Tuesday, October 21, 2008

Cross-Talk: Deleveraging the Consumer and the New Realities of a Pay-As-You-Go World

Margie and I were flipping through channels and happened to stop on financial guru Suze Orman making the case that we're now living in a pay-as-you-go society. Her point was that credit of all sorts--from credit cards to student, mortgage, and car loans--was going to be more difficult to come by and thus more expensive. In a world of constrained lending, we go from a credit card mentality to a debit card mind set. We pay out of money that we already have, not out of money that we can borrow.

At a broader level, this means that the deleveraging we've been seeing at banks is filtering down to the public. As Mish observes, this greatly affects consumer outlooks: it's no longer about keeping up with the Joneses. Rather, frugality becomes the operative priority. When employment, housing values, stock values, and bond values are contracting, the incentive is huge to hang on to what you've got. You certainly don't dig a hole for yourself by going into debt. Pay-as-you-go is the prudent alternative.

There have been many comparisons of the current market/economic period with the 1930s and the Great Depression. Most of those comparisons, understandably, focus on how bad market and economic conditions could get. A better comparison, however, would be the ways in which financial crises affect societal attitudes for an entire generation. From the Roaring 20s to the Depression 30s, we saw a dramatic shift in attitudes about saving, investment, and risk. My grandfather, who lost his fortune in the that crisis, never went back to investing in stocks and bonds. He became a frugal saver, who kept many different bank accounts lest there be problems at any one institution.

That is the way of psychological trauma: a single set of painful, powerful emotional events can reshape perception and action. As the deleveraging of the consumer unfolds, I believe we'll see a similar reshaping of views: fiscal prudence will become a mantra for households--and eventually will be expected of government. Not all of that will be for the worst. In the interim, however, that deleveraging--and the accompanying shift in attitudes--will create winners and losers on Wall St. Companies that produce necessities and that create unique value will prosper over those that connote luxury; firms that are well-capitalized and generate significant free cash flow will have the advantage over those that depend upon borrowing--their own, and that of consumers.

I was looking yesterday at companies in my basket of stocks that were making fresh 10-day closing highs. They included MRK, PFE, T, VZ, MO, and JNJ. All make products that, rightly or wrongly, are perceived as necessities--or at least affordable (and indispensable) luxuries. At the end of this month, we'll spend a little extra to get our kids the cell phones they want. We may very well, however, scale back our plans to buy them cars or travel abroad. As the recession unfolds, the companies that make the things you'll buy in a pay-as-you-go world may be the best place to look for market outperformers.


JB said...

Brett, good points about consumption.

I wanted to add that it has never actually been about the "resilience of the retail consumer" so much as it has been about their access to increasing quantities of credit. As long as credit was made available to them, they spent it. It took credit going away to end the consumption spree.

My guess is if credit card offers were suddenly to reappear in mailboxes, consumption would return, and fast.

I distinctly recall our own government encouraging us to save back in the 1980s, like the Japanese, yet its own policies on such matters largely aimed in the other direction... knowing that it was consumption holding things together and boosting GDP.

When too much credit was extended, and for too many un-creditworthy people, I suppose the outcome was inevitable.

I'll believe that consumption/savings patterns have changed when credit is extended yet again and refused. Not likely, in my opinion, but time will tell.


Joshua said...

Yep, I wonder if we'll start seeing longer skirts in fashion as well. :)

Another mass psychology idea to consider is the political ramifications; how people experiencing economic hard times succumb more easily to non-ideal ideologies. For example, Germany and its nationalistic furor and scapegoating of Jews (achieved more easily after economic collapse). I certainly don't think such extremes would be reached here, but I wouldn't be surprised if the "foreigners stealing our jobs" argument became a more rallying political cry. Maybe we'll see more protectionist trade policy around the globe. Not to mention that I don't even like to think about how difficult it will be to avoid war over scarce resources in the coming generations. Even a new type of cold war would be wasteful of resources and potentially add to a "downward spiral".

Unfortunately, on average, politicians make decisions largely based on what will keep them in power for the short-term. And we face long-term problems, many of which may require politically unpopular solutions.

It seems irrational to have hope or be optimistic, but somehow I still am.