Consumers to Rescue Wall Street?

Adam Hamilton    April 6, 2001    3986 Words


As the awesome equity carnage of 2001 continues virtually unabated, Wall Street is bleeding.  All the major US indices… the S&P 500, the DJIA, and the NASDAQ have just finished barely limping through abysmal first quarters.  The implications of the first three months of 2001 for the future of the US equity markets will be vast over the near and mid-term.


The Wall Street professionals, of course, realize the dire peril they are in.  They have circled their wagons and dug in.  The slowing economy and disappointing earnings performances of companies on a myriad of different fronts are raining down torrents of flaming arrows on Wall Street.  Some days the incoming arrows are so thick that one can’t even see the menacing skies from the circled wagons of Wall Street.  The situation continues to deteriorate, with little hope in sight.


While the Wall Street insiders realize how precarious their position is, most everyday investors do not yet discern it.  The Wall Streeters know that their good fortune is based almost exclusively on faith.  For over a decade, they have been hammering their creed into the US investor.  They have claimed, over and over and over again, that short-term market movements do not matter and that simply by investing for the long haul everyone can retire multi-millionaires.  They have made it sound so easy to beat the markets that most investors have chosen to believe their carefully presented and well-articulated perpetually bullish case.  The Wall Street crowd fully realizes that if ANYTHING damages the popular perception that equities are a prudent and relatively safe place to park capital for decades, their livelihoods are at stake.  Wall Street only rakes in a king’s ransom when average Americans continue to send checks every month to their brokers, regardless of market action.


It has been really interesting watching interviews on TV with Wall Street Insiders in recent weeks.  MANY of them are very nervous, and they can’t seem to suppress their nervous looks, mannerisms, and speech anomalies in order to appear reassuring and positive.  It is especially enlightening to observe the same analysts and Wall Street cheerleaders that became so prominent during the NASDAQ bubble last year.  Today, there are more lines of worry etched in their faces, their involuntary facial expressions belie their statements that all is well, and many have developed a really distracting habit of looking away from the camera every 20 or 30 seconds.  Are they being coached?


Ever since last March, the propaganda brigade of Wall Street (“public relations” in more polite circles), the folks who appear on television to tout stocks and assure us that all is well, have not changed the thrust of their message one iota.  “Buy for the long haul.”  “The bottom is near.”  “If you sell you will regret it.”  “The economy is great.”  Yada yada yada.


Although the public cheerleaders’ message has always been mega-positive and ever-bullish on stocks, its primary pillar, or the cornerstone of the so-called “new-economy logic”, has changed dramatically since last March.  Early after the NASDAQ crash, the bullish propaganda brigades were confidently telling us that the awesome action was “merely a correction”.  They assured us that the NASDAQ would soon bounce back.  Were they right?  All one needs is a stock chart to determine the truthfulness of their words.  Result… dead wrong!


After they botched their “correction” stage prognostications, the party-line changed dramatically.  Like a school of fish spotting a hungry killer whale, the public Wall Street cheerleaders all seemed to change direction at the same instant.  After it was evident to even the market naive that more than a simple correction was underway, the next foundation for the bullish message was “park your money in the big name, large cap technology stocks.”  “They are fantastic companies with awesome prospects and they will be safe.”  Really?  Result… dead wrong!  Looking at any large-cap tech darling’s chart since last July shows the utter fallacy of this bullish assertion.  Case in point is the bubble king Cisco Systems.  CSCO was loved and touted by almost EVERY mainstream analyst from its highs near $80 in March, when it was the biggest company in the world in terms of market capitalization, down to its current levels around $15.  Another bit of Wall Street propaganda designed to influence people to stay in the US equity markets is shattered.


