Investors May Be Too Optimistic About Consumer Recovery

The most accurate banking analyst, Meredith Whitney, has warned that banks are likely to continue to restrict consumer credit, particularly if reforms to end “gotcha” practices, like universal default and double-cycle billing, are implemented. Credit card issuers shifted their model away from one where they earned a reasonable return from all types of customers – sporadic users, active but “pay in full” types, the somewhat in debt and the chronically indebted. Indeed, in the stone ages of the 1980s, banks were really not too keen on having permanent balance carriers as customers. But lower interest rates (meaning much higher spreads on deadbeats), more aggressive fees, and more favorable bankruptcy laws made the not-quite-a-deadbeat their very best customer. With their fees from this group curtailed, banks are likely to cut credit to risky borrowers even beyond what they would have done in a risk-averse environment.

Separately, many economists foresee either an L shaped recession or an anemic recovery.

This Reuters piece suggests that stock investors may be discounting a stronger recovery than is in the cards:

Consumer consumption, long an engine of the U.S. economy, is poised to contract the most since World War Two and may impede a fast recovery that many equity investors are counting on.

U.S. stocks have rallied about 17 percent since sliding to 11-year lows in late November on the belief the worst of the deepest post-war bear market on record may be over.

But unlike every recession since the Depression, a boost in consumer spending — primed by a lowering of interest rates — will not lead to a sharp recovery, several investors at this week’s Reuters Investment Outlook Summit 2009 said.

After a buying binge that pushed consumer spending to five times the rate of economic growth for this decade, the American consumer is tapped out and needs to shore up finances.

“I don’t see fast growth in the United States for several years,” said John Taylor, chairman and chief investment officer of hedge fund FX Concepts Inc, which oversees $14 billion in assets.

“People need to get their personal finances back in order,” he said….

Morgan Stanley estimates the slowdown in real consumption will be a negative 1.6 percent in the 12 months ended June 30, 2009, a post-World War Two record. World growth, at 1.7 percent, will be the weakest rate since 1991, the bank said.

Growth in consumer spending over the next several years will be about 1 to 1 1/2 percentage points less than the 3.5 percent clip during the decade ending 2007, it said.

That slowdown could lead to a slow and long recovery, and change the outlook for capital markets in the years to come, especially retail and other consumer-oriented securities.

Investors do not appreciate yet how long the downturn in the U.S. retail industry may last, said Shawn Kravetz, president of Boston-based hedge fund Esplanade Capital LLC.

“We don’t think that people have fully factored in this general level of malignancy going on for a year, 18 months, maybe two years,” he said at the summit.

The consumer recession will be so “deep and brutal” the U.S. retail industry could lose one out of every 10 stores in coming years, Kravetz said.

Consumers, businesses and investors all are rushing to reduce risk amid a broad deleveraging, said Mohamed El-Erian, co-chief of fixed-income powerhouse Pacific Investment Management Co in Newport Beach, California.

Investors pushing a rally in equity markets after stocks slumped in November to lows last seen in 1997 may be too optimistic as more bottoms are likely, El-Erian said.

“It puzzles me that people feel confident to declare the bottom,” said El-Erian…

“What we’re looking at is a very bumpy journey that will continue well into 2009. We’re looking at multiple bottoms.”…

As a percentage of GDP, private debt has soared to close to 250 percent last year from about 10 percent in 1952, according to Ned Davis Research.

After paying food, energy, debt service, health care and taxes, the American consumer has little left, Atteberry said.

“This person is starting to get very, very stressed, and their ability to pay off is virtually impossible,” he said.

“There are only two ways to repair the balance sheet; sell the asset and pay down the debt, or you’re going to spend less than you earn. There is no third choice,” Atteberry said.

“We see this recession lasting into 2010.”

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  1. Anonymous

    I know that this is going to sound stupid but I need to get my wife to read and believe this. She keeps saying things like yesterday when it was “Conventional wisdom says that the market disregards bad news when it is at or near the bottom”.

    I love her dearly and want a relationship with a strong willed woman but…..

  2. Anonymous

    Actually your wife has it backwards… the market was disregarding bad news when it was near the top.

  3. Charles Frith

    Both of you are wrong. The market is excessively gloomy at the top, and excessivly confident at the top.

    The market chooses the news that supports the view of it’s current state of affairs. People don’t like change and yet is the only constant.

    Markets are also remarkably stupid. Like some married couples.

  4. Anonymous

    much higher spreads on deadbeats

    Is that “deadbeats” in the normal sense, or the CC-insider sense? (Credit card companies openly use the term internally to describe “pay in full” users.)

