The Death of Excessive Luxury

For years, Americans have been mocked for their materialistic nature. A "gotta have it now" mentality has become the norm for consumers, and the middle class has literally disguised itself as part of the wealthy. At nearly every level of our society, individuals have been living well beyond their means, thanks to a dirty four-letter word: debt.

Behind the expensive cars, luxury clothing, hottest gadgets and of course, the McMansion homes, lies an enormous pile of debt. As a nation, we collectively have about $850 billion, or $9,659 per household, outstanding in credit card debt alone. Total U.S. household debt as a percentage of GDP has risen from 23.5% in 1952 to 97.8% today. The personal savings rate has been hovering in the 0-2% range for years. Putting money away for a rainy day has become a concept of yesteryear.

But that rainy day is here...
And it has made one heck of a grand, torrential entrance. Banks have collapsed, home "owners" have been forced into foreclosure, and consumer confidence is at its lowest level ever recorded. The possibility of a borrower being risky has finally caught the attention of lenders, but it's too late. After handing out credit cards to everyone in line at Macy's and issuing mortgages without down payments, our entire economy is swamped by debt. We don't have the means to pay it off, and we're so reliant on it that life without more credit is slowing our economy to a halt.

Policymakers may not like it, but de-leveraging must occur, and we suspect it's going to be a bloody drubbing since many stocks were boosted by the consumer spending frenzy. We've long been suspicious that easy credit and a related asset bubble had been firing up GDP growth for ages now that was not only unsustainable but artificial, since it wasn't based on real income. Well, the dirty little secret is out -- and it's not pretty.

The end of an indebted era
The era of conspicuous consumption will have to turn into one of austere frugality. High-end luxury goods are going to collect dust on store shelves as consumers either have no way to finance them or simply realize that their debt-fueled lifestyle is completely unsustainable. That's right, Saks (NYSE: SKS  ) , pricey stores aren't going to appeal to consumers who just had their credit lines slashed. Those that have shelled out cold hard cash for premium prices at Whole Foods (Nasdaq: WFMI  ) on a weekly basis might find themselves trading down to a traditional grocery. And without the swipe of a Mastercard (NYSE: MA  ) , few will be able to truly afford a night out at Ruth's Hospitality and McCormick & Schmick's.

We already know the current problem doesn't bode well for holiday shopping this year. But more importantly, what does all of this mean for the long term future of luxury retail? Not only does our economy need to shake out the excessive debt it has taken on over the past few years, but it seems that a permanent change will be required in the retail world, as a seismic shift in the way consumers spend money is inevitable. Sure, Coach (NYSE: COH  ) purses will always be sought out by a certain caliber, and there will always be young professionals who can afford J. Crew's latest line. But the herds that drove to these stores in the past years simply won't have the means to "buy big" anymore.

The housing bust has been a lesson well learned for those that pushed their living style to the limit. Leverage can only be used for so long and without maxing out credit lines, and individuals are being snapped back to middle class reality. Like the bubbled housing market fueled by gigantic loans, the retail industry's past performance and valuations have been stimulated by credit cards. Thus, the historical growth rates many of these companies have enjoyed in the past won't be possible in the future, or at least in the next few years. And while many retailers look cheap in comparison to past ratios, it's important that investors remember to factor in a drastic reduction in growth to come when looking longingly at some of those single-digit P/Es.

Weeding out the winners
There's no way to sugarcoat this situation. Still, investors should remember the tenets of long-term investing. Difficult times yield opportunities for the very long term, provided you've got nerves of steel and the ability to weed out the best potential investments. The highest-quality retailers, fortified with the strongest balance sheets and best brands, will be the ultimate survivors. And with overall growth rates trending downward, superior inventory management will be key. Finding companies like Nordstrom (NYSE: JWN  ) , which can drive return on investment without hefty growth expansion, will help you get out of this mess alive.

In the meantime, look for companies that actually thrive from thrifty spending, given the uncertainty of when consumer spending will rebound. It doesn't take rocket science to see why McDonald's (NYSE: MCD  ) has been on fire lately. And Costco's (Nasdaq: COST  ) high-end merchandise sold at rock-bottom prices will always attract bargain-oriented shoppers.

Choose the stocks you invest in carefully, Fools -- pick strong companies with great brands, not fads or second-tier consumer-facing companies. And weigh your decisions carefully, since many luxuries may become nothing more than symbols of an age of excessive, debt-fueled lifestyles -- an age that is now past.

Kristin Graham does not own shares of any of the companies in this article. Alyce Lomax owns shares of Whole Foods. Coach, Costco, and Whole Foods are Stock Advisor selections. The Fool has a disclosure policy.

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 10, 2008, at 9:07 PM, maiday2000 wrote:

    Though Americans are heavily indebted, I cringe when I see the "average credit card" debt figure repeated without any background. I have never carried credit card debt, but if you look at my credit report, it shows my credit card debt to be whatever the "balance" on my last statement was. The first time I saw this several years ago, I wondered how the average credit card debt was figured, because clearly if they use credit card debt from statements, then they could be overestimating by several magnitudes. Then a couple of years ago, I read an article from Liz Pulliam Weston (who writes for MSN money) who said that this IS how they figure it! Think about how many people (much like me) use their credit card for all of their purchases just because its easier than paying cash and tracking receipts. It is not surprising that as the percentage of retail transactions using credit cards has risen, so to has the "average" credit card debt in pretty close correlation.

    Frankly, I expect more from the Fool than to be CONTINUALLY trotting out misleading statistics like "average credit card debt." Are you just trying to make people feel good about themselves because, "hey, at least my debt is BETTER than average!"

  • Report this Comment On November 11, 2008, at 10:26 AM, gcooley1 wrote:

    good comment maiday,

    I think articles like these scare people. No one is being "forced" into foreclosure.

    If someone signed up for a 100% Adjustable Rate mortgage knowing it would adjust up in the next 3-5 years, then it's their own fault they can't afford the payments. Usually people get an Adjustable rate becuase they will move in the next couple years, or they want to refinance. The problem with a 100% ARM is that in the 3-5 years they might not have any equity. When you get a home and plan on moving, you need to know that it will take 7-10% of the purchase price in fees to pay your real estate agents, title companies, closing costs for the buyer, etc. Just like the seller paid those fees when you bought the house.

    Also, I have about 3 credit cards, that I never carry a balance on, unless it's an emergency, and it's not like they are calling me up and saying their going to take my cards back. People have credit, but maybe not the people that have screwed up their report by missing a payment, or ruining their credit.

    We are adults now and need to take responsibility for our actions. Not blame it on mortgage companies, banks, or the government. Grow up.

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