The rebirth of the American consumer
Households set to restore net worth by owning more, not owing less
Don't look now, but a nation of shoppers is about to be reborn.
Thanks to rising stock prices, stabilizing home values, increased savings, improved confidence in the economy, and reduced debt, there is building evidence that the quintessentially American capacity for consumption is returning. The key has been a recovery in net worth and more manageable debt burdens.
According to Deutsche Bank economists, from a low in the first quarter, households are already halfway down the road to rebuilding net worth to the 20-year average of 533% of income. Also, thanks to ultra-low interest rates, debt service ratios are quickly returning to more normal levels even as total debt levels remain elevated. This helps spending since people focus on monthly payments, not the total balance outstanding.
It's worth noting that the stock market is already pricing in a more optimistic outlook in this area. Retailers and other consumer discretionary stocks have been on fire: Specialty outlet Lululemon (LULU) is up some 470% from its March low while big-toy manufacturer Polaris (PII) is up more than 200%. The Consumer Discretionary SPDR (XLY), meanwhile, has returned to levels last seen in the summer of 2008.
The big question is how consumers will respond now that their financial situation is somewhat improved.
With 70% of the U.S. economy dependent on the consumer, much depends on the savings rate -- which current stands at about 4%. Deutsche Bank built a savings model that factors in things like net worth, credit card interest rates, consumer sentiment, and the unemployment rate. They predict the savings rate to increase to 6% over the next several years.
So what are the implications? Bank of America - Merill Lynch economists believe that such a moderate rise in the savings rate could complete the healing of household balance sheet. And the drag on the economy would be relatively modest, with consumption growth falling by 0.25% to 0.75%.
Under this scenario, debt levels would remain elevated as new savings are used to buy high-yielding assets to boost wealth instead of paying down debt. You've gotta love this solution. Better to own more than owe less. Especially since the vast majority of consumer debt is tied to real estate and early repayment of mortgage debt isn't as popular as taking a flyer on a hot stock idea.
If this is true, than the biggest beneficiaries of the return of the consumer could be asset managers like SEI Investments (SEIC) and Blackrock (BLK) instead of luxury retailers like Coach (COH) and Tiffany (TIF).
Disclosure: The author does not own or control a position in any of the funds or companies mentioned.
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