<<Americans, bless them all, do not have a clue about how dependent we are on foreigners giving us their money in exchange for ours. We incur astronomical debts each year, called the current account deficit, and it is financed by foreign borrowing and by foreigners investing in our stocks.>>
yup, and our bonds.
<<Can't happen? Don't bet on it. >>
beleive me i'm not!
Now excuse me while I go write a check to pay off this month's credit card charges in full as I always do!
Victor
What happens when the spending stops
The economy has a plastic tiger by the tail: credit-card debt
that’s far above historic levels. Spending has to shrink —
but for the market’s recovery to work, we’ve got to keep on charging.
By Jon D. Markman
If we look back a year from now at July 2001 and wonder why the stock
market hasn’t budged an inch since, we will probably blame what could come
to be called the “plastic bubble.”
This is a condition created by the average consumer’s staggering credit-card
debt -- an I.O.U. to the likes of Visa and MasterCard that has reached a
historically unprecedented level. From 1968 to 1986, consumer “installment
debt” interest payments as a percentage of disposable income never moved
above 2.8%, and it averaged around 2.4%. But in 1995, this ratio of take-home
pay to short-term interest payments began what one prominent economist
calls a “moonshot” -- hitting 3.2% in May 2001.
While the difference between 2.4% and 3.2% may not sound like very much,
to veteran observers this elevated level of indebtedness is as extreme as last
year’s tech-stock valuation bubble. And, the experts say, it must inevitably
reverse, as it always has.
Will stocks fall with it? The record is not encouraging.
In mid-1987, the time of one big reversal in this metric, debt as a percentage
of disposable income peaked at 2.8%, then fell to 2.4% by mid-1989. Over the
same period, the S&P 500 Index ($INX) advanced at just a 5% annual pace.
During the next big reversal, from mid-1991 (at the end of the last recession)
to mid-1994, the broad market rose just 18%, a mere 5% per year.
Time to pay the piper
Karina Mayer, an economist at ISI Group in New York, says that historically
consumer installment debt has never risen to excessive levels without
encountering “retribution.” She’s not talking about anything as scary as a
market crash. But because consumer spending accounts for two-thirds of the
U.S. economy, it’s hard for her to imagine any wildly positive scenarios for the
economy if folks start leaving home without their cards. ISI notes that by last
summer, real consumer spending had averaged 5% growth annually for three
years, a pace it had reached just three times before. After those previous
peaks, ISI reports, real consumer spending growth fell to 2% or less, on
average, for three years.
“Given that there’s cyclicality to debt, we are very cautious,” Mayer says. “It’s
bound to roll over and come down, and that may halt or stall a sharp recovery
in the economy. People may decide to pay down debt and boost their
liquidity.” Likewise, Princeton economics professor and former Fed official
Alan Blinder told The New York Times on Sunday that he’s “worried about the
consumer,” adding: “"It wouldn't take much downward movement in consumer
spending to cause a recession."
Mayer and most other economists are puzzled, to be sure, by surveys that
suggest consumers are still confident about the economy, given that U.S.
households’ net worth last month recorded its first year-over-year decline
since 1945. How can people feel positive about the future, economists
wonder, amid the continuing drumbeat of corporate layoffs and the raw fact
that U.S. manufacturing employment has fallen to 17.8 million, a level not
seen since 1965?
Mayer blames the disconnect between reality and public perception in part on
the media, which she contends has failed to report accurately on the troubles
in the real economy. Personally I think that overstretched consumers are
simply in denial -- and are continuing to charge and spend recklessly longer
than in the past by force of habit. Also, it sort of makes sense that layoff
victims might use their credit cards to buy stuff while they’re looking for work.
Before you start accusing me of practicing pop psychology without a license,
let me remind you why it is important for every investor to think about this.
The market rebound of the past three months is predicated on the hope that
the Fed’s monetary stimulus and Congress’ fiscal stimulus will boost the
economy by year-end. Thus the economic health of our nation depends on the
untested concept that consumers will actually intensify their record pace of
borrowing and buy more big-ticket items like homes and cars.
It just might work; never underestimate the government’s ability to print
money. And consider that the few technology-sector stocks that our new
StockScouter rating system likes for the next six months (see table) are all in
the credit and bank transaction field.
But if the consumer backs off, watch out below.
StockScouter: Top-rated tech stocks
Name
Rating
Price
Fiserv (FISV, news, msgs)
10
60.69
Concord EFS (CEFT, news, msgs)
10
59.85
InterCept Group (ICPT, news, msgs)
10
35.13
SunGard Data Systems (SDS, news, msgs)
10
32.00
First Data (FDC, news, msgs)
10
70.44
*ratings and prices as of 7/17/01
Flushing the system of excess
For a ground-floor point of view on this issue, I turned to Randy Yoakum, chief
investment officer at the WM Group of Funds in Seattle. In an interview on
Friday, the manager of $10 billion said he fears that the decline in individuals’
net worth combined with the growth of consumer debt has created a toxic
cocktail that could lead the economy “to get much sicker than people think”
and result in a “prolonged downturn.”
That doesn’t make him glum, however. Yoakum contends that there’s “nothing
wrong with a recession” because it’s a natural process that cleanses the
economic system of excess. Over the past five years, he says companies
and individuals made irrational investments as long as money was essentially
free. A recession, he says, “levels the playing field” and ultimately will lead to
more productive investments that will benefit everyone.
Bottom line: A prolonged trading range in the major market averages will “buy
time” while the poisonous effects of that easy-money hangover works its way
out of the system. He thinks that the market is likely to end 2001 just about
where it is right now, give or take 10%, and not stage a lasting recovery until
2002. If you want to bet alongside Yoakum, check out his market-beating WM
Growth Fund of the Northwest (CMNWX), which is up 18% year to date. |