  5. eh

    Actually I would more say that if consumer spending depends on credit that it’s more a sign of unsustainability than recovery.

  6. River

    The psychological state of the consumer has been overlooked by all that are implementing the abc plans to keep the credit markets open.

    Consumers are frightened and with good cause. The longer this recession continues the more frightened the consumer becomes. I believe that one of the major reasons that the great depression lasted so long was the drawn out attempts to revive consumer spending instead of letting inefficient institutions fail quickly. I think that the same is happening now.

    The view that the psychological state of the consumer can be manipulated easily falls to those with large egos. They believe that their knowledge is great and that by manipulating a few levers the consumer will, like some automaton, begin acting in a fashion three years prior.

    The consumer is being underestimated. The shopper knows that moral, if not legal, wrongs have been committed and they know that the same people that committed the crimes have not been punished or relieved of their positions, but are managing the bail out attempt.

    Many former consumers are voting with their wallets…and they are just saying no…even if they are not fully aware that they are doing so.

  7. killben

    I would agree .. that this is going to be a longer and different recession from the ones after the Great Depression … one because consumers have become or trying to be frugal and two the repricing of asset is going to make the consumer feel poorer and further curtail spending.

    that is why trying to drive consumption is leading nowhere … you have wait for it to hit the bottom …. bankruptcies, job lossses, home prices bottom etc…

  8. nanute

    Bankruptcy reform: the law of unintended consequences. All the corporations will be able to get a fresh start thru bankruptcy. The poor individual consumer; no such luck.

  9. Anonymous

    I feel that the pain is much greater than most people expect. This crisis is huge and has many compounding problems that make it difficult to see any way out. This is probably the event that equalizes the world in terms of wages and standard of living. America can no longer just keep borrowing and outsourcing to maintain a higher standard of living than everyone else. We need to suck it up, foreclose, file for bankruptcy, work for less and start building stuff again.

    Mark ROwell

  10. fresno dan

    Consumers will spend less because…wait for it…they have less money. In Montgomery county Maryland you can look up real estate transactions on the innertubes:

    Two years ago a house on my row of townhouses went for 350,000K, which was incredible. Now, the townhouse next to me went for 175,000K – no more HELOC, no more spending

  11. ruetheday

    There are WAY too many people looking for clues into what will happen next by looking at the 2001 or 1990-91 recessions. This one will not be anything at all like either of those. Unemployment and lost output will be more similar to 1973-75 and 1980-82, but the similarities end there as those were inflationary recessions. I honestly don’t know what to expect. Judging by the behavior of the authorities, the similarities to 1990’s Japan are most striking, but even so, there are significant differences (savings rate, trade balance, institutions/culture).


    Man, I was feeling fine until I read the article and all these comments! Good thing my office is on the first floor(for Europeans that’s the ground floor, just kidding). Nobody seems to agree what will happen next year, if it will be Armageddon or just a severe recession. I’m depressed!

  13. lineup32

    If the current high level layoffs keep occuring then the two income family is in trouble and it woun’t take long for the banking idustry to reprice credit risk for sectors getting hit. The idea that the American consumer can forge ahead and maintain high levels of durable good consumption keeping Germany,china,South Korea and Japan in the black while pushing up GDP at home is a joke.. a bad joke

  14. River

    Somewhat off topic:

    I am certainly glad that the developed nations of the world are going to cooperate to solve the cross border financial debacle. If this isn’t a trade war, what would one look like? Does this mean the ‘strong dollar policy’ is dead. :)

    ‘China to Print Money to Combat Slowdown’

    ‘China will increase its money supply by 17 percent next year, the Cabinet said in a statement on its Web site. It said that would be 3 to 4 percentage points above the total growth of economic output and consumer prices.’

    ‘Beggar Thy Neighbor tactics are a hallmark of deflationary times. When and how this madness ends no one knows.’

    Thanks to Mish…

  15. River

    Hi Lineup32. It looks as if China is gearing up to sell stuff cheaper than ever. Even if we are all unemployed maybe we can still get plastic Chinese crap for a buck at the Dollar Store.

    This is going to get crazy. Every producing country is racing to get their currency to the bottom first. Maybe prices on imports will go negative and stores will pay consumers to take it home? Send in the cupon from the carton and the producer will send a check in the mail? :)

    Aint globalization great?

  16. Anonymous

    Man, it took these economist a year to finally admit an L shaped recession. I remember last time this year people are talking about a V, then a W, then a U, and finally we got the L. Frankly I think most investors know their shit better than the economists.

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