The Michigan Consumer Sentiment Index has been a major leading indicator for investors and economists for decades. This respected index is published monthly from the results of random telephone surveys.
Several key economic indices and indicators can help investors and economists predict where the economy will go. The Consumer Price Index (CPI), the Producer Price Index (PPI), and Gross Domestic Product (GDP) all forecast the future health of the US economy. The Michigan Consumer Sentiment Index is another key indicator that reflects the level of confidence of the average U.S. consumer. This indicator is important for retailers, economists, and investors, and its rise and fall has helped predict economic expansion and contractions in the past.
History, Nature, and Purpose
The Michigan Consumer Sentiment Index was developed in the 1940s by Professor George Katona at the Institute of Social Research at the University of Michigan. His efforts eventually led to a national telephone survey, which is conducted and published monthly by the university. The survey, conducted today by the Survey Research Center, consists of at least 500 telephone interviews conducted each month with a different cross-section of consumers in the continental United States. The survey asks consumers about their views on their own personal finances and the short- and long-term state of the US economy.1 Each survey contains about 50 key questions, and each respondent is contacted again for another survey six months after the first survey is completed.2 The answers to these questions form the basis for the index.1
About 60% of each monthly survey consists of new responses, while the remaining 40% comes from repeat surveys.2 The repetitive surveys help to show changes in consumer sentiment over time and provide a more accurate measure of consumer confidence. The survey also seeks to empirically integrate consumer expectations into behavioral spending and savings models.
How the index is calculated
The CSI is generally calculated by subtracting the percentage of unfavorable consumer responses from the percentage of favorable responses. The CSI website breaks down how the index is calculated based on the answers to the survey’s five key questions:3
x1) “We are interested in how people are doing financially today. Would you say that you (and your family) are better off financially or worse off than they were a year ago?”
x2) “If you look to the future now – do you think that you (and your family living there) will be better or worse financially in a year, or about the same as now?”
x3) “Well, on the economic conditions in the country as a whole – do you think we will have good financial times in the next 12 months, or bad times, or what?”
x4) “If you look to the future, what do you think is more likely – that we in the country as a whole will have consistently good times over the next five years or so, or that we will have periods of widespread unemployment or depression, or what?”
x5) “About the big things people buy for their home – like furniture, a fridge, stove, TV and things like that. Do you generally think that now is a good time or a bad time for people to buy large household items?”
To calculate the CSI, first calculate the relative values (the percentage of positive responses minus the percentage of unfavorable responses, plus 100) for each of the five index questions. Round each relative value to the next higher integer. The formula below adds the five relative values, divides them by the total value of the 1966 base period (6.7558), and adds 2.0 (a constant to correct changes in sample design since the 1950s).3
The actual equation into which this data is used is:
The influence of CSI
Since its introduction, Michigan CSI has become one of the leading indicators of consumer confidence in the United States. History shows that consumer confidence has reached its lowest point just before and in the midst of recessions. The index rises as consumers regain confidence in the economy, announcing an increase in consumer spending and thus economic growth. This growth, in turn, leads to greater interest from foreign investors, leading to a higher value of the dollar against other foreign currencies. Historically, the value of the dollar has typically risen whenever the Michigan CSI has been higher than expected and has fallen when the index has been lower.
The Consumer Expectations Index (ICE) was created as a subsidiary of CSI. It was included in the larger index of Leading Composite Indicators published by the Commerce Department’s Bureau of Economic Analysis.
How investors can use CSI
As consumer confidence rises, certain sectors tend to benefit earlier than others. Companies that offer consumer goods often reap the first fruits of improved consumer sentiment. Consumers who have more confidence in the economy tend to have a better sense of their employment prospects and are therefore more willing to buy homes, cars, household appliances, and other things. Investors should look at the shares of automakers, home builders, and other retailers, which typically see sales rising as the economy begins an expansion phase.
As mentioned earlier, the value of the dollar also tends to fluctuate in line with the rise and fall of THE CSI, so traders and speculators can take positions to benefit from sudden movements that may occur when the index is published. (It is no longer possible to purchase a subscription that provides you with this information five minutes before the public announcement, as the University of Michigan terminated its agreement with Thomson Reuters to do so after the chairman of the Securities and Exchange Commission said it might have been an unfair practice).
The Michigan Consumer Sentiment Index has provided a relatively accurate prediction of future consumer confidence and consumer spending in recent decades. For more information about Michigan CSI and its impact on economic analysis, contact your investment advisor or visit the Surveys of Consumers, University of Michigan website.