There is still some upside left in the XLF as we head into 2018, yet I think there is greater risk i...
Maybe the U.S. consumer is never coming back--and the global economy will stay awash in excess capacity
01/29/2010 11:00 am EST
I know that’s not the conventional wisdom--or maybe conventional "wishing" is a more accurate term-- right now.
You’ve heard the current version of history over and over again. U.S. consumers got ahead of themselves in the last few years and spent money that they didn’t have by running up balances on their credit cards and treating their houses as ATMs.
It will take some time, maybe as long as two years, the consensus opinion on Wall Street, in Washington, and on Main Street goes, to work off the excesses of the last couple of years but consumer demand will come back to something like the level of the years before the global economic crisis. Consumers may not go back to spending like it’s 2007 but they will spend like it’s 2006 or 2005 or ….
Frankly I don’t think anyone is actually terribly convinced by that story. It’s just that the alternative is too grim to contemplate. Most folks in the financial advice industry and most politicians in Washington would rather go whistling past the graveyard and hope that nothing bites them.
But, I think there’s a good chance that this story and this reading of history are wrong.
Not a certainty, mind you. But a very good chance.
And if you don’t at least consider the possibility that the story and the history are wrong, you can’t possibly hope to protect your portfolio or come up with a strategy to grow its value.
I think there’s an alternative history of the global consumer that makes waiting for demand to come back to “normal” absolutely wrong. It’s at least as likely that it won’t—more so I think but you decide after you’ve read my arguments.
And result of investing in anticipation of demand coming back to pre-crisis levels will be absolutely painful if the consensus story is wrong. Stop worrying about whether or not the current downturn will turn into a full scale correction of 10% or worse. We’ve been through that. We know—sort of—how to deal with it.
But if global consumer demand isn’t set to bounce back, then we as investors face a huge challenge. And we’d better face up to it and formulate some strategies for coping with it—even if it’s not an absolute certainty.
I’m increasingly convinced that the behavior of global consumers in general, and U.S. consumers in particular, over the last twenty years was an aberration. And that what we’re seeing now isn’t the beginning of a gradual recovery to the spending levels of the years before the global economic crisis, but a return to the long-term spending (and saving) trend that stretches back to 1945.
If that’s the case, the global economy is indeed awash in excess manufacturing and service capacity because companies and industries projected future consumer demand by drawing trend lines from consumer behavior over the last couple of decades. And they then built factories and service networks to meet that projected future demand.
The global economy isn’t going back to that trend line and the projections based on it when the crisis is over. Over the next decade or more, industry after industry isn’t going to gracefully absorb that temporary extra capacity. Instead the global economy is in for a decade or more of tooth and claw fights for market share, bloody consolidations as industries are forced to radically shrink capacity, and an increasing number of walking dead companies that are kept alive only by massive infusions of capital from national governments.
This isn’t the first time recently that I’ve said this.
I’ve referred to this scenario in a number of recent posts including one where I even suggested a couple of ways to cope with this scenario as an investor http://jubakpicks.com/2010/01/19/get-your-portfolio-ready-for-the-profitless-global-economic-recovery/ . But a recent piece from global consultants McKinsey & Co. fleshes out some of the details in this alternative history. (You can find the article at McKinsey’s online journal, The McKinsey Quarterly at www.mckinseyquarterly.com.)
Like many other consultants these days, McKinsey has been busy asking consumers about their spending plans. In a survey in March 2009, for example, 90% of the U.S. households that McKinsey surveyed said that they had reduced their spending because of the recession. About 33% of respondents said that they’d reduced spending significantly. Roughly 45% of those who had reduced spending did so because of necessity. More than half of those who said they had reduced spending said they planned to keep spending down after the recession.
Consumers are not only spending less; they’re also borrowing less and saving more. In the quarter to the end of June 2008, net consumer mortgage borrowing turned negative for the first time since 1946. In March 2009 the personal savings rate reached 5.7% of disposable income, a 14-year high. That still lags the post-1945 average of 9%.
There’s nothing startlingly new in these findings. Everybody who does a survey these days is finding that consumers are spending less. With unemployment at 10% officially (and 17% if you count the discouraged and those working part time who want full-time jobs) any other result would be surprising.
But what is unusual in McKinsey’s survey is the consulting group’s willingness to think that the trend of you derive from the data depends on how long a slice of time you look at. If you look at just the last 20 years or so, then the recent move to a 7% savings rate and a negative number on net mortgage borrowing seems like the outlier that will be hammered into insignificance by the trend. If you take the longer view, however, and look at the years stretching back to 1945, then it’s the 0% savings rate of 2008 and the mortgage debt blow out of 2006-2007 that look like outliers.
