The Great Debate For The Bears No Spending. Part I

The post below this one is an excerpt from Barrons talking about consumer spending. I want to spend a moment on this because I think this is an important structural shift that is occurring and one that most in the investment community are not focused. One of the Bear's greatest arguments is that to quote Doug Kass "the consumer is spent up not pent up". I believe there is a lot of truth in this. In my discussions with folks, they tell me that the thing that weighs on them the most is getting out of debt. This takes priority in their minds over investing money in the markets.

First off though let's talk about what in my mind has happened with individuals and their money over the past 20 some years. Ever since I've started in the business economist have discussed the low level of consumer savings. For years I've tried to pin down what exactly this means and surprisingly consumer savings means different things to different economists. However, the consensus seems to be that it only includes cash held in savings accounts or checking accounts.

This of course assumes that today's consumer's emulated earlier generations and decided to keep all of their money in these type of accounts. In the meantime other avenues of investment opened up, most notably money market accounts. It should not be surprising that money gravitated towards these investments since these typically pay a higher rate of interest than banks. It is unclear to me how money market assets are counted when judging the savings rate but for the most part they seem to be left out of that equation. There is something like a trillion dollars today in money market accounts.

There is an old saying that "money goes where it's treated best". Since the early 1980's that has not been a savings account. We as investors very seldom take a longer view of things but it is still true to say that investors who for the most part have held financial assets or real estate longer than 10 years have done very well. Stocks may have spent the last 10 years going nowhere but investors lucky enough to have put money in the markets in the early 1980s have made a fortune on that investment. The Dow Jones Industrials started off 1983 at 1,027.04. It is currently trading around 9,600. That's a gain of over 800% not including dividends. Real estate has seen similar gains for much of that period as well.

Today I believe consumers are undergoing a fundamental reassessment of where to invest their assets. That is I don't believe that currently they believe in aggregate that any of the above will be areas that will treat them the best for the foreseeable future. Hence money that might have been invested is being diverted to do two things: Increase savings and pay down debt.

The debt side is something I believe weighs heavily on individuals. As I mentioned above the first thing most folks I talk to say they want to do is pay down debt. I also think how & why of how they went into debt needs to be analysed. The popular press too often portrays debt levels as mostly due to the American consumer gorging himself on Walmart trips and fancy new cars. The Barrons article will discuss healthcare costs which are increasingly being driven onto individual's balance sheets and away from corporate America. In fact something like 20% of all bankruptcy filings cite unexpected illness or injury as the reason for their indebtedness.

The other expense is financing higher education. As the parent of a college student I can tell you that you are looking today at four year expenses, all in, hovering between $70,000 and $200,000. Scholarships, aid programs and loans can take out some of that bite. But the fact remains that this is likely, next to a mortgage on a home, the single most expensive item that will affect consumer's budgets. Traditionally parents if they can help it do not want to excessively burden their children with this debt. They tend to try and finance it themselves. This is unlikely being met from current income for most people. Also we are entering a period where students going to college will find that the monies put away by their families (using after tax dollars by-the-way) have at best not appreciated all that much in the past 10 years. The current employment picture is not helping this out either.

Finally Adam Smith's dead hand of economics is coming into play. Consumers are being forced to cut back on their spending habits even if unwilling to do so by the credit markets. Simply put it is almost impossible for many Americans to get credit today and what credit they've had available to them has been curtailed as banks and loan companies cut consumer credit lines. This has been especially prevalent in the credit card industry as card companies continue to contract credit lines to even healthy balance sheets. Simply put they don't want the risk.

So the Bears are probably going to win this argument for the foreseeable future. At some point individuals will be in a position to take more risk but that is unlikely to be until they've substantially repaired their own balance sheets. Stocks I think can continue to rise but it will likely come from monies individuals have already committed to risk (such as IRAs or other types of retirement accounts) and not from their own paychecks anytime soon.