Today, I’m going to try to tie together three distinct threads into something I’ve been debating for about a year now – the savings rate, consumer discretionary stocks (i.e. “retail”), and the economic foundations of America. Please bear with me – I’ll start with something from my colleague Peter Cohan, who was writing about the savings rate hitting a 50+ year high. From “Fiscal prudence is great for consumers. But is it bad for stocks?”:
If investors think that all this saving will eventually lead to mounds of dry powder to be invested in stocks, then now could be a fine time to invest in stocks. But if consumers stop borrowing and keep saving, it could be years before consumer spending increases lead to economic growth…
So all that fiscal prudence could be bad for stocks. But at least people will start relying on themselves to prepare for their retirement. And that’s a good thing in the long-term.
Now, the savings rate is another economic datapoint, and as such not one I highly pay attention to beyond (maybe) glancing at what it is. Is a negative savings rate bad for the country? It’s certainly unsustainable, and if you have companies levering up to build out capacity based on the belief that such a level of spending is normal, you’re in for trouble when the cycle turns. That, in my opinion, is an under-rated cause of some of the non-financial pain we’re seeing now.
People looking for a trade like to extrapolate things like the savings rate to consumer discretionary stocks, which seem like a natural link. But that overlooks that most stocks in the sector – say, apparel retail and restaurants – are just generally bad groups to own. The economics are unfavorable across the board, and until you have a real rationalization of store base counts, I don’t see how the operating leverage really starts to work in favor of the companies.
Of course, with commercial real estate supposedly the next great shakeout due to overleveraging and overbuilding, how this will get accomplished in a timely fashion if mall owners are looking to make deals is beyond me. The number of companies who mention looking to be “opportunistic” in real estate is staggering, and makes me wary since it suggests the full cycle of pain has not yet been felt.
All of this focus on the service sector calls to mind a conversation I had with Peter Schiff last week, who has long been saying that America as a country needs to return to a culture of making “stuff” and saving. Manufacturing jobs are down to around 10% of overall employment, compared to about 30% during the post-World War II period.
I’m unsure as to whether Peter is right or not about the need to become more economically geared toward factory production; his background in economics is stronger than mine, but economics is a fuzzy art. My main issue is that manufacturing standard commodity-type goods doesn’t really create value for all the capital it employs, because it’s too competitive of a field. Wouldn’t it be better to focus on the high-value stuff as much as possible?
I’m not really sure if there’s an answer to that question, but I always feel like it’s left out of the usual debate. But to bring it back to consumer discretionary stocks, I think the majority of them aren’t going to create value over a full cycle, and thus aren’t worth investing in, whether the savings rate is high or low. Most of the value at any time is attributed to a brand name, which may or may not survive a change in fashion trends.
So, how will consumer discretionary stocks emerge on the other side, whenever that occurs? Apparel will still be a tough business, as will restaurants. I’ve favored hardline retailers for some time, because the pricing advantage that exists there looks to be more sustainable than in softline. Companies like Home Depot (HD), Lowe’s (LOW), and Bed Bath & Beyond (BBBY) rule their categories – Bed Bath particularly so now, if their recent earnings are in any way indicative.
But this stance is in no way based on savings rates; it’s based on the market position of each of those companies. Don’t let macroeconomic variables be the determinant of taking a position in a well-run company, even if they indicate that the former tailwinds (extremely high spending) are now turning into headwinds. As J.P. Morgan CEO Jamie Dimon wrote in the spring:
I’m not a psychologist, but if you ask me whether there has been a sea change in consumption in society, I would say yes. Having two cars instead of three or going out to dinner less and turning the lights off - those are not sacrifices the way you would traditionally mean sacrifices. If people are a little more thoughtful, more conservative, and if their fundamental values are more important than how much money they make, those are all good things. These changes are not going to destroy our country; they’re good for our country.
Disclosure: No positions in stocks mentioned.