After the mega-cap tech stock scam, the Wall Street PR front-line went to the “fall rally” party line.  They claimed that stocks always rallied in autumn, and especially into Christmas.  The folks paraded on bubblevision to seduce the ever more nervous masses even came armed with … shudder … statistics this time!  They made bold assertions such as “in 95% of past years, the markets rally in the holidays”.  They said that if only investors had faith and “waited for the inevitable fall rally” all would be well.  Result… dead wrong!  The DJIA held its own, but the NASDAQ continued to sink like a millstone trying to tread water in a fierce ocean storm.


Then, just as the Wall Street cheerleaders were nearing despair and running out of cunningly devised fables to keep the masses from protecting the remnants of their hard-earned capital, Alan Greenspan and the US Fed threw them a juicy bone.  In December, the Fed changed its bias from a tightening to a loosening interest rate mode.  The tech-bulls and Wall Street propaganda departments were ecstatic, and danced in the streets.  A couple weeks later, before the New Year’s hangovers had even wore off for the majority of investors, the US Fed slashed interest rates inter-meeting.  This emergency rate cut was hugely uncharacteristic of the careful, plodding management of Alan Greenspan, and many savvy analysts from around the world read the message as wholesale panic by the US Fed.


Nevertheless, the Wall Street PR legions flooded into television shows and proudly proclaimed that stocks ALWAYS rise when interest rates are being cut.  They assured the average American investor that “the bottom is here” and “interest rate cuts mean a mega-rally in the stock market is coming”.  Result of this prognostication?  Dead wrong.  Once again, the markets continued to fall, and even the venerable Dow shattered its old trading range, plummeting to the downside in a loosening interest rate environment.  Trillions of MORE dollars of scarce capital was vaporized as the Wall Street propaganda machine continued to convince the average investor to stay in the markets, tickling their ears and filling them with false hope.


After the rate cuts proved fruitless and unable to stop the slide, the next new Wall Street propaganda coup was the idea that “the economy will be excellent in the second half of 2001”.  The Wall Streeters, finally able to begrudgingly admit that last year witnessed a huge equity bubble, trillions of dollars after the fact, now looked straight into the cameras and assured the frightened investing masses that we were observing a “normal inventory correction in the business cycle”.  Will they be right about a miraculous recovery in the latter half of 2001?  With the publicly paraded Wall Street PR folk’s record the past year, we certainly would not bet on it!


As the increasingly jaded investment community began to realize that the Wall Street propaganda people paraded on TV are paid only to promote stocks, just like a used car salesman, and had no financial incentive to be objective and honest, they started to question the prophesied recovery in the second half of 2001.  As the professional Wall Street PR battalions were driven back by the unyielding tides of fundamental economic reality, they found they had to buttress their “recovery second half” philosophy to withstand the onslaughts of the obvious.


The latest bit of “logic” designed to keep investors fully invested and persuade them NEVER, EVER to sell a stock was carefully grafted onto the “recovery 2001” hypothesis.  Today, if you turn on bubblevision, the commonly shared propaganda mantra designed to calm the nervous legions of normal investors is “consumer spending will lift the economy into recovery.”  “The US consumer is strong and robust, and will spend money to help US companies profit and grow their earnings.”  “As the consumer spends, the stock market will rally and everyone will live happily ever after.”


As this latest fable brings us to the bleeding edge of the latest Wall Street propaganda blitz, we will briefly investigate the hypothesis in this essay.  Can the US consumer be relied upon to spend, spend, spend later this year to save the financial world?  Even if consumers want to spend, can they?  Will Wall Street FINALLY be right this time, for the first time in well over a year?


As everyone is forced to confront at some point in their personal financial lives, there are immutable financial truths, rock-solid and time-tested, that have aided in wealth creation for millennia.  No matter how much our world changes, how fast new technology evolves, and how sophisticated the financial markets become, the road to wealth is paved by the exact same principles that enabled ancient Babylonians, Greeks, and Romans to increase their personal fortunes.


