demand can initially be the more influential factor in favor of higher stock prices.
That is, for a period of time, it can be the more-dominant driver of stock prices, overshadowing the negative impact of rising bond yields (as discussed above). While the renewed strength in attitudes might suggest an eventual need for Fed rate hikes, it probably wouldn't be deemed immediate because of an otherwise weak economic backdrop. It would likely take some time for other economic reports to strengthen in order to validate the existence of an economic recovery.

Downbeat attitudes could lift bond prices (reduce yields) based on expectations of less inflation pressure. Suppose the economy is strong, but monetary policy had recently become tight (restrictive). Stock prices could improve on hopes of a halt in the Fed's rate-hike campaign, along with the possibility of a future injection of economic stimulus if the next move by the Fed were a rate cut.

Downbeat attitudes and a weak economy probably wouldn't help stock prices, because the chance of recession and reduced corporate profits would likely be the dominant fears.

How are they calculated?
Though similar, each of the two indexes makes a different calculation.

Consumer Confidence is based on responses from a representative sample of 5,000 U.S. households to five questions related to:

Current business conditions
Expectations regarding business conditions six months hence
Current employment conditions
Expectations regarding employment conditions six months hence
Expectations regarding total family income six months hence

The Conference Board averages these results to produce the Consumer Confidence index. A base-year approach is used. That is, the Conference Board converted the index’s 1985 outcome to a base figure of 100. All prior and subsequent Consumer Confidence monthly readings are relative to this base year. Three indexes are presented on a seasonally-adjusted basis:

Consumer Confidence (average of all five questions)
Present Situation (average of questions 1 and 3)
Expectations (average of questions 2, 4 and 5)

Consumer Sentiment is derived from the monthly “University of Michigan Surveys of Consumers.” According to the University of Michigan and Reuters, “Each survey contains approximately 50 core questions, each of which tracks a different aspect of consumer attitudes and expectations. The core questions cover consumers’ assessments of their personal financial situation, overall economic conditions, and buying attitudes. The core areas are supplemented by special questions on a variety of topical issues and concerns.”

Respondents answer core questions within the following five categories:

Financial situation – current
Financial situation – a year from now
Business conditions in the country – during the next 12 months
Business conditions in the country – during the next five years
Is now a good or bad time to buy major household items?

The University of Michigan scores and then summarizes these results to produce the following indexes (base year 1966, not seasonally adjusted):

Consumer Sentiment (based on all five questions)
Current Conditions (based on questions 1 and 5)
Consumer Expectations (based on questions 2, 3 and 4)

The mid-month or preliminary report is derived from phone interviews with about 300 households. The month-end or final report is the result of phone interviews with approximately 500 households.

How are they used?
The reports are used to help gauge the impact of consumer attitudes on the growth rate of the overall economy—present and future. While some analysts would argue that what consumers say often differs with what they do, particularly spending, these indexes provide valuable information. Not only are business, employment and income conditions covered, but other key areas such as inflation and plans to buy a home and other noteworthy household purchases, such as vehicles, major appliances and vacations. Given these details and the use of special questions by the University of Michigan, the results make it easier to identify where specific areas of weakness and strength might exist, and provide extra insight into conditions of salient interest.

When are they released?
Consumer Confidence is released near the end of the month and can be found at the Conference Board’s home page. Click on “Consumer Confidence” for the latest report.

Consumer Sentiment is released twice per month, usually on Friday, near the middle and the end of the month. Go to Reuters/University of Michigan Surveys of Consumers for the latest press release.

Important Disclosures

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The type of securities mentioned may not be suitable for everyone. Each investor needs to review a security transaction for his or her own particular situation. Data contained here is obtained from what are considered reliable sources; however, its accuracy, completeness or reliability cannot be guaranteed.

(2008-3705)

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