It reminds me of a conversation I had with recently deceased Nobel economist Paul Samuelson many years ago as a cub reporter sent out by my editor to find out what average annual returns investors could expect after some big market crash. In the nicest possible way, Samuelson laughed at my question. You know, he said, that we’ve only got 80 years of good data on the stock market. And we don’t know whether that data is a good representation of the long-term behavior of stocks or whether the period we’re looking at is a total anomaly.
We ought to start out admitting the same ignorance when we try to figure out what consumer spending will look like over the next 20 years. And we certainly shouldn’t assume that the last 10 or 20 years is either the long-term trend or the outlier.
I don’t think we can say anything certain about that trend. But I do think the odds increasingly favor a conclusion very different from the-consumers-will-relatively-quickly-start-spending-like-it’s -2006 scenario. Even though we can’t say anything about the long-term trend with complete confidence, I don’t think that means we can’t say anything at all.
First, we do know from the evidence of the Great Depression and other economic events that what changes consumer behavior is duration. The Great Depression was formative of consumer and economic attitudes in ways that the Panic of 1907 (13 months), for instance, wasn’t because it went on and on and on. From the crash of 1929 to the true recovery of 1940 or so adds up to more than a full decade of economic pain when millions lost jobs and stayed jobless, when millions lost their life savings, and when millions lost their homes.
The Great Recession hasn’t yet lasted nearly that long—if you define it narrowly from the financial crisis of October 2008 (the Lehman Brothers bankruptcy) or the stock market top of October 2007.
But periods aren’t defined quite so neatly. The stock market bubble that broke in October 2007 was the second bubble of the decade. The combination of the two, the tech bubble that broke in 2000 and the mortgage bubble that broke in 200, mark out what many have begun to call the lost decade for U.S. investors in which the stock market indexes went nowhere and net returns were close to zippo.
This was also a period where a relatively shallow recession was followed by extraordinarily slow job growth, when real incomes stagnated, and where workers learned that just about anyone—union or non-union, employee of big company or small, worker at profitable enterprise or money losing turkey—could lose a job to a buyout, to off-shoring, to global competition.
By itself, the Great Recession is the longest economic downturn in the United States since the Great Depression. Measured in terms of economic insecurity, stagnant incomes, and falling stock portfolios, it’s roughly of the same duration, though by no means anywhere near the equal in pain, to the Great Depression.
And, of course, it’s really not over yet, even though the economy managed to show positive 2.2% GDP growth in the third quarter of 2009.
Objectively with employment at 10% officially and 17% unofficially the recession feels like it’s still going on. Home prices, the major store of wealth for most American families, are still falling in most markets. Real incomes are falling if you consider such things as rising insurance premiums and co-pays, or college tuitions. Real living standards are falling if you include price hikes and/or cuts in public services.
Second, we know from past economic events that how people feel about the future is a key determinant of things like consumer spending and saving in the present. The future to many people in the United States now feels like a landscape under a black cloud. The current season of political protest—from Republicans to Democrats to independents I don’t know of anybody who’s happy—is fueled by a pervasive sense that things are going to get worse. And looking around at the size of our budget deficits, the quality of our political leadership, the intense global competitive challenges the United States faces, it’s hard to be hopeful about our ability to solve our problems.
And third, we know that consumer spending and saving is closely linked to the life cycle of individuals. Early in their working careers individuals spend more freely. In the middle, during what’s called the peak earnings years, people stash as much as they can into savings. They’ve gotten close enough to paying college tuition or retirement to feel a real and pressing need to save. As people get still older, they start to draw down on those savings and, these days, to very carefully watch every penny of spending because so many of us are now worried about outliving our retirement nest egg.
That pattern holds, economists theorize, across economies and societies as well. As societies age, we surmise, they spend more on health care and retirement services and less on things like flat screen TVs, second or third cars, or dress clothes. We don’t know any of this for a fact—the world has very limited experience with whole societies aging. Throughout history we’ve killed ourselves off by war or disease before societies reach this point. But these guesses on spending patterns are logical and they do bode ill for consumer spending in some of the industries that have, globally, expanded production capacity most rapidly during the last 20 years.
I’m by no means a perma-bear those of you who have read my work over the last 13 plus years know.
And I have a deep-seated and perhaps foolish optimism that it’s possible to find an investment strategy that that can work around even an economic problem as big as this one. In my post investor http://jubakpicks.com/2010/01/19/get-your-portfolio-ready-for-the-profitless-global-economic-recovery/ I sketched out three ways—brands, service and distribution, and technology—as a way to build a profitable portfolio in a profitless recovery.
In my next column I’ll take a look at an approach to a global portfolio strategy that attacks this problem.
Full disclosure: I do not own shares of any stock mentioned in this post in my personal portfolio.
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