The single most important factor for increasing wealth, bar none, is the simple concept of saving.  If anyone in the world wants to improve their lot in life and develop a capital reserve sufficient to invest or speculate with, there is only one way to do it.  The person MUST live beneath their means, they MUST spend less money than they are earning in income.  Period.


Saving is the very first, and most important, step toward financial freedom.  Once an ancient Roman made or a modern American makes the difficult step of cutting out the fat and spending less than they earn, a whole new world of financial possibility begins to slowly open up before them.  Even psychologically, saving has HUGE benefits.  Once a person realizes they have the discipline necessary to live on less than they thought and save the rest, their financial confidence begins to grow exponentially.


As savings slowly accumulate, the next prudent step is to pay off ALL personal debt.  If saving is the way to grow wealth, the mortal enemy of wealth is debt.  Debt destroys wealth.  Debt is robbing from the future to finance personal expenditures in the present.  Debt GUARANTEES a lower standing of living in the future, while saving guarantees a higher standard of living down the road.  Debt is the quickest way to the poorhouse, as interest payments that seem benign at first can quickly become crushing as a person becomes addicted and accumulates more and more debt.  Debt is the financial equivalent of crack-cocaine.


The legendary US consumers, now touted by Wall Street as being the saviors of the US economy and US equity markets in the coming months, can only spend money if they have it.  Corporations cannot have good profit growth unless consumers are willing to buy their wares.  The hopes and dreams of the Wall Street perma-bulls are saddled on the backs of the US consumers. 


There are basically two ways to finance the essential huge increase in consumer spending necessary to save corporate profits and therefore the US markets.  Consumer spending can either come from savings or be financed by fresh debt.  We will begin by looking at consumer savings.


Financing spending from savings, of course, is the only prudent way to spend money.  If US consumers have been frugal and saved money in the past, then they have the means and the financial “right” to buy whatever they want with their savings in the second half of 2001.   If they have vast savings, they could indeed be a powerful force to help the economy in the near future.  The trillion dollar question becomes…  Do the US consumers, in aggregate, have the savings to spend their way out of the current economic malaise that is setting in?


Our first graph, quite frankly, is terrifying.  It shows the US personal savings rate over the last decade…



Ominously, the US personal savings rate is NEGATIVE.  Rather than just saving a little or simply stopping saving, American consumers in the aggregate broke their piggy banks and are in the process of emptying out every last penny.  The decay of the US savings rate, represented by the solid red line, is mind-boggling.  The linear trend line of the data series, also a steep decline, is shown by the dotted black line.


In the early 1990s, the US savings rate was a fairly healthy and respectable 8%-9%.  Beginning in the Clinton years, and in the great bull market of the 1990s, a quiet and almost imperceptible shift in the saving patterns of Americans began to become evident.  As the US equity markets ramped higher and higher, US consumers became seduced by the allure of “money for nothing”.  “Why save,” they reasoned, “when we can put our money in the markets in earn 20%, 40%, even 60% per year?”  American consumers bit the carefully dangled Wall Street hook.


From 1995 to the Asian financial crisis and the Long Term Capital Management debacle of 1998, consumer saving seemed to have stabilized around 5%.  As soon as the turbulence of 1998 had passed, however, and the Wall Street propaganda machine ensured hard-working Americans that “the getting is good” in equity-land, and they should “save” money in the stock markets instead of the banks, US savings fell off a steep cliff.  They have not recovered since and continue to plummet.


The next graph further illuminates the dire savings situation for the ever-hyped US consumer in the aggregate.  The yellow line represents the growth rate of disposable income and the blue line the growth rate of consumer spending.  Green shaded areas of the graph represent rare times when consumer income grew at a faster growth rate than consumer spending.  Red shaded areas help explain the prior graph, as they represent periods of time when consumer spending grew at a higher rate than consumer income…



Once again, it is quite obvious that consumers have been living well beyond their means in the United States for a long time.  Unfortunately, in the US we are one of the most materialistic and vanity-driven cultures in the world.  We tend to think appearance is more important than reality.  Many US consumers believe it is important to have the biggest house, drive the coolest cars, and generally portray an image of wealth and status.  Even if they can’t afford these perks, many consumers in the United States are willing to mortgage their entire future, spending far more than they earn, in the hopes that happiness can be attained through having the right status symbols.  It is truly sad.  Our grandparents who lived through the great depression would shake their heads in disgust at the plain FOOLISH way the average American consumer perpetually mismanages their personal finances.  The surest way to financial ruin is continuing to spend more than one earns!


