The causes cited for the tough economy include deleveraging, a housing bubble, fed manipulation and global trade imbalances between the U.S. and China. However, all of these forces are side effects of the same problem which is a reality that most Americans refuse to face. That issue is that most Americans have been priced out of their own country and cannot sustain what is traditionally an American standard of living. This is not a uniquely an American problem as most of Europe has tried to deal with this problem through generous pension and social welfare programs which have bankrupted these countries to the point of a sovereign debt crisis. The implications of Americans and Europeans being largely unable to finance a first world lifestyle are severe and can lead to contracted downward spiral of the economy until the Western standard of living comes to parity with emerging economies.
The current economic slowdown has pushed the majority of Americans to the brink. According to a survey done by Harris Interactive and Careerbuilder.com 77% of Americans currently live paycheck to paycheck. Due to increases in efficiency and a global glut of labor, 41% of jobs are low paying work (under $15 per hour) and with the unemployment rate 9.1%. Combining these two groups shows that half of the American labor force is earning poverty level wages.
Below, I have displayed charts of the minimum budgets for a single person living in various parts of the country at a decent standard of living in a safe neighborhood. I used Greater Miami/Austin as the basis for a cheap city, Philadelphia for a mid tier city, and Southern California for the expensive city (even though SoCal looks cheap compared to the San Francisco Bay Area whose minimum expenses added up to over $38,000 in a similar budget). The assumptions I used for these budgets are generous because I did not include any potential student loan or credit card debt and had a reasonably short commute.
Basic Expense Charts:
|Rent (with roommate)||$1,000|
|Avg Monthly Expenses||$2,688|
|Avg Annual Expenses||32250|
|South Florida or Texas|
|Avg Monthly Expenses||$1,947|
|Avg Annual Expenses||23364|
|Avg Monthly Expenses||$2,229|
|Avg Annual Expenses||26742.86|
With median wages only at $26,261 per year, that puts a large portion of Americans in the red just to survive. And the outlook for a families' expenses is not much better as the average family often needs to fall into debt to just cover basic living expenses. If Americans cannot even afford to pay their bills, how do you expect the economy to ever grow at a healthy rate? That is the crux of the problem where rising commodity and real estate prices outpaced wage growth in the early 2000's.
As a result, consumers were forced to leverage themselves to maintain a "middle class" standard of living that they could no longer afford. The country levered itself up to the point where it could no longer pay back the debt and demand for housing (and goods in general) collapsed with the bust. Now with households already highly indebted and credit harder to obtain, the game is up and these people will have to pull back to a lower standard of living and spend less. Less spending leads to a lower demand for goods. Then less sales for businesses forcing them to lay off workers. The newly laid workers cannot afford their previous lifestyle and then this process becomes a downward spiral. This trend has been ongoing in Japan as their standard of living has slowly been grinding down since the late 1980's. Unlike Japan, America has a low savings rate and higher inflation which will speed the cycle of Americans falling below their means. The economy cannot recover consistent growth until this cycle is somehow reversed or completely bottom out.
Is there a way to trade this economic trend? My best bet is shorting the retail, entertainment and financial sectors since they have the most to lose from the overstretched consumer (and not as beaten down as real estate already is). The ETFs that are the best to short for this trade are RXI, XLF, and the PEJ. The PEJ stands out the most to me because it focuses solely on entertainment. When times get tough, entertainment and leisure goods such as their overpriced Starbucks coffee and ordering products on HSN. Technically, the ETF also has a large gap up from 16.50 to 17.00 which is a strong short term bearish signal.
Another sector to benefit from an extended economic malaise is apartment REITs. The last thing individuals will give up in hard times is a roof over their head. Due to millions of Americans walking away from their mortgage and the inability of many to buy a house apartment demand has skyrocketed. While mortgage rates have been falling, rents have actually begun to rise again in several major cities across the U.S. The housing market will continue to be weak for the next five years, so the long term demand is still there. Even if the economy weakens even further, apartments will do well as most people will take the needed desperate measures to pay rent and avoid homelessness. The leading apartment REITs are Avalonbay Communities (NYSE:AVB), Apartment Investment & Management Company (NYSE:AIV), and Equity Residential (NYSE:EQR).
What kind of solutions are there to this problem? In part two, I propose some solutions to this problem and then what I think is the likely result if things remain unchanged.
Disclosure: I am short SPY.