- Consumer confidence is one of the leading forces driving consumer spending and stock market expansion.
- Consumer confidence is measured using different indexes worldwide, two of which include the Consumer Confidence Index (US) and the Westpac Consumer Confidence Index (Australia).
- Consumer confidence indices use surveys to measure consumer sentiment by assigning relative values to the survey questions.
- While one cannot rely on the accuracy of a single measure of consumer confidence, the trend followed by an index can be used to gauge the state of consumer confidence.
- An increase in consumer confidence is the prime reason for the occurrence of the Santa Claus Rally.
- The economic indicators that contribute to the stock market rally, comprise economic growth, interest rates, effects of economic policies and prices in related markets.
Consumer confidence is one of the most powerful economic indicators that influences the equity market. When there is high consumer confidence, people tend to purchase more and spending increases. Thus, there is an overall positive sentiment in the market, and stock prices rise.
However, when consumer confidence is low, people tend to save more, and economic growth slows down. Consequently, investors lose confidence, and the stock market plummets. Such a situation can be witnessed in the case of a recession or during global health emergencies like COVID-19.
It is imperative to note that there is a high level of linkage between consumer confidence and consumer spending. However, economic shocks can cause a divergence between the two indicators.
Measuring Consumer Confidence
There are various measures of consumer confidence used worldwide. These can be listed as follows:
- Consumer Confidence Index: It is used to measure the degree of optimism that consumers have about the US economy. The index is published by The Conference Board, which is a non-profit business membership and research association consisting of companies worldwide. The organization has over 1000 private and public companies as its members, belonging to 60 different countries.
The consumer confidence index is based on a survey of 5000 households, and is released on the last Tuesday of each month. Each question in the survey is given a relative value, and this value is compared to that in 1985. This formulates an index, which is used as a consumer confidence index.
- Westpac Consumer Confidence Index: Published by the Westpac Group and produced by the Melbourne Institute, Westpac Consumer Confidence Index is used to measure the consumer confidence in Australia. It averages five different indices which are used to measure different aspects of consumer sentiment. These include consumer spending on cars, housing, and the views of individuals on government policies like taxation and other factors like inflation, unemployment, etc.
There are various other consumer confidence indices that primarily use surveys to measure the sentiments of the public. However, whether or not these indexes justify the level of consumer confidence in an economy deserves closer attention.
Can Consumer Confidence be Accurately Measured?
Measuring consumer confidence is like predicting the trail of thought of the consumers based on certain questions answered by them. It is difficult to make an accurate prediction based on just survey answers. This can especially be hampered by unexpected shocks, which tend to change consumer views and confidence over a short span of time, leaving previous measurements invalid.
Tastes and preferences as well as expectations about the future, vary across the surveyed demographic. Thus, it is difficult to bring out an ideal individual who can be labelled as an “average consumer”.
Over the long run, the trend followed by an index plays a more vital role than the index’s measured value in determining market expectations. Thus, it would not be wrong to say that the direction of consumer confidence can tell more about the state of consumer confidence over time, rather than a survey.
It is also important to note that the survey questions include the consumer perception about policy changes that have already taken place. This means that there is a lagged response from the consumers because their reaction is being observed after the policy in question has been implemented. Thus, various consumer confidence indicators are considered to be “lagging indicators”.
However, it is important to note that measures of consumer confidence are not completely deemed invalid because of these reasons. There are various improvement points that may help bolster the accuracy of these measures, like proper framing of questions coupled with correct timing of surveys.
Consumer Confidence and the Santa Claus Rally
A Santa Claus Rally is a persistent increase in the stock market during the last week of December due to a usual positive sentiment among the consumers. The rallying of stocks between Christmas and New Year is termed as a ‘Santa Claus Rally’.
This rally has a direct linkage to the consumer confidence, as the whole concept of Santa Claus Rally is based upon the idea of high consumer confidence.
There are various reasons due to which consumer confidence is expected to be high during the last week of December. These include a greater supply of liquidity in the market due to the festive season, tax considerations, and the absence of bearish investors in the market due to holidays.
The period of a Santa Claus Rally sees most investors selling their stocks in the stock market, only to buy them later in the month of January for tax purposes. This is termed as the ‘January effect’.
Experts consider the existence of Santa Claus Rally as market inefficiency. This is because even when investors are aware of its potential occurrence, it does not stop the rally from taking place. Therefore, it is believed to be a sign of market inefficiency.
Economic Indicators Building Up to a Stock Market Rally
Various economic indicators like economic growth, interest rates, the effect of economic policies, the stability of related markets and consumer confidence/expectations contribute towards changes in the stock market.
When an economy is expected to grow, firms are expected to receive increased profits. Therefore, their share prices would subsequently increase in the stock markets. Similarly, a low rate of interest can lead to a boost in the stock market. Low interest rates, when utilized by firms for their expansion, can result in higher dividends on their shares.
The stock market can also be affected by the prices in related markets. These markets include the markets for government bonds or commodities. If these markets seem unfavourable to investors, they are likely to only invest in stock markets, thus rallying the market.
And finally, consumer confidence goes a long way in explaining the rallying prices. Higher confidence in the stock market can influence a large number of investors to enter into the market. Thus, driving stock prices higher. Undeniably, the Santa Claus Rally is one of the prime examples of how consumer confidence can strengthen the market in a short time frame.