A must-know investor’s guide to the evolving consumer health

Market Realist

A must-know investor's guide to the evolving consumer health (Part 1 of 8)

Consumption and the economy

Consumption is, perhaps, the most important driver for economic growth in the U.S. Accounting for approximately two-thirds of the economy, increases in Personal Consumption Expenditures (or PCE), increase the gross domestic product (or GDP). Consumption, in turn, is affected by the expectations of consumers regarding their personal prospects and those of the economy.

How do consumer confidence indicators impact fixed income ETFs?

An increase or decrease in GDP has significant impact on fixed income investors. An increase in GDP implies economic expansion which is usually accompanied by an increase in consumption expenditure. Other factors remaining constant, the faster the pace of GDP growth, the higher is the demand for funding from businesses. This is because firms seek to take advantage of increased demand from consumers by borrowing and investing. A higher demand has the effect of raising inflation and interest rates. Other factors remaining constant, this would raise interest rates and lower prices of fixed income securities. A decrease in GDP would have the opposite impact, that is, it would lower the rates and raise the bond prices. So, consumer expectations are crucial in gauging where the economy is heading.

An increase in consumption expenditure would be especially beneficial to the retail sector. The State Street SPDR S&P Retail ETF (XRT) tracks the S&P Retail Select Industry Index (an equal-weighted market cap index), composed of the retail sub-industry portion of the S&P TMI. Top 10 holdings in XRT include the national retailer Walgreens Co. (WAG) (1.19%) and apparel company Abercrombie & Fitch (ANF) (1.24%).

This series will look at a number of economic indicators that measure consumer expectations or consumer sentiment, and how they influence stock (OEF) and bond (IEF) markets.  The indicators that will be covered are retail sales, average daily discretionary expenditure incurred by individuals, and consumer confidence indices, notably the Bloomberg Consumer Comfort Index and the Thompson Reuters / University of Michigan Surveys of Consumers. The series will also look at correlations between consumer confidence indices and macro-economic variables like Gross Domestic Product (or GDP) and employment.

ETFs that have exposure to the stock and bond markets include:

The iShares S&P 100 ETF (OEF) tracks the S&P 100 Index. The Index is a market-cap weighted Index and tracks the performance of 100 blue-chip companies from a cross-section of industries.

The iShares 7-10 Year Treasury Bond ETF (IEF) tracks the Barclays Capital U.S. 7-10 Year Treasury Bond Index. The index measures the performance of U.S. Treasury securities that have a remaining maturity of at least seven years and less than 10 years.

Part 2 of this series discusses an indicator that releases monthly, which highlights discretionary consumer spending trends.

Continue to Part 2

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