Heading into the new year, the financial media will be making much of the Obama administration’s fiscal stimulus plan, infrastructure rebuilding and other news out of Washington.
But what we really need to be paying attention to is the dawning realization among America’s baby boomers that rising asset prices can no longer support debt-to-income ratios of nearly 140%. As that happens, a 20-year credit expansion and associated consumption binge will come to an end.
Anecdotally, I am already hearing this from my own friends and family members. Every time they get some money from a bonus or investment, in these fearful times it is going to pay off a home equity line of credit, a second-home mortgage or car loan, not to buy something new.
This new frugality, will likely have profound impacts and long-lasting reverberations that will reshape the global economy. Remember that roughly 20% of all the economic activity on Earth is tied to the American consumer, of which the boomers are dominant.
One key result will be deflation, or at least dis-inflation. Although normally benign or even beneficial when it comes through productivity gains and technological advances, recessionary deflation is a completely different beast especially when accompanied by high debt levels.
Despite the Federal Reserve’s best efforts, expect to see more debt repayment, increased savings and asset liquidation as people offset hits to their household balance sheets.
Through the third quarter, households have lost more than $7 trillion in total net worth this year. End-of-year losses will likely exceed $12 trillion. With retirement looming, wages flat, investment accounts down and credit harder to get, consumption will continue to plummet.
The high-end retail sector will be ground zero for the fallout, as the rich join the middle classes for once in feeling the pain of a slump.
Already fancy stores like…
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…Nordstrom (JWN), organic grocery Whole Foods (WFMI) and art auction house Sotheby’s (BID) have been among the hardest hit in the past two years, though they are just starting to lift now. On any sign that the rich can make a comeback, we would love to own these three, so let’s keep a close eye on their progress.
Accompanying these financial realities will be a continued mentality shift away from ostentatious displays of wealth and frivolity towards non-material goods like more time with the family, volunteer work, membership at places of worship and the like.
This is perhaps where one can find silver lining this holiday season. A study of 274 families in San Francisco found that over a 10 year period changes in income didn’t affect reported happiness. We can hope that closer bonds with one’s family and community can help make our society stronger during this time of turmoil.
Focus on Credit
All year we have repeated the mantra that the bear market has been lead by a decline in credit, and it will only end when an appetite for distressed credit returns. So when will investors star to buy speculative credit again in anticipation of better times to come?
Well, consider that equities are entering the new year priced for recession while bonds and loans are priced for depression nearly as deep as the 1930s. It’s hard to tell whether the credit market really thinks the default rate will get that high or there’s simply not enough buyers right now due to the exit of so many hedge funds from the scene as well as the decline in leverage ratios.
I will stick to my guns, though, with the contention that the equity market won’t bounce back until the market for distressed credit — which is by far the majority now — improves. Our play on corporate credit so far has been a lot more conservative: I have recommnended buying the iShares iBoxx Investment Grade Corporate Bond Fund (LQD), which has offered both capital appreciation and a fat 6.5% annual dividend.
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This article was written by Jon Markman, contributor to InvestorPlace Media. For more actionable insights likes this, visit www.InvestorPlace.com.
