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Putting to Rest the Myths About Consumption

Putting to Rest the Myths About Consumption

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Published by benclaremon
It is clearly time to re-evaluate the prudence of having an economy so dependent on consumption. Here are some way in which to profit from what I see as secular trends towards US consumer frugality.
It is clearly time to re-evaluate the prudence of having an economy so dependent on consumption. Here are some way in which to profit from what I see as secular trends towards US consumer frugality.

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Published by: benclaremon on Sep 07, 2009
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08/17/2010

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The Inoculated Investor http://inoculatedinvestor.blogspot.com
Putting to Rest the Myths about Consumption
It’s Labor Day Weekend. What are you doing sitting at home? Go out and spend! There are endless numbers of salesgoing on at your favorite retailers. Forget that your credit card is maxed out, you are late on your utility paymentsand that you are trying to get the bank to reduce the face amount of your mortgage. If you don’t leave the house to buy things and eat fancy dinners there is no way the US is going to recover from this recession. It is your duty as anAmerican to help us spend our way out of the current economic malaise, irrespective of the additional debt you areforced to take on to achieve this universally desirable goal. The idea that people should save their money and livewithin their means only applies to
those
countries over there in Asia. Americans are innovative and resilient. We arenot going to let something as trivial as an excessive amount of debt (that must eventually be paid back) get in theway of living the life we have always dreamed of. Please, take your cues from the US government and borrow andspend more so we can get back on the path towards limitless prosperity. Don’t worry about those who say we cannotconsume our way out of a debt-induced crisis. They are either un-American or are just jealous of our position in theworld.Forgive the hyperbole but this is disturbingly similar to the message being sent to the American public by both thecorporations that rely on consumer spending to reward shareholders and pay huge bonuses and the government thatseems to think that if we can just go back to 2006 everything will be fine. I think the widely popular Cash for Clunkers initiative embodies perfectly the sentiment espoused above. Have a car that is already paid off but think you could use a shiny new ride? The US government can help. In exchange for your old jalopy and a car note thatonly increases your debt burden, the government will subsidize your desire to drive around in style. And guesswhat? A wonderful side effect is that your purchase will help the struggling automakers that the US government nowowns. It’s a win-win for everyone. Well, except for maybe your balance sheet that now is even more strained.It was with all of this in mind that I came acrossa posting on Zero Hedge with commentary from the chief economist at Saxo Bank . An idea that I don’t think gets anywhere near as much attention as it should is the onewhose premise is that the US consumer has basically hit a debt wall.To me, it looks like the consumers have finally hit the wall where there is essentially no pent-up demandleft. After decades of systematic and constant demand stimulation via artificially low interest rates and theemergence of the “demand driven economy” (as if there ever was any such thing!), we have succeeded in borrowing so much from future demand that our present GDP has been overstated by 10-30%. How manyresources have been put to use in order to make American consumers push their excessive debt-financedconsumption to new highs? How many malls, shopping centers, financial intermediaries, debt extensioncompanies and SUV dealers have been set up for which there is no long-term use? And by how much hasthat overstated prior GDP figures, since these types of companies were mal-investments and need to bewritten off?In my eyes, it wasn’t the subprime housing market that caused the crisis; that collapse was just a symptom of theconsumer no longer being able to service his/her debt. In other words, this was a balance sheet and solvency crisisfrom the beginning. Yes, maybe that caused a liquidity freeze but that was also just a symptom. I think whenhistorians look back on this period they will easily conclude that the Anglo Saxon world accumulated so much debtthat one day that burden became unsustainable and caused a necessary but painful unwind of the economy. I alsothink they will look at government initiatives that pulled forward demand and induced irrational spending (such asCash for Clunkers) kind of the way we look at the economists of influence in the 1930s. They will ask without anylack of condescension: “What in the world were they thinking?” Instead of a debt crisis our current leaders saw aliquidity freeze. Instead of encouraging frugality and debt repayment (however painful that would have been in theshort run) they expected people to consume in order to prop up a failed economic system that was far too dependenton frivolous spending.Has it occurred to anyone else but me that we take the fact that 70% of US GDP is based on consumption as if thatnumber were ordained by God? Seriously, that percentage is quoted so much you almost start to believe that it isetched in stone or is the secret code that leads to sustainable prosperity. What if it really means our economy wasincredibly imbalanced? What if it means that Obama’s attempts to make us spend more are actually making thingsmuch worse? No company ever fixed its over-levered balance sheet by engaging in even more debt fueled spending.So, how is that the US consumer is going to achieve this miracle? From the piece by Saxo Bank:
 
