How's Business? Does It Really Matter?


"How's business?" Some use the question to kick off a conversation with their barber, while others use it to help them invest millions of dollars after reading the latest confidence surveys. Should investors actually care about the numerous economic confidence surveys?

For example, when the Economist and the Financial Times asked 1,500 senior executives this question, over 60% thought business conditions in Europe would worsen, and North America has turned from bullish to bearish since April. Should investors be worried?

A survey of surveys
(NYSE: MCO) publishes a weekly survey on business confidence, an example of the many that are available, recently noting "global business confidence is soft." Like consumer confidence surveys that measure how good consumers feel about the economy and jobs, business confidence surveys ask executives questions like "How has business activity developed over the past several months?" and "How do you expect your firm's total employment to change over the next several months?" Those, in fact, are the two questions that the Organisation for Economic Co-operation and Development, or the OECD, asks businesses every month. Those answers are converted into numbers for a quick overview of how businesses feel about the current and future economic climate:

Those OECD numbers are plotted above, along with the annual GDP growth for the U.S. The question is: Can you use the surveys to help predict growth? Do the bars follow the lines, or vice versa?

Just another distraction
One OECD study finds that business confidence can predict future output, whereas consumer confidence cannot. Great! At least we can ignore consumer confidence surveys. But wait, a more recent study (link opens PDF) suggests errors in the OECD study, and comes to some other fascinating conclusions: "If we know the GDP growth rate today, business confidence today is no help in predicting the growth rate of tomorrow. And even if we don't know the GDP growth rate today, knowing business confidence only appears to help predict the future when right-leaning governments are in power."

Why don't business surveys better predict the future? And why do they provide useful information only when there is a right-leaning government in power?

The study suggests some of the issues include a sampling bias of survey respondents, the fact that some surveys handle extremely negative or positive conditions the same as slightly negative or positive, and that many surveys keep survey methods, response rates, and responders secret. By having survey organizations typically be pro-business organizations, which are typically in favor of right-leaning political stances like lower taxes, respondents can overstate the impact of left-leaning policies on growth. But, this judgment error disappears when a right-leaning government is in power.

Focus on company specifics
So while these surveys can help confirm what we already know, they really can't help us see what's coming ahead. And, even if these surveys did help predict future GDP, GDP growth has little correlation with future market returns. These are both reasons to focus on company-specific qualities instead.

Also, survey respondents put too much weight on how the government will affect the economy. For example, companies may be overreacting to how much the fiscal cliff and the next election will affect them:

  • Chairman and CEO of Honeywell (NYSE: HON) David Cote has been very outspoken on fixing the national debt; however, only 12% of Honeywell's revenue comes from the U.S. government.

  • UPS (NYSE: UPS) management said that "uncertainty stemming from this year's elections and the looming fiscal cliff constrains the ability of businesses to make important decisions, such as: hiring new employees, making capital investments, and restocking inventory." Even so, UPS' profit was up 12% over last year in the latest quarter.

  • Eaton's (NYSE: ETN) CEO blames cutting its truck-demand forecast on the fiscal cliff, with total orders for North America down 21% so far from one year ago. On the other hand, Eaton's competitor, Parker-Hannifin (NYSE: PH) . "predicted that its best performance next year will occur in its North America industrial-business unit," TheWall Street Journal reports.

With Wall Street robots focused on these latest confidence numbers, the individual investor is in an even better position to outdo the professional traders. And, like Peter Lynch preached, there are plenty of stocks that consumers can recognize way before Wall Street will, especially with their minds on economic reports. For three such stocks, grab your copy of our free report: "Middle-Class Millionaire-Makers: 3 Stocks Wall Street's Too Rich to Notice."