Stop Trying to Jump-Start the Consumer - Barron's Interview

Includes: DIA, SPY
by: SA Eli Hoffmann

Barron's interviews Robert Albertson, Sandler O'Neill's chief strategist and principal. "Denial is growing," he warned in Nov. 2006. "The markets are hearing what they want."

What surprises Albertson most about how the crisis has unfolded:

Instead of recognizing the damage in a controlled fashion and trying to deal with it, everything has gone to the other extreme. In other words, stress tests back in 2005 or 2006 were useless; they were silly and assumed things were going to continue to go to the moon. Now you hear about nothing but toxic assets and their worthlessness and the impending disaster, and I have to believe the reality is probably somewhere in between.

What has to happen for things to return to normal, he says, is a deleveraging of consumer debt and an increase in savings. Consumer debt is currently 130% of (annual) income - up from 100% in 2000 and 80-90% before that. "It has to come down" in order to repair the consumer's balance sheet. The savings rate used to be 10-12% of income. Now it's 3%. These two factors will reduce consumer spending by $2.5T over the coming years - and "no government-stimulus program is going to offset that effectively." Which is why Albertson is critical of the government's current process, which seems to be focused on "jumpstarting" the economy instead of recognizing that deleveraging is a necessary part of recovery. "Jump-start consumer credit for what? So we can be more indebted?"

Instead of focusing on increasing credit, he says, we should have the patience to de-lever. The biggest danger of the stimulus plan is that it will be a false start, causing the economy to crash even harder and prolonging recovery.

The mistake is that the government believes credit drives the economy, instead of the economy driving credit. They have got that backward, and this is a very dangerous time to be misfiring.

Furthermore, he's worried officials are short-sightedly taking on massive debt thinking 2-3% interest rates aren't bad, but at some point they'll be servicing that debt at 5%, 6%, 7% and 8%. "If they really understood that, I don't think they would be so ready to put the taxpayer at risk."

On toxic assets, Albertson thinks we're throwing out the baby with the bathwater. Just like we ignored the absurdity of home prices on the way up, we're writing down many valuable securities to ridiculously low levels.

His advice to investors: keep your powder dry. Sectors he likes: infrastructure, agriculture/commodities.