RIYADH, 17 January 2005 — Consumers’ attitude toward the health of the economy is influenced by what they hear and read. The same is true about the investors’ confidence in the securities market. The presence of consumer confidence or lack of it affects how the economy fares. If consumers feel good about their current situation and about their future, they tend to spend more freely, which boosts economic growth. If they are worried about things like job security, they tend to save more and spend less, slowing economic growth and the economy itself. Consumers often respond slowly to news of an economic recovery if they don’t see an immediate, positive financial impact on their own lives. Their reluctance to start spending keeps the recovery slow. Consumer confidence is based on several monthly indicators like, personal income, unemployment rate, producer prices and real GDP. The gross domestic product, the value of goods and services produced in a given country, is a key measure of economic activity. When it drops, it’s a signal that the economy is stalled or sluggish. Increases suggest that the consumer confidence and spending are strong. Unfortunately not all countries produce such indicators on a timely basis.
The consumer price index, CPI, looks at the economy from the consumer perspective. It reports what it costs to pay for food, housing and other basics. CPI, originally called cost-of-living index, is usually calculated on a monthly basis, and serves two roles namely, reflecting economic trends, and influencing economic policy decisions. It is compiled based on a specific basket of goods and services that includes housing, food, transportation, medical care, clothing and entertainment. It also provides a measure of inflation. Under normal economic conditions, the index should change no more than 5 percent per year.
The basic building block of the stock market is “Investor Sentiment” which is closely related to consumer confidence. Through such confidence, investors pour money into the market and overlook many of the current poor indicators or risk factors associated with it. It takes a long time to build investor confidence however the confidence can be lost quickly. Confidence building and loosing is contagious. One company can pass it on to another and one industry may catch it from a different sector. At full swing, it holds the power of a strong wave that pushes everything along it’s own path.
Investor confidence is built on many diverse events. An oversold stock market that produces bargain prices usually triggers an investor confidence rally. Good financial results that meet or beat expectations of few companies, announced over a short period may initiate a new cycle to build investor confidence. New fiscal or monetary policies normally have similar positive effect.
Investor sentiment in Saudi Arabia is currently in full swing. High oil prices, healthy economic indicators, abundance of cash, success in recent IPO, increased government spending, have contributed to the current positive sentiment. This is also manifested in the performance of the stock market during the past twelve months.
Investor confidence however can be lost quickly, as demonstrated in early 2002 with the collapse of Enron and the surfacing of other accounting scandals in the US. All of a sudden accountants became the new bad guys because they covered up for Enron unacceptable activities. In fact 64 accounting and financial reporting cases were opened in the US during first quarter of 2002, more than double the total of the earlier year. The cases covered most industries including accounting, energy, software, telecom, securities, biotech and others. In fact the failure of Enron triggered a chain of scandals among well established and respected companies the like of Kmart, Arthur Andersen, Adelphia, Worldcom, Qwest, Global Crossing, Dynergy, Tyco and the list goes on. Phoney earnings, inflated revenues, conflicting ratings from analysts, and directors asleep at the bridge, all of a sudden became the focus of investigation. This was not few bad apples as was initially labeled by the authorities, it was a systemic breakdown. This prompted investors to start thinking, if accountants can’t be trusted to warn the public about giant illegal activities like what happened at Enron, there must be other time bombs out there waiting to explode because of lax accounting. This belief scared investors and kept them away, and in the process squeezed stock prices down.
Market news and events frequently fail to produce a clear direction. Most events are either too small, isolated or uneventful. In an environment with a high investor confidence, even such events have a positive effect on the market.
Consumer spending represents around 75 percent of total spending in nearly all developed countries. It is one of the most important drivers of any economy. When consumer confidence is high, consumer spending increases and the respective economy carries on with a smooth sail. Lack of consumer confidence reduces spending, and has the power to bring any economy to a standstill. When investors have confidence in the stock market, they spend more as consumers. And since many consumers are investors, investors’ confidence produces an equally strong impact on the economy.
(Salim J. Ghalayini, [email protected], is the author of “Stocks for the Practical Investor”. He manages several investment accounts.)