A growing sense of insecurity about jobs, future income, household debt, and falling home values is driving American consumers back to an activity that's rarely been seen over the past 20 years: saving money. The shift is not by choice, but of necessity: Consumers are coming to grips with the realization that easy credit won't be available to pay for cars, homes, or any other big-ticket purchases in the years immediately ahead. Even as more people are saving, can investors find ways to make money off this trend?
It's astonishing to think that, during the past two decades of credit expansion, Americans went from squirreling away more than 7.0% of their aftertax income to less than zero (-0.7%) in the third quarter of 2005, according to the Commerce Dept.'s Bureau of Economic Analysis. That means consumers were not only spending all of their aftertax income but drawing from prior savings or increasing their borrowing to fund their spending. After hitting that low, the personal saving rate remained at 1.0% or below from the fourth quarter of 2004 through the first quarter of 2008, before spiking to 2.6% in the second quarter of 2008 and climbing to 2.9% by the final quarter of the year.
And that may be low compared to what lies ahead. Barry Knapp, U.S. equities portfolio strategist at Barclays Capital (BCS), says the savings rate needs to return to at least 6% over the next few years to ensure investment in future productivity. The combination of a negative wealth shock and tight credit is expected to push the saving rate to 5.6% by the end of 2010, Julia Coronado, a U.S. economics research analyst at Barclays Capital, said in a Feb. 6 report.
A Drag on GDP Growth
The fear is that too quick a rise in the saving rate could push U.S. consumer spending off a cliff. That would not only be disastrous given that consumer spending accounts for more than two-thirds of U.S. gross domestic product, but would also undercut one of the major goals of the nearly $800 billion economic stimulus package the Senate approved on Feb. 10.
Just to return to the 8.5% saving rate, the average rate going back to 1960, suggests that as much as $900 billion in consumption could be pulled out of the U.S. per year, not including the multiplier effects on GDP as the drop in consumption filters through retailers and their suppliers, says Bruce McCain, chief investment strategist at Key Private Bank (KEY) in Cleveland. That would translate to not only a fairly significant contraction during the recession but also an extended period of slower growth once the economy starts to rebound, he adds.
Before the recession, consumption had been growing at an average rate of 3.5% a year, when adjusted for inflation, says Ethan Harris, co-head of U.S. economics research at Barclays Capital. If the saving rate ratchets up quickly during the recession, a realistic scenario for consumption growth over the next five or six years could be around 2%, with spending growth trailing income growth by 1%, he adds. He expects discretionary items to be hit harder than other types of consumption.
However damaging its short-term impact, there are good reasons for wanting the saving rate to climb over the long term, most importantly the fact that more savings means a bigger pool of capital to finance companies' investment in improved productivity and innovation, says Nicholas S. Souleles, a finance professor at the Wharton School. Without a higher level of savings, innovation and increased productivity would stall, leading to wage stagnation and a lower standard of living in the future. Ideally, savings would build up gradually. The last thing you want to see in the middle of a serious recession is for savings to go up all at once, says Souleles.
"If you scare people badly enough, they do begin to change their stripes," says McCain at Key. "We've heard at least anecdotally that a lot of people are rethinking the way they lead their lives."
Breaking Old Habits
Although people could resume their overspending habits once the economy recovers, since so much of that spending was tied to credit, McCain says "we wouldn't think they'll have that option to return to spending, and lenders will be much more careful about who gets the loans and how much they get."
A return to old spending habits also seems unlikely from a psychological perspective. Past academic studies show there tend to be long, drawn-out responses to changes in wealth, says Harris at Barclays.
How should investors respond to the prospect of Americans' rediscovered thrift? McCain's first recommendation for investors is to stay away from any assets leveraged to consumer spending, especially consumer discretionary items such as autos. Many retailers are likely to go under as sales of big-ticket discretionary items struggle over the next few years. Harris predicts some products that enjoyed a boom in demand over the past decade will fall out of favor for a long time. That includes fancy foods such as $5 cups of coffee and consumers' upgrading of electronic gadgets every two years. Heavy spending on housing-related durable goods such as furniture and appliances will also fall off, though not necessarily home improvement outlays, he predicts.
While Jason J. Tyler, director of research operations at Chicago asset management firm Ariel Investments, generally advises steering clear of companies that sell luxury items like high-priced motorcycles, he makes an exception for stocks he calls "aspirational buys," such as Nordstrom (JWN). "Even as people look to improve their [personal] balance sheets, they still want the experience of shopping and buying high-quality goods," he says. Nordstrom's stock price reflects the market's tremendous fear of a complete withdrawal by consumers, which makes Tyler feel "there's a great margin of safety in Nordstrom right now."
Slow Recovery in Financial Services
And even after banks have wiped their balance sheets clean of toxic assets, expect to see a period of slower growth for the financial services sector. The product lines that drove profit margins, such as credit cards and home equity loans, will be constrained or will have to compete for better-quality customers, which augurs an environment of lower margins than in the heyday of consumer lending, says McCain.
The increased desire for savings, along with a presumed return of some stability in the stock market over the next few years, bodes well, however, for investment management firms such as Janus Capital Group (JNS) and T. Rowe Price Group (TROW), says Tyler at Ariel. "Large 401(k) plans will be looking for mutual funds to invest in for their plan participants. Janus is close to half-and-half institutional and retail [clients]," he says.
Discount brokerage Charles Schwab (SCHW) will also be in great demand, particularly among smaller investors seeking access to high-level research without having to pay the high minimums that some top money mangers charge, says McCain.
While domestic stocks are the place to focus until the global recession starts winding down, eventually equities in emerging markets will be a better bet, especially if depressed consumer spending slows GDP growth to the point that it lags growth in economies overseas, McCain says. The sharp drop in investment returns in emerging markets over the past year has soured investors on those countries for the moment, but most people expect India and China to resume their hyper-charged expansion as soon as the global recession has passed.
Look to Emerging Markets
A general savings glut around the world is likely to further fuel the development of emerging markets, says McCain. Exchange-traded funds and mutual funds that provide diversified exposure to those markets will be the best way to play them, while investors wealthy enough to have separately managed accounts could choose individual stocks in those markets.
Tyler at Ariel recommends looking for U.S.-based companies with a solid footing in the domestic economy as well as positive growth potential internationally.
Commodities funds are another way to play the uptrend in savings. The developing world will continue to generate rising demand for commodities. McCain suggests using ETFs such as the iShares S&P GSCI Commodity-Indexed Trust (GSG) and the PowerShares DB Commodity Index Tracking Fund (DBC).
Despite concerns about another downdraft in U.S. equity prices, some strategists still believe stocks offer investors more upside than bonds right now. The odds that the Federal Reserve will keep interest rates low for an extremely long time in order to ensure there's a real recovery coming out of this recession promise very low returns on safe, short-dated assets such as Treasury bills. Longer-dated government bonds are equally unattractive because of the high probability of a rapid return of inflation after the recession ends, warns Tyler.
With U.S. consumers scaling back on lattes and luxury vacations, and fretting about their financial futures, it's likely that they will be keenly interested in the relative merits of all of these types of assets as the Thrifty American returns from a long exile.
Bogoslaw is a reporter for BusinessWeek's Investing channel.