By A. Gary Shilling, Forbes | 30 November 2009
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If you want to know where the economy and our markets are headed over the next decade, focus on the consumer. The picture I see is rather depressing. Most people don't share my view, which is why we have had a bull run in stocks since March. The bull market presumes a 'V' recovery with consumers quickly returning to their profligate ways. [[FWIW, even assuming that's true of consumers' propensity to spend, where's the cash/credit to come from? The banks aren't lending (and most of the 'non-bank' lenders— except for pawnshops and the neighborhood loan shark— have long since gone bye-bye)— and if history is any guide, may not for another generation or so. Most banks are at least technically insolvent; moreover, they are looking forward to the 'second wave' of home mortgage defaults*— prime and alt-A ARMs will reset during 2010 (peaking in mid-January) and most 'homeowners' cannot afford the new payments (shades of sub-prime) and cannot refinance (their home prices are far 'underwater'). The trend in the CC default rate is still rising (and will probably continue to do so until at least the unemployment picture stabilizes). Then, the banks have yet to be really hit with that bad commercial RE tsunami (if money is borrowed to build a mall in **** and no one buys any homes in the housing developments nearby, guess whether that loan is likely to be repaid?) At the moment, the only one lending is Uncle Sam— and there has to be a limit to that! : normxxx]] I'm not expecting any such rebound. If consumer spending doesn't improve, 2010 earnings won't support current stock prices. Third-quarter GDP rose at a 3.5% annualized rate [[since adjusted down to 2.2%: normxxx]], but don't kid yourself that our economic malaise is over.
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From the early 1980s through 2007 consumers were on a borrowing-and-spending binge fueled by rising asset prices [[net wages, after inflation, were disappointingly flat: normxxx]]: stocks in the 1980s and 1990s, houses in this decade. Their saving rate dropped from 12% to 1% of income. Home mortgage and consumer debt jumped from 60% to 135% of aftertax annual income. Consumer spending in relation to GDP went from 62% to 70%. And. for every 1% increase in consumer spending, U.S. imports climbed 2.8%. That propelled foreign economies, as the American trade balance dropped from zero to an $800 billion annual deficit.
But now consumers have no choice but to begin a decade long saving spree. The nosedive in house prices has left a third of those with mortgages underwater. Their average home equity has dropped from 48% in the early 1980s to 23% now. Despite the recent stock rally, equity prices remain well below their 2000 and 2007 peaks.
In relation to aftertax income, household net worth is lower than in the 1950s. Also, the postwar babies hoping to maintain their standard of living in retirement desperately need to save. The good news is that they can. Many are in their 50s, their peak earning years [[assuming that they are still employed or have not suffered a 'job turnover' benefits/wage cut: normxxx]], and their tuition payments are done. If their kids are as old as mine, they no longer have to replace smashed-up cars.
People will save because it's scary out there. Unemployment is high and rising. Moreover, the layoff and unemployment numbers understate the problem because they do not include involuntary furloughs and wage cuts, which have surfaced for the first time since the 1930s. It's scary for employers, too; with a pickup in orders, they just work remaining employees harder. In the recession so far the average number of weeks between jobs has gone from 17 to more than 26.
No wonder that consumer confidence remains depressed. Households saved virtually all of last spring's tax cuts and extra Social Security payments. Families are paying down debts. Homeownership rates are declining as foreclosures leap. Those forced out are doubling up with family and friends, leaving apartments vacant. The government's cash-for-clunkers deal and other stimulus subsidies have provided temporary growth that won't last.
Spending this holiday season will follow Scrooge's inclinations. Stocks will fall through March lows as investors begin to worry about disappointing 2010 earnings. [[I'm not sure I agree with either of the two preceding points. I think holiday sales (though disappointing) will beat expectations, and stock prices may fall, but will hit a great buying point— possibly good for a one or two year move— sometime next summer or fall. : normxxx]] Stockholders should abandon their dreams of a V-shaped recovery and instead worry about how we are going to break out of the vicious cycle of consumer weakness, depressed output and underemployment. We might see another round of fiscal stimuli, this time aimed at job creation. It might end the recession by mid-2010, in time to save some incumbents from being unelected. [[But in November look for the Republicans to retake the House, or very nearly so, and for them to reduce the Dems 60 votes in the Senate. Then it's all gridlock from then on out.: normxxx]]
But [any] 'recovery' will likely be so weak as to be nearly invisible. This kind of recovery won't put consumers back in a consumption mood and won't absorb the excess inventory of housing [[nor cause banks to open their coffers: normxxx]]. Within a decade the saving rate will probably return to double digits. Until recently, consumer spending was rising a half-percent per year faster than aftertax income; now it will be rising 1% slower. That shift will knock 1.5 percentage points off annual real GDP growth in the next decade to a low 2% compared to 3.7% in the 1982-2000 salad days.
Those seeking to preserve wealth or even make a profit in this environment should avoid producers of big-ticket consumer discretionary products like autos, appliances, airlines, ocean cruises and boats. They'll suffer twice as consumers cut the nonessentials in order to save and as 'deflationary expectations' convince them to wait for still lower prices. Companies with slow revenue and big debts are vulnerable in a deflationary economy. Sell them.
Stick with stocks that pay meaningful and rising dividends. Consumer staples are relatively immune to slow growth and deflation, although trading down from national brands will persist. Treasury bonds will continue to rally as deflation settles in. [[But beware of the hit that bond prices take when interest rates rise, as they ineviably must.: normxxx]]Brace yourself. The U.S. consumer will rule the world economy for years, but I expect he will be a miserly king.
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A. Gary Shilling is president of A. Gary Shilling & Co., economic consultants and investment advisers. Visit his homepage at www.forbes.com/shilling.
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