Consumer Spending: Something Has to Give

The Economist has a great piece out about how the overleveraged American Consumer of recent memory is going to quietly take a backseat to the saving-oriented consumer of decades past. Why? Well, because they will have to. The recession obviously has a negative impact on spending power and we've written numerous times about this current/upcoming phenomenon.

1. The decline in housing prices and the increase in the unemployment rate will obviously have a negative effect on the economy and in turn the consumer. Visa's (V) consumer trends have already started to show this.
2. As these consumers find themselves struggling to get by, we'll notice that credit card debt will rise and we'll get a credit card squeeze. This, along with a ton of auto loan exposure has been the macro thesis behind shorting Capital One (COF). Add in the fact that they are continually seeing rising charge-offs and delinquencies and it's not a pretty picture.
3. Add in the fact that many Americans have suffered from the destruction of wealth due to a horrible year in the stock markets.

All of the above plays right into our theme of shorting discretionary retailers and going long the "cheapest of the cheap" in consumer plays. The only retailers we want to be long in this environment are McDonald's (MCD) and Walmart (WMT). MCD makes sense because it provides cheap and easy food. When people are short on cash, that dollar menu goes a long way. WMT benefits from a similar thesis. When you're buying groceries, toiletries, you name it... Walmart has it and at the cheapest prices. Not to mention, it also has the Sam's club warehouse, which plays right into our 'cheap' theme.

As far as shorting discretionary retail goes, you can really take your pick. Whether it be casual dining chains, jewelry stores, or any leveraged consumer play, you have plenty of options. Or, you could just short Retail HOLDRs (RTH) and then go long a select few retailers as a hedge. Consumers are/will be in a pinch for a few months to come and that's how you play it.

Now, take all the aforementioned facts and then add in this commentary from The Economist and you'll notice that a shift is coming. They write:

On average, consumers from 1950 to 1985 saved 9% of their disposable income. That saving rate then steadily declined, to around zero earlier this year (see chart). At the same time, consumer and mortgage debts rose to 127% of disposable income, from 77% in 1990. Those forces have now reversed. The stock market has fallen to the levels of a decade ago. House values have fallen 18% since their peak in 2006. Banks and other lenders have tightened lending standards on all types of consumer loans. As a consequence, consumer spending fell at a 3.1% annual rate in the third quarter (in part because tax rebates boosted spending in the second), the steepest since the second quarter of 1980 when Jimmy Carter briefly imposed credit controls. More such declines are likely to follow. Richard Berner of Morgan Stanley projects that in the 12 months up to the second quarter of next year real consumer spending will fall by 1.6%—a post-war record. “The golden age of spending for the American consumer has ended and a new age of thrift likely has begun,” he says.

Take a look at this powerful chart. Personal savings has been in a steady downtrend ever since the '90s. Household debt, on the other hand, has almost doubled since the '90s. Something has to give.

click to enlarge

Source:

• The Economist

Comments

[CLH:]

And what does the gov. want people to do? Borrow and spend!! The gov. is the problem and not the answer.

2008 Dec 05 06:55 AM

[Jack K:]

I agree. Socialism doesn't work. But lots of people get something for nothing from the government, and if you ask them, they all deserve it.

2008 Dec 05 07:00 AM

[Jason Rines...:]

Wasn't published savings rate for last month 2.7%? I believe it was -.4 at the beginning of the year. At this rate this will be a dog economy for four years. Right as reporting actually acknowledges we are/were in a depression we'll be coming out of it.

2008 Dec 05 07:14 AM

[Chris B:]

80% of what Wal Mart sells could easily be cut from the family budget, even if it is cheap: jewelry, nutritional supplements, seasonal decor, DVD's, CD's, 50" LCD TV's, overpriced plastic toys, dog sweaters, car customization items, lawncare accessories and ornamentation, cheap purses (what woman doesn't already own at least 8?), new computers (that do little more than your 4-5 year old computer already does), mechanical Santa Clauses, and exercise bikes. If you are facing a job loss and an uncertain future, you're not buying this junk. Yard sales will be prolific this spring. You're also unlikely to renew your Sam's card just for the privledge of buying all this same stuff in quantities that are greater than what you need. Who needs 100 rolls of paper towels and 2 gallons of horseradish when the heat bill is due and you have no job? What Wal Mart will sell is low-margin stuff. Toilet paper. Groceries.

McDonalds' dollar menu is a joke. What's their margin on that? More likely the dollar menu is a marketing tool to sell lattes, milkshakes, deluxe sandwhiches, $6 salads, and now movie rentals (!). With nobody buying their high margin products, but everyone taking advantage of their marketing tool, I can imagine earnings falling a long way.

2008 Dec 05 11:33 AM

[Chris B:]

GDP = Consumption (70%) + Investment (15%) + Govt Spending (20%) + Net Exports (-5%)

A 9% increase in savings would reduce consumption by 9%. Consumption is 70% of GDP, so the stand-alone effect of this inevitable reversion to the historical mean would be a (-9%)(70%)= -6.3% decrease in GDP.

Worse yet, this increase in savings is obviously not flowing into investment, such as stocks, bonds, small businesses, equipment, housing, etc. It is paying off debts accrued in earlier times - car loans, credit cards, ARM's. The economic benefits of those debts (sales) have already been had. Because the rest of the world is also hurting, our trade balance is unlikely to be affected significantly. ... which leaves government.

It seems that the only way to prop up GDP to earlier levels is to increase the size of government. Perhaps from 20% to 26% of GDP. This would result in a 30% increase in govt. spending, paid for through either taxes or inflation, which is the same thing. To be effective, this all would have to have no additional negative impact on consumption or investment.

On second thought, bring on the recession! A GDP decline to decade-ago levels would be less bad than the side effects of trying to prop up GDP.

2008 Dec 05 11:51 AM

[bbowen7:]

Is there a good economist who can perform a "reversion to the mean" scenario for home values and savings rates to determine the point at which we will get back to a stable economy? The answer may be "never" if we don't get the balance of trade under control, and that will take major inflation and a corresponding devaluation of the dollar. A good data-driven model would be great, but my sense is that it is several years, at best.

2008 Dec 05 12:23 PM

[Market Folly:]

i think a few commenters are missing the point that going long MCD and WMT is a hedge to an overall retail sector short. WMT and MCD are immune to the problems just like everyone else. we just think they are positioned the best given the current & upcoming environment. so, they are merely a hedge to our overall XRT short and specific discretionary shorts

2008 Dec 05 05:31 PM

[Market Folly:]

^^^ should be "WMT and MCD are *NOT* immune

2008 Dec 05 05:31 PM

[graywolf:]

Your November 13 Note in Seeking Alpha says you are long TBT for the reasons given. Both TBT and PST have as their main underlying a Treasury swap with Lehman Bros. Doesn't counterparty credit risk exist here? what am I missing?

2008 Dec 10 09:10 PM