A Better Measure of Confidence — Especially for Retail and Consumer Goods

Today we call it confidence or sentiment. It has also been famously described as “animal spirits” and more recently tied to matters of “trust” and “fairness” in the economy.¹·²

Whatever you call it, there are psychological or behavioral factors that affect spending and investment decisions beyond what is measured in traditional economic indicators.

The trouble is that our measures of confidence are flawed. This has been independently documented, but not reflected in the widespread usage of the Consumer Confidence Index from the Conference Board and the Consumer Sentiment Index from the University of Michigan.

spending confidence trendsThe usefulness of the existing measures is hurt by their month-to-month volatility—which is the result of “asking consumers about such distant, ambiguous phenomena as ‘business conditions,’” according to an analysis in the Journal of Economic Perspectives.3

The recommendation of that analysis is that: “If the objective is to use expectations data to predict personal consumption… why not ask more questions that probe personal expectations directly and eliminate the questions on business conditions?”

That is exactly what is accomplished by a new alternative measure of Spending Confidence described here. This measure is published jointly by Prosper Insights and Analytics and MacroSavvy LLC.

The Spending Confidence Index™ by MacroSavvy™ and Prosper is especially relevant to business analysts and investors in the retail and consumer goods space. Why? Because it is built on responses by consumers to survey questions about their spending plans in 19 specific product categories.

That said, the Index also performs well as an overall macroeconomic indicator. It captures the underlying trends of the existing measures of confidence without the volatility. The Index also clearly identifies high and low points and periods of confidence. For example:

  • Onset of Financial Crisis. The falloff in the Index to an October 2008 low point coincides exactly with the official start of the recession in December 2007 and the October 2008 plunge in the stock markets, which occurred in the wake of the controversial bank bailout votes in Congress.
  • spending confidence trends

  • 2011 Debt Crisis. The falloff in the Index from April to July 2011 closely shadowed the heightened economic uncertainty amid a government standoff over raising the U.S. debt ceiling, which resulted in a downgrade of U.S. debt by Standard & Poor’s.
  • Pre-Health Care Reform Caution. The flat spending confidence in 2013 accurately reflects a period of heightened precaution among consumers in advance of the implementation of the Affordable Care Act (a.k.a., ObamaCare) starting in January 2014. The Index began to rebound very quickly in the first months after the measure took full effect.

Another strength of the Index is the access it provides to insights for separate subgroups of categories as well as consumers—which was another recommendation of the analysis in the Journal of Economic Perspectives.4

Besides the 19 subcategories, the Index is compiled for Consumable vs. Discretionary Goods as well as six other category aggregates: (1) Apparel & Shoes, (2) Drugs, Health & Beauty Care, (3) Electronics, (4) Food & Groceries, (5) Homegoods, and (6) Leisure Goods.

The category level on which this Index is founded may appear unusual to anyone familiar with the much broader and higher-level questions that underlie the Consumer Confidence and Consumer Sentiment indices.5 However, this granular level meets the recommended goal of asking consumers questions “that are directly relevant to their personal lives.” This is the level at which consumers most accurately gauge their behavioral response to economic events and trends—especially in terms of discretionary goods.

This granular category level also represents a weakness of the data that underlies the Index. The survey responses vary with the seasonal nature of the category. For example, spending plans in the candy category spike every October in advance of Halloween. This weakness is corrected, however, by adjusting the data using moving averages. As a result, the Index does not lose any of its ability to accurately reflect the timing of peaks and valleys in spending confidence.

No measure of confidence—of something first described as “animal spirits”—will be perfect and without weakness. Every measure of economic activity from Gross Domestic Product (GDP) to the Consumer Price Index (CPI) has its strengths and weaknesses.

Against this backdrop, the Spending Confidence Index™ by MacroSavvy™ and Prosper represents a significant step forward. It is a much stronger measure of confidence that is not hampered by month-to-month volatility, which limits the usefulness of other existing measures of confidence.

Footnote References

1 Keynes, John Maynard. 1936. The General Theory of Employment, Interest, and Money. New York: Harcourt, Brace.

2 Akerlof, George A., and Robert J. Shiller. 2009. Animal Spirits: How Human Psychology Drives the Economy, and Why it Matters for Global Capitalism. Princeton, N.J.: Princeton University Press.

3,4 Dominitz, Jeff, and Charles F. Manski. 2004. “How Should We Measure Consumer Confidence?” Journal of Economic Perspectives. 18:2, pp. 51-66.

5 Ludvigson, Sydney C. 2004. “Consumer Confidence and Consumer Spending.” Journal of Economic Perspectives. 18:2, pp. 29-50.

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