Thursday, 26 July 2018

Understanding The Consumer Confidence And Price Index

An Educational Article

Traders use each the CCI and the CPI as economic indicators that can help formulate a successful trading strategy in either an up or down market.

Naturally imagine that you are talking with your neighbour in your backyard, and you mention that you and your wife are shopping for a new car, you are getting ready to refinance your house and your wife's brother recently lost his job. Your neighbour tells you he was recently promoted, his wife is starting a business and his daughter just bought a new computer. What kind of analysis about the health of the U.S. economy could an economist make based on your backyard conversation? Well, that depends on what the conversation suggests about consumer confidence.

The mention of recent or upcoming purchases of a computer and a car suggests strong consumer demand. Your plan to refinance your home is a positive sign for the future, implying that you are confident in your ability to meet future mortgage payments. The refinancing suggests also the possibility of lower mortgage payments, which could mean an increase in your discretionary income. Your neighbour’s promotion and the start of his wife's new business are also positive economic signs. The only negative reference during the conversation was the mention of one person who recently lost a job. But from the other information exchanged between you and your neighbour, the economist might conclude that consumer confidence is high. That is good news for the economy because, on average, consumers are responsible for two-thirds of the nation's economic activity, or the gross domestic product (GDP).

Consumer Confidence

Consumer confidence, measured by the Consumer Confidence Index (CCI), is defined as the degree of optimism on the state of the economy that consumers (like you and me) are expressing through their activities of saving and spending. The CCI is prepared by the Conference Board and was first calculated in 1985. In that year, the result of the index was arbitrarily set to 100, representing the index's benchmark. This value is adjusted monthly based on results of a household survey of consumers' opinions on current conditions and future economic expectations. Opinions on current conditions make up 40% of the index, with expectations of future conditions comprising the remaining 60%.

The Survey

Each month the Conference Board surveys 5,000 U.S. households. The survey consists of five questions that ask the respondents' opinions about 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."
The results from the Consumer Confidence Survey are released on the last Tuesday of each month at 10am EST.

How the Data is Used

Manufacturers, retailers, banks and the government monitor changes in the CCI to factor in the data in their decision-making processes. While index changes of less than 5% are often dismissed as inconsequential, moves of 5% or more often indicate a change in the economy's direction. A month-on-month decreasing trend suggests consumers have a negative outlook on their ability to secure and retain good jobs. Thus, manufacturers may expect consumers to avoid retail purchases, particularly large-ticket items that require financing. Manufacturers may pare down inventories to reduce overhead and/or delay investing in new projects and facilities. Likewise, banks can anticipate a decrease in lending activity, mortgage applications and credit card use.

Consumer Price Index

The Consumer Price Index is a measure estimating the average price of consumer goods and services purchased by households across a specific city, region, or nation. It measures the price change for a set market of goods and services from one-time period to the next. The market basket the CPI is based on attempts to mimic the spending of a typical urban consumer. By tracking the change in CPI, traders can estimate inflation. In fact, the CPI is often used to make inflation adjustments to wages, salaries, and pensions. CPI is calculated around the world and is one of the most closely watched economic statistics.

Those who keep an eye on CPI often watch the Consumer Confidence Index as well. As explained above, the CCI measures the consumer optimism through tracking their spending and savings habits. Those using CCI as an economic indicator operate under the assumption that if consumers are optimistic, they’ll spend more money and stimulate the economy. The CCI can vary greatly from one country to the next, and recognizing international trends can be a pivotal economic indicator. In the US, the CCI is calculated by an independent research organization that surveys 5,000 households on a monthly basis. The CCI is used to calculate the US gross domestic product and factors into the Fed’s decision when determining interest rates. Like CPI, the CCI is an economic statistic with a wide sphere of influence.

Although they are both lagging indicators, together, understanding the Consumer Price Index and the Consumer Confidence Index can give day traders valuable insight into the health of the market and the economy as a whole. 

Reference: James E. Mc.Whinney  

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