Armed with these graphs, it is readily apparent that if consumers are to lead the cavalry charge to rescue the US economy and stock markets in the coming months that they are NOT likely to be able to finance their spending largesse through savings.  That leaves the mortal enemy of personal wealth creation, debt.


Consumer debt is at record levels.  We all are bombarded with credit card offers virtually everyday.  Statistics show mortgages are growing dramatically.  Many particularly adventurous consumer speculators even took out additional home equity loans to buy stocks before the US markets begin imploding last March.  By all accounts consumer debt, whether mortgages, car loans, home equity loans, or plain usurious crushing-interest credit cards, has exploded.  Virtually every week some measure of consumer debt reaches dizzying new heights.  Consumer debt now equals a record 71% of the United States Gross Domestic Product and another record 85% of personal income.  Ouch!  The growth in consumer debt is frightening to the financially prudent and is certainly unsustainable in light of historical precedent. 


The US consumer continues to approach the point of debt saturation.  Debt saturation is reached when a family can no longer afford any more monthly payments.  They reach the point where even an extra $100 per month in debt service would be the proverbial piece of straw that breaks the camel’s back.  With both husbands and wives working more than ever before in US history, there is simply not enough additional bandwidth to service increasing debt in many US families.  And God forbid if one of the wage earners is laid off!  Then there is REAL trouble in making important consumer debt payments each month.  Each week, tens of thousands of new layoffs are announced by flagship American corporations.  And each week more US consumers are pushed over the edge by the unbearable debt load they have accumulated.


Soon, the US consumer will have yet another major disincentive to continue taking on more debt.  As new consumer credit laws make their way through Congress, the traditional very easy out provided by US bankruptcy laws may be closed.  Although bankruptcy is immoral and dishonorable, it has been really easy to declare personal bankruptcy in the United States and have all one’s debts “forgiven”, granting a “clean slate”.  Interestingly, the US consumer credit industry probably sees trouble on the horizon as they are lobbying heavily for new laws that will make it MUCH more difficult for a consumer to escape their accumulated debt through bankruptcy.  In the future, if the laws pass, consumers who live beyond their means and declare bankruptcy are likely to be forced by law to have to spend a long, painful time slowly repaying their debts that existed when they declared bankruptcy.  After a few high-profile cases of debtors being held accountable are reported on the plethora of weekly “news magazines” on TV, the insidious allure of debt should diminish and the greatly increased consequences of bankruptcy will likely begin scaring consumers.


Consumers are unlikely to use debt to finance another spending boom as they see the economy and markets continue to burn around them.


Since the interest rate cuts were initiated by Greenspan and gang, there have been a huge number of mortgage refinancings.  They involve paying off an existing mortgage with a new mortgage taken out at current prevailing lower interest rates.  This has no doubt helped many US consumers slightly reduce the amount of their monthly debt load.  What will the consumers do with the “extra” couple hundred a month?  Will they save it?  Will they send it to Wall Street?  Will they spend it and help the economy?


In aggregate, we think there is a high probability that the money will not be saved at this stage in the game.  The personal savings rate continued to be very negative in early 2001, even after the first interest rate cuts.  The Wall Street crew would LOVE to entice any additional money resulting from refinance savings into the US markets, but it will be a tough sell.  Even the most outspoken perma-bull average US investor is becoming very uneasy and will have a tough time psychologically throwing more money at their fallen tech-equity champions.  That leaves spending any small surplus as the most viable option for the US consumer.


