Class4 mff[1]

ECON 612 Macroeconomics for Financial Forecasting Class 4 Consumption, Saving, Investment

Consumption The relationship between economic slowdowns and bear markets is remarkably consistent, though not infallible, over many cycles. Most bear markets begin when the year-over-year rate of growth in consumer spending is peaking, and investor and general business optimism are at their highest! Considerable courage is required to reduce investments at such times. http://www.bea.gov/bea/dn/nipaweb/SelectTable.asp#S2 Table 2.3.3

Consumption This suggests that finding an effective discipline for forecasting consumer spending is essential for stock market exposure. Leading indicator = a measurable economic factor that changes before the economy starts to follow a particular pattern or trend

From GDI To Personal Income Personal income is the total income of households. Equals (national income) minus (corporate profits minus dividends) minus (social insurance payments) plus (interest income received from the government and households). Disposable income is the income received by households after paying personal income taxes.

Consumption Theory The theory of consumption was developed by Milton Friedman in the 1950s, who called it the permanent income theory of consumption , and by Franco Modigliani, who called it the life cycle theory of consumption .

Consumption Consumption is an increasing function of total wealth, and also an increasing function after-tax labor income. Total wealth is the sum of nonhuman wealth – financial wealth plus housing wealth – and human wealth – the present value of expected after-tax income :

The Role of Expectations Expectations affect consumption in two ways: Directly through human wealth , or expectations of future labor income, real interest rates, and taxes. Indirectly through nonhuman wealth - stocks, bonds, and housing. Expectations of the value of nonhuman wealth is computed by financial markets.

This dependence of consumption on expectations has two main implications for the relation between consumption and income: Consumption is likely to respond less than one for one to fluctuations in current income. Consumption may move even if current income does not change ( due to changes in consumer confidence). Expectations

Consumption Assumption: Consumption depends on current income.

The Consumer Confidence Index (compiled by The Conference Board) and the University of Michigan’s Consumer Sentiment Index are based largely on questions asked of consumers regarding their expectations of future economic conditions. http://www.conference-board.org/ Can we proxy C.E

How it is measured? Monthly from household survey. Survey of consumer opinion on current condition and future expectations. 3 separate headline figures: - How people feel currently (Index of Consumer Sentiment) - How they feel the general economy is going (Current Economic Conditions) -How they see things in six months’ time

Q-1 How would you rate present general business conditions in your area? (good/normal/bad) Q-2 What would you say about available jobs in your area right now? (plentiful/not so many/hard to get) Q-3 Six months from now, do you think business condition in your area will be (better/same/ worse)? Survey questions: How it is measured?

Retail Sales The retail sales report is a measure of the total receipts of retail stores. Retail sales are often viewed ex-autos, as auto sales can move sharply from month-to-month. It is also important to keep an eye on the gas and food components, where changes in sales are often a result of price changes rather than shifting consumer demand.

“ Healthy, sustainable increases in real GDP and rising standards of living are incompatible with an economy where input has replaced output and the product of a nation’s endeavors is a growing mountain of debt—with the byproduct being a dwindling number of wealth-generating assets serving as a source of repayment.” Richard Eckert, CFA Lahde Capital, CFO / Risk Manager December 17, 2007

Household Debt Americans have chosen to bridge the gap between their real, after-tax income and their spending in recent years with increased borrowings. In addition to borrowing outright, U.S. consumers seem to have dipped into their savings—both their cash and non-cash savings (i.e., through the monetization of their assets, including their home equity). Declining home values and the apparent retreat of the capital markets from the housing finance sector have left many U.S. without access to what has been an important source of liquidity. Therefore, equity extraction from houses will fall off, and people will return to spending what they actually earn. Such a transition spells slower consumption and real GDP growth over the foreseeable future.

Saving Personal savings is still at the lowest point since the Great Depression.

Forecasting Long Run Consumption

Investment Are included purchases of new produced machinery, tools, equipment construction, (both residential and business) and changes in business inventories. If firms produce more than what they sell, the unsold good go into their inventories. But such undesired increase in inventories prompt the businesses to reduce production in subsequent periods.

Class4 mff[1]

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Class4 mff[1]