The Inoculated Investor http://inoculatedinvestor.blogspot.com
The Keynesians never get tired of telling us that 70% of GDP is consumption. This is obviously amisleading statement as if we can consume ourselves rich.
If we want growth in the Western economies,this percentage has to come down and investment and savings should be higher. This is the only long-termsolution to the extreme difficulties that we are confronted with. Only by growing our capital base will we be able to increase production and growth. It is time we learn from the Chinese or simply look in thehistory books and be inspired from how the economy of our ancestors could grow even though they didn’tconsume 70% of their income immediately. (Emphasis mine)The future economy of the Western countries will be investment-driven if driven at all. Unfortunately, italso means that the companies that are most dependent on consumption will be underperforming in theyears to come. Demand is permanently impaired and will not come back to 2007 levels soon.What this implies is that the underlying demand for consumption that existed during the boom years may be reducedor limited for a long time as people repair their balance sheets. As I continue to stress, the US has an incredibleamount of excess capacity of businesses that depend on an unsustainable amount of spending. We built too manymalls, too many restaurants, too many drug stores, and made the conscious decision that convenience trumpedeconomic realities. Why else would there be a drug store, bank, nail shop, and convenience store on every singlemajor intersection of every city and town in the US? These amenities were built to cater to peak demand (that maynever be revisited) and were based on the idea that supply and demand did not matter because the consumer wasalways willing to spend for proximity and convenience. Now these ideas are being turned on their heads as peopleare forced to spend less, eat at home more often, eliminate discretionary purchases and go out of their way to savemoney. This is a particularly toxic combination of incentives from the perspective of those companies that relied ona complete lack of fiscal restraint in order to prosper.Based on all of this, what can we conclude about the potential impact on stocks of this excess capacity and reducedconsumption? Well, it can’t be good for restaurants that need people to eat out as opposed to cooking at home or for retailers that offer goods whose purchase can be foregone without much of a detriment to an individual’s lifestyle.Powershares Dynamic Leisure and Entertainment (PEJ) is an ETF that holds stocks such as Carnival Corp (CCL),Darden Restaurants (DRI), Cheesecake Factory (CAKE) and Starbucks (SBUX). From a low of $6.15 in November 2008 this ETF has just about doubled and trades around $12. Call me naïve, but based on the evidence of anincreasing and perhaps prolonged consumer retrenchment, the recent appreciation of this stock seems a bit out of line with the fundamental realities. Or how about Powershares Dynamic Consumer Discretionary (PEZ)? Betting oncompanies such as Ralph Lauren (RL), Bed Bath and Beyond (BBBY) and Gap (GPS), this ETF has rallied from alow of $11.79 in March and now trades at more than $18. This is despite the fact that retail sales numbers continueto be absolutely terrible and the number of analysts voicing concerns about the upcoming holiday shopping season isa bit startling.Therefore, for investors looking to profit from the consumer being increasingly tapped out, there are a number of options. Here are a few that make sense but of course involve the risk of the thesis being wrong or for the market toremain exuberant and disconnected from the fundamentals for longer than anticipated. Keep in mind these are justsome suggestions presented in order to stimulate further thought.
1.
SZK is the Proshares Ultra Short Consumer goods inverse ETF. It is levered in that it seeks “dailyinvestment results, before fees and expenses, which correspond to twice the inverse of the daily performance of the Dow Jones U.S. Consumer Goods index.
The problems with levered ETFs are welldocumented so beware of the possibility that the returns will not track twice the inverse of the index over longer periods of time. Having said that, from a high of over $125 in November 2008 the stock is tradingnot much above its 52 week low of $51. This ETF has been a casualty of the recovery trade and if an whenthe recovery peters out, this one could explode to the upside.
2.
For investors who are inclined to short individual stocks, I would look for companies that offer productsthat are very discretionary in that cash-strapped and over-levered people can live easily without their goods.Specifically, a company such as Pool Corp (POOL) that has more than doubled off of its 52 week low could be compelling on the short side. I know the company derives a good deal of revenue from sales of poolmaintenance supplies but it is easy to imagine homeowners and builders not installing many new pools for years to come and cutting back on maintenance expenses. Or what about ATV and snowmobile supplier 

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