If past behavior is any indication of future performance, chances are the US consumer will spend any meager “surplus” on imported goods.  They may treat themselves to a new television or DVD player made in Japan, or they may buy more clothes made in China.  They may consider an extra hundred or two a month a small allowance to allow them to “enjoy” their increasingly difficult lives more.  They may go out to eat one more time a month, catch a couple more movies, or something along those lines.  We don’t think that any mortgage refinancing induced marginal cashflow will be of much benefit to profits in crucial American companies or sent to the US equity markets.  Chances are it will be spent on foreign produced consumables which will further exacerbate the US trade deficit and put further pressure on the so far amazingly resilient US dollar.


All-in-all, any way you slice it, it sure looks like the latest Wall Street propaganda rallying cry, that consumers are galloping to the rescue, is as false and hollow as all the previous rationalizations offered by the Wall Street cheerleaders to keep people invested at all costs.  As 2001 rolls on and massive consumer spending fails to materialize, we fully expect Wall Street to find some new rallying cry to keep the average US investor from selling to protect his or her scarce capital.


As all Wall Streeters know, the equity markets are a pure confidence game.  If the confidence and faith of the average American investor is shaken, it will be disastrous for the markets.  Provocatively, there are two financial inter-continental ballistic missiles screaming towards the US consumers RIGHT NOW that are highly likely to scare the living heck out of them.  Once these ICBMs hit and spread fear and panic, chances are the consumers will act in the exact opposite way that the Wall Street cowboys are trying to corral the frightened herd.


ICBM One will probably unleash its deadly psychological payload later this month.  The warhead is full of 401(k) statements.  The vast majority of average US investors really do not directly buy stocks or mutual funds at all, but only invest through the ever-popular 401(k) programs.  As such, the great bulk of the 401(k) investors have no idea how their precious retirement nest egg is doing until they see the quarterly statements.  With Q1 2001 401(k) statements coming in the mail in the imminent weeks, chances are a lot of US consumers will be blown out of the water by what they see.  With the dismal first quarter had by all the US indices, chances are the average 401(k) holder will see HUGE losses on their capital.  With the baby boomers nearing retirement age and unable to afford giant hits this close to the end of the line, the punishing negative psychological effects of the 401(k) statements could be greatly exaggerated even further.


We believe that there is a high probability for widespread redemptions of mutual funds leading to enormous selling pressure as US consumers see their bubblevision dreams shattered in their coming 401(k) statements.  US consumers will NOT be happy when they see how well the professionals managed to preserve and enhance their capital in Q1 2001…


The second ICBM hurtling through the atmosphere that could hit at any time and eviscerate US consumer confidence is the potential for widespread mainstream media agreement that the US is in a recession.  SO FAR, there have been no recession headlines, so the average consumer is probably not fully aware of how badly the US economy is limping.  A recession is usually defined as two consecutive quarters of the US economy shrinking.  Since recessions are only fully recognizable after the fact, and six months of data is needed to make the pronouncement, this ICBM will probably not nuke consumer confidence until later this summer or autumn, but the probability is high that it is indeed approaching.


The dismal US consumer savings and crushing consumer debt indicate the US consumer is probably simply not equipped to save the US economy single-handedly, even if they want to.  The Wall Street spin crew needs to find a new rationalization for the “ever-approaching bull market” very fast, because the US consumer is unlikely to prove the savior of Wall Street this time around.  The tapped out consumer, coupled with the confidence shattering approach of 401(k) statements very soon and widespread recession headlines in the near future, is likely to smash to smithereens this latest Wall Street myth that the “US consumer will rescue the US economy and US stock markets.”


One of Wall Street’s worst nightmares is a consumer who will not spend and will not invest.


Adam Hamilton, CPA     April 6, 2001     Subscribe