The Lowdown on the Consumer Confidence Index (Hint: It's Not a Crystal Ball)

Let's get a jump on next Tuesday and talk about consumer confidence, although that may be an oxymoron right now. The last Tuesday of every month is when the almost-sacred Conference Board Consumer Confidence Index is issued, giving us the degree of optimism or its opposite on the state of the economy held by U.S. consumers.

The Conference Board, a business research group, defines the Consumer Confidence Survey as “a monthly report detailing consumer attitudes and buying intentions, with data available by age, income and region.” The CCI was first calculated in 1985 and arbitrarily set to 100, representing the index’s benchmark. This value is adjusted monthly on the basis of a household survey of consumers’ opinions on current conditions and future expectations of the economy; opinions on current conditions make up 40% of the index, with expectations of future conditions comprising the remaining 60%. Typically, when their confidence is trending up, consumers spend money, indicating a healthy economy. When confidence is trending down, consumers are saving more than they're spending (quite a feat for us spendy Americans), indicating the economy is in trouble. The index assumes, with some reason, that when consumers are optimistic for whatever reason, they'll spend more, and vice versa.

The CCI surveys 5,000 U.S. households, asking for opinions on the following:

1. Current business conditions.

2. Business conditions for the next six months.

3. Current employment conditions.

4. Employment conditions for the next six months.

5. Total family income for the next six months.

Survey participants are asked to answer each question as “positive,” “negative” or “neutral." It's a pretty fuzzy questionnaire, you will admit, but of course it's not designed to elicit accurate answers, just feelings, and apparently it does that well. Once the data is gathered it's complexly calculated to produce an index value for each question, and then those are averaged to form the Consumer Confidence Index. (The average of values for questions one and three forms the Present Situation Index; the average of index values for questions two, four and five forms the Expectations Index.) The data is calculated for the United States as a whole and for each of the country’s nine census regions.

So why go through all this foofaraw? Because manufacturers, retailers, banks and the government monitor changes in the CCI and factor the data into their business and policy decisions. Index changes of less than 5% are often dismissed as inconsequential, but moves of 5% or more often indicate a true change. A month-on-month decreasing trend suggests consumers have a negative outlook on their ability to secure and retain good jobs. Manufacturers may expect consumers to avoid retail purchases, particularly big-ticket items that require financing, so they may pare down inventories to reduce overhead or delay capital expenditures. Likewise, banks can anticipate a decrease in lending activity, mortgage applications and credit card use. When faced with a down-trending index, the government has a variety of options, such as issuing a tax rebate or taking other fiscal or monetary action to stimulate the economy. Conversely, a rising trend in consumer confidence indicates improvements in consumer buying patterns. Manufacturers can increase production and hiring, banks can expect increased demand for credit, builders can prepare for a rise in home construction (ah, ha ha ha) and government can anticipate improved tax revenues from the increase in consumer spending.

It's important to keep in mind that economists view consumer confidence as a lagging indicator, which responds only after the overall economy has already changed, since it takes time for consumers to respond to macro-economic events. The importance of a lagging indicator is that it confirms that a pattern is occurring: An increase in spending today may reflect the results of an economy that recovered a few months ago while a decrease in spending today may confirm an ongoing recession. So whatever the CCI says next Tuesday morning, remember that it doesn’t tell us what's going to happen, but what has happened and whether it can be expected to continue.