What if Consumer Demand Is Dead?
01/29/2010 9:31 am EST
It's not a popular idea right now as pundits predict a full economic recovery. But history and current trends suggest a different possibility that investors should prepare for.
Consumer demand isn't coming back. Not anytime soon. Not for a decade or more. Not anything like the levels of 2006 or 2007, before the global economic crisis hit full force.
I know that's not the conventional wisdom right now.
You've heard the current version of history over and over. Consumers got ahead of themselves in the past few years and spent money that they didn't have by running up balances on their credit cards and treating their houses as ATMs.
The consensus opinion on Wall Street, in Washington, D.C., and on Main Street is that it will take some time, maybe as long as two years, to work off the excesses of the past couple of years. And then consumer demand will return 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 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 nothing bites them.
But I think there's a good chance 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—more so, I think, but you decide after you've read my arguments—as the mush that clogs the political and economic discourse of the moment.
Demand: Gone But Not Forgotten
The result of investing in anticipation of demand coming back to pre-crisis levels would be absolutely painful if it's wrong. Stop worrying about whether the current downturn will become 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 a certainty.
I'm increasingly convinced that the behavior of global consumers in general, and of US consumers in particular, over the past 20 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 had projected future consumer demand by drawing trend lines from consumer behavior over the past couple of decades. They then built factories and service networks to meet that projected demand.
The global economy isn't going back to that trend line. 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 consolidation as industries are forced to radically shrink capacity, and an increasing number of the walking dead that are kept alive only by large infusions of capital from national governments.
This isn't the first time recently that I've said this.|pagebreak|
I've referred to this scenario in a number of recent blog posts, including one in which I even suggested a couple of ways to cope with this scenario as an investor. But a recent piece from global consulting company McKinsey fleshes out some of the details of this alternative history. (You can find the article at McKinsey's online journal, the McKinsey Quarterly.)
Like many other consultants these days, McKinsey has been busy asking consumers about their spending plans. In March 2009, for example, 90% of the US households McKinsey surveyed said they had reduced their spending because of the recession. About 33% of respondents said 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 their spending down after the recession.
Consumers are not only spending less; they're also borrowing less and saving more. In the quarter ending in 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%.
Different, Sure; But How?
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—17% if you count the discouraged who have stopped looking and the people 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 the data depends on how long a slice of time you look at. If you look at just the past 20 years or so, then the 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 a longer view, however, and look at the years stretching to 1945, then it's the zero savings rate of 2008 and the mortgage debt blowout of 2006-07 that look like outliers.
It reminds me of a conversation I had with Nobel economist Paul Samuelson many years ago when I was 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 (who died last month at age 94) laughed at my question. You know, he said, we've got only 80 years of good data on the stock market. And we don't know whether that information is a good representation of the long-term behavior of stocks or whether the period we're looking at is a total outlier.
We ought to start out admitting the same 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 past ten 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 point to a conclusion very different from a scenario in which consumers will relatively quickly start spending like it's 2006 again. 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 13-month Panic of 1907, 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 was more than a decade of economic pain when millions of people lost jobs and stayed jobless, when millions lost their life savings, 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 fall 2008 (the Lehman Brothers bankruptcy) or the stock market top of October 2007.|pagebreak|
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 2007—marks out what many of us have begun to call the lost decade for US investors, in which the stock market indexes went nowhere and net returns were close to zippo.
The Pain Drags on
This was also a period when a relatively shallow recession was followed by extraordinarily slow job growth, when real incomes stagnated, and when workers learned that just about anyone—union or non-union, big company or small, 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 as—though by no means anywhere near equal in pain to—the Great Depression.
And it's really not over yet, even though the economy managed to show positive 2.2% gross domestic product growth in the third quarter of 2009.
For one thing, continuing high unemployment makes the recession feel like it's still going on. And 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 health insurance premiums and co-pays. Real living standards are falling if you factor in 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 is a landscape under a black cloud. The current season of political protest—I don't know of anybody who's happy, whether it's Republicans, Democrats or independents—is fueled by a pervasive sense that things are going to get worse. And from the size of our budget deficits, the quality of our political leadership, and 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 are closely linked to the life cycle of individuals. Early in their working careers, individuals spend more freely. In the middle, during what are called the peak earnings years, people stash as much as they can into savings. They've gotten close enough to paying for college or retirement to feel a pressing need to save. Then, as people get older, they start to draw down on those savings and, these days, to very carefully watch every penny of spending because so many are now worried about outliving their retirement nest eggs.
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, as disease and war have limited the world's experience with whole societies aging. 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 past 20 years.
I'm by no means a perma-bear, something those of you who have read my work over the past 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 this recent column, I sketched out three ways—using brands, service and distribution, and technology—to build a profitable portfolio in a profitless recovery.
In my next column, I'll look at how to build a global portfolio strategy that attacks this problem.
Jim Jubak has been writing "Jubak's Journal" and tracking the performance of his market-beating Jubak's Picks portfolio since 1997 on MSN Money. He is the author of a new book, The Jubak Picks, and he writes the Jubak Picks blog. He is also the senior markets editor at MoneyShow.com.