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Don't get too excited about these intermittent market mini-rallies -- there's still plenty of risk out there. And among what look like gathering storms on all fronts, we may soon be faced with an economy-crushing rise in the personal savings rate.
The paradox of thrift
From a long-term perspective, it's hard to argue that heavily indebted U.S. consumers shouldn't be spending less and saving more. Unfortunately, any dramatic increase in savings comes at the expense of consumption. In a healthy economy -- or one in which the central bank has room to cut interest rates -- that negative effect might be offset by a corresponding rise in business investment. Unfortunately, that's not the world in which we're living. If consumers decide to do what appears to be the right thing, they'll be pushing the economy into (or deeper into) recession.
Certainly, that's contradiction enough, yet it's not the endgame. The cited "paradox" arrives when the falling incomes typical of a recession eventually strangle the consumer's ability to save. In simpler terms, an initial push to save more could ultimately result in consumers saving less.
Is that scary theory really what we face today? It certainly seems so.
Moving on up
According to a recent study by PricewaterhouseCoopers, the savings rate is expected to rise to a staggering 10% during the next five years. For perspective, the June figure came in at 4%, which, as recently observed by Barron's, is already more than double the average rate in the year leading up to the recession's December 2007 start.
Such an increase would initially take an additional $600 billion of consumption out of the economy, assuming that consumer spending is roughly 70% of U.S. GDP. Moreover, a 10% savings rate isn't far-fetched -- the 1980s saw savings average 8%. Along with reduced access to credit, the study names demographics as the primary trend that will elevate the savings rate: During the coming years, an expected 76 million baby boomers will cross the divide into retirement.
Given what I expect to be retirees' focus on capital preservation and income, it's difficult to argue that those incrementally saved dollars will help prop up stock market valuations. Instead, I'd expect the bond market and fixed-income products in general to be the prime beneficiaries. Furthermore, while one might contend that companies focused primarily on selling to aging consumers would take the greatest hit under such a scenario, it's tough to imagine that negative effects wouldn't eventually ripple through all sectors of the economy.
Given all that bad news, good luck finding a silver lining.
Such a dour outlook obviously makes a strong case for defensive stock holdings. Along those lines, my colleague Alex Dumortier recently offered three names that fit the bill, all of which are selling at discounts. However, investors would do at least equally well by identifying which companies to avoid. A host of consumer discretionary companies top that list.
Specifically, I'd note that top-ranked retail analyst Deborah Weinswig has cut earnings estimates and price targets for a slew of retailers, including Wal-Mart (NYSE: WMT ) , Target (NYSE: TGT ) , Home Depot (NYSE: HD ) , and Lowe's (NYSE: LOW ) . I'm particularly cautious on the latter two, given that shares are trading above their respective five-year average price-to-earnings ratios. In addition, the housing market is lousy, as a rise in mortgage delinquencies most recently highlighted.
However, that doesn't mean the consumer discretionary landscape doesn't offer some gems, at least in relative terms. As recently noted by Barron's, teen (and increasingly, preteen) retailer Aeropostale has bested competitors American Eagle Outfitters (NYSE: AEO ) and Abercrombie & Fitch (NYSE: ANF ) in same-store sales growth for 10 quarters straight. Amazingly, those rivals tend to sell their wares at higher prices, and their stocks trade at higher projected P/Es. In addition, while graying boomers might cut back on spending in general, gifts for the grandkids will probably be the last thing to go.
Among other potential buys, I've gone on record saying that shares of sneaker and apparel maker Nike (NYSE: NKE ) would be attractive in the low $60s. I stand behind that call, even in light of a potential consumer-savings stampede.
A final word of caution
A few weeks ago, I introduced readers to the Consumer Metrics Institute, whose proprietary models then predicted a 2% contraction in Q3 GDP. I suggested that such a forecast shouldn't be taken as a crystal-ball reading. But for those inclined to believe that the economy does run a substantial risk of declining, consider the following: The BEA's most recently revised estimate of Q1 GDP, down to 2.7%, is only a shade shy of the 2.62% growth that CMI predicted a full seven months earlier.
In that vein, let me recant my opening statement: Do get excited about these market bounces, but only as an opportunity to unload riskier positions and buckle down for what could be a long, tough slog.