Consumer Sentiment And Investment Decisions

"Consumer/Investor sentiment is more important to investment decisions than variations in interest rates"

Before I determine whether or not this statement is true or false, let us take a closer look at the statements main components. I am referring to Consumer/Investor sentiment, Interest rates and Investment Decisions.

Consumer sentiment can be defined as the degree of optimism on the state of the economy that consumers are expressing through their activities of saving and spending. Essentially consumer sentiment is the over all "feel good factor" that people may feel toward a particular option available to them, these options may be in the form of a new car which may require a loan from a bank or the purchase of a new house which would require a mortgage. Consumer spending is the most vital component of any economy. Depending on the economy's sheer breadth, consumer spending can range from 50-75% of the Gross Domestic Product (GDP). In the most highly industrialized nations, this percentage is about 65% of total spending. Because consumption is such a major part of any economy it is essential that it be measured and hence the measurement of consumer sentiment, which is derived completely from a consumer's standpoint.

The consumer sentiment index is measured by several bodies. In general, the consumer sentiment indices are produced in a similar manner across different countries. A number of consumer confidence surveys already exist and are well established. Two separate consumer confidence indicators in the U.S are widely reported and followed by policy makers and the financial markets. Both aim to measure consumer confidence in the overall economy. The most notable index is compiled by the University of Michigan. Originally established in the late 1940's as an annual survey it subsequently became quarterly in 1952 and then monthly in 1978.

Answers are taken from forty thousand households across America at random. The survey consists of fifty carefully selected questions which mainly relate to different consumer attitudes and expectations such as: personal finances, business conditions, and buying conditions. The first 40% of questions concentrate on the present economic situation with the remaining 60% of questions relating to how the respondents feel about the future economic situation. The surveyed are given a choice between three possible answers. Once the answers have been collected, the information is analysed and the mean value of the three possible answers is found. This is achieved by calculating the different responses i.e. positive responses less negative responses to a group of questions.

In the1980's, the benchmark for the index was set at 100, so for example if the consumer sentiment for January was reported to be 102, then it was reported to stand at 104 in February and finally 106 in March then this would indicate that consumer sentiment within the economy had risen. Then one could assume that consumers are confident about their economy and also confident about its future state. When assessing consumer sentiment it is important to look at the results over a period of time as to identify any trends in the index. From our example it is obvious that there is an upward trend.

From the University of Michigan's survey three separate indices are produced: Index of Consumer Sentiment, Index of Consumer Expectations and Index of Current Economic Conditions. The second most internationally known survey comes from The Conference Board, consumer confidence survey data are available bi-monthly from 1967 through mid 1977. Beginning June 1977, data are available monthly. The Conference Board produces three indices; Consumer Confidence Index, a Present Situation Index, and an Expectations Index. Some differences do exist between how the two indicators in the U.S are calculated.

Slightly closer to home the E.U. Commission publishes a consumer confidence indicator for Europe, and includes details of Ireland as one of the member states. As an input to the E.U. wide Consumer Survey, the Economic and Social Research Institute (ERSI) in association with the IIB Bank here in Ireland carries out a nationally represented survey of a minimum of 1,100 completed questionnaires on a monthly basis. A fresh national sample is used each month. This sample is representative of the totality of persons living in private households in Ireland. Thus, the survey represents the views of all persons aged 18 and over across all regions of the country and includes all different labour force status and educational attainment levels. The principle objective of the survey is to record details on consumers attitudes towards trends in the economy. The survey is carried out on a telephone basis and sampling points are selected at random from the Electoral Register. The ERSI and IIB Bank indices are constructed using the methodology of the University of Michigan using similar questions.

These are:

Q.1. How do you think the economic situation will develop over the next 12 months?

(Get better/ stay the same/ get worse)

Q.2. Do you think the number of people out of work in the country in the next 12 months will (increase/ remain the same/ decrease)

Q.3. How does the financial situation of your household compare now with what it was 12 months ago? (Got better/ stayed the same/ got worse)

Q.4. How do you think the financial position of your household will change over the next 12 months? (Get better/ stay the same/ get worse)

Q.5. In view of the general economic situation at the present time, what you think about the people buying large items such as furniture, washing machines, TV sets etc. Do you think that for people in general the present time is (good/ neither good nor bad/ bad)

To surmise consumer sentiment in its most simplistic form, one could say when their confidence is trending up; consumers spend money, indicating a healthy economy. When confidence is trending down, consumers are saving more than they are spending, indicating the economy is in trouble. The idea is that the more confident people feel about the stability of their incomes, the more likely they are to make purchases. The data collected can have serious implications for manufacturers, retailers, banks and the government who monitor changes in the index in order to factor in the data in their decision making processes. The implications of a negative outlook for the manufacturing industry may be that they expect consumers to avoid retail purchases, particularly large-ticket items that require financing. Manufacturing may pare down inventories