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State of the Consumer: History 101

One thing I’ve learned at Research Edge is how to be a student of history, and understand how the sins of the past shaped the challenges we face today. The evolution of the wealth effect is classic.

One of the biggest drains on the consumer today is the fact that the personal savings rate is hovering near zero. Yes, we debate academically as to how it is calculated, and how it could technically go below zero (which it has). But let’s look at the big picture here. The chart below says it all.

1. Starting in the Regan/Volcker years and all the way through the end of the Clinton era (when the tech bubble burst), we had a 20-year uber-bull market for equities driven in part by systematic cuts in interest rates to drive consumer spending and keep the economy cranking forward.

2. Once we saw George W. come into office, the equity markets took a pause, but the housing market went parabolic.

3. Put those two together and what do you get?? What I’d consider a 27-year wealth effect. By the way, that’s within 5 years of the average age of a Wall Street analyst. Sad.

4. While this freight train rolled on, the consumer took down the savings rate from the peak of 11.2%, to less than 1% today. As a frame of reference, China’s savings rate is near 40%.

5. Now what? Housing values are deflating, and equity markets do nothing but go down. My sense is that consumers take whatever they can and actually save a bit for once. In fact, it was fascinating to see that the tax rebate checks that hit this summer went almost entirely to beef up savings (the rate temporarily bumped to 2.5%) and repay debt.

As sure as the sun will shine, this savings rate needs to head higher. The order of operation will need to be 1) survive (buy essentials, etc…), 2) pay down debt/save money, 3) buy a $500 cashmere sweater at Saks.