The New Economy: Death by Savings

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.

Portfolio strategy
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.

Home Depot, Lowe's, and Wal-Mart are Motley Fool Inside Value recommendations. Motley Fool Options has recommended writing puts on Lowe's. Try any of our Foolish newsletter services free for 30 days.

Fool contributor Mike Pienciak holds no financial interest in any company mentioned in this article. The Fool has a disclosure policy.


Read/Post Comments (12) | Recommend This Article (29)

Comments from our Foolish Readers

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  • Report this Comment On July 12, 2010, at 1:00 PM, ChrisFs wrote:

    In the short term, savings may present problems, but in the long term it's ultimately helpful. The economy was supported by credit cards and borrowing against inflated home prices. That is not sustainable. A long term consumer economy has to be fed by what people actually make, rather than the credit issued.

    On a side note, then the 'stimulus' for the economy came from credit cards and home equity lines that had to be paid back at a rather high rate, no one complained, when the 'stimulus' comes from the govt repaid at lower rates (close to zero), suddently it's a disaster and horrible.

  • Report this Comment On July 12, 2010, at 2:07 PM, PhulishMortal wrote:

    ChrisFs has nailed it.

    From my perspective, if having people save more is "bad for the economy," then so be it. "The economy" has been warped long enough for the benefit of too many people who add no value. At least some private people will be acting responsibly; Wall Street certainly has shown no inclination to do so.

    I also wonder exactly which sectors would be hit hardest by reduced consumer spending. Would it be automobiles? Electronics? Service? Imported five-cent party favors? Perhaps there will be a shift to an emphasis on producing actual value instead of simply making any old junk.

    On top of that, I have a hard time seeing a 10% savings rate as "staggering." We could do with a bit of that sort of staggering.

  • Report this Comment On July 12, 2010, at 4:05 PM, SundayRider wrote:

    Of course, the "savings rate" has always been distorted. According to how this rate is calculated, if I take $1000 from savings account and buy bonds, stocks, or gold--or ETFs or mutual funds consisting of these--I have reduced the "savings rate" because I reduced cash savings. For some reason you aren't "saving" if you own gold or bonds (even if they're short-term Treasurys). So the much-touted "negative savings rate" was a sham, a product of people realizing that investing was better than savings accounts.

    That said, we are due for a big increase in the savings rate just from demographics. As people move into their 50s they tend to focus more on savings, and now the peak of the post-war baby-boom has hit 50. So there's not going to be any getting around the additional savings instead of consuming, and what he says above about the impact on consumption and GDP is true.

  • Report this Comment On July 12, 2010, at 4:21 PM, rufianno wrote:

    I DO NOT BLAME THE CONSUMER FOR WANTING TO SAVE MORE INSTEAD OF SPENDING.when things went down hill, wallstreet was rescued by the government. The consumer was left to deal with their problem by themselves.I'm glad we are becoming the next china when it comes to saving money.

  • Report this Comment On July 12, 2010, at 7:25 PM, gimponthego wrote:

    Please don't take me wrong for saying "I don't care about the Nation's Economy at the moment." I care about my wife and myself. We both retired at 50 and at 64 are doing fine. We have zero debt (it's not what you have, but what you don't..debt), trade within my IRA, doing a lot of DD. Believe me it can be done. we've done it for 14 years. A diverse portfolio ranging from WAG and BRKB to GG, JOYG, and a few more. No broker, no funds, just us. If we mess up we take the blame..if we make a killing we celebrate.

    Don't let anyone ever tell you "you can't handle this yourself..you require professional help. It's the last thing you need. I spend 6 to 8 hours at the computer on average.

    We operate on John Standard Time and it's great. We saved for 35 years and it went into IRA's the last 20. You need the nut and unless you're a trust fund baby you'll have to gather those yourself. Good Luck!

  • Report this Comment On July 12, 2010, at 7:43 PM, ragedmaximus wrote:

    our economy was run by us the stupid in debt public. We were manipulated by overpriced cars ,houses, goods ,services and taken to the woodshed for a bat loaded with nails with absurd criminal credit percentages. Why does a bank give you next to nothing when you loan them money but borrow from them for overpriced crap that will one day amount to nothing and maybe even negative worth and now everyone is crying because we the public are getting smarter paying off our debt amd living within our means and actually saving in a bank we hope doesn't get shut down and cutting up our credit cards,I say tough luck were overstretched in costs and the average paycheck isn't keeping up.Tough luck wallstreet and credit card companies.

  • Report this Comment On July 12, 2010, at 8:44 PM, susan400 wrote:

    ideal is you save others don't

  • Report this Comment On July 13, 2010, at 12:06 AM, ViolaLeeBlues wrote:

    I think people have short memories. It was only a few years after the tech/internet bubble burst and caused so much pain before people had the same unrealistic mentality towards real estate. I don't see America becoming a nation of savers for the long hall. I could be wrong. I agree with susan400. After the recession hit I paid off the little amount of debt I had. Really just in case I lost my job which luckily I didn't. I save for retirement and after the economic crisis I decided it would be prudent to create a savings for emergencies. I save to buy stuff too. You end up paying so much less for the things you want buying it outright.

    After the depression sales of movie tickets rose. I think entertainment like movies and video games might continue to see strong sales despite peoples thrift as they offer a relatively cheap form of entertainment. $50-$70 might seem like a lot for a video game but if you consider the amount of time the product entertains those who enjoy it it's actually a much better buy in terms of hours of entertainment than a movie.

    Also people will probably still need to purchase medical services and supplies regardless of their miserly tendencies.

  • Report this Comment On July 13, 2010, at 8:42 AM, catoismymotor wrote:

    ChrisFs hit it on the head. Well done!

    I have heard it said that out economy is like a junky in the middle of a stint in rehab: we have the shakes, vomiting, sweats, nausea and the creeps. The government keeps forcing medicine into our system to make it better but nothing but time will have the desired effect. Once we have cleansed our system of the toxic debt loads we can cement some behaviors that will help keep many of us from finding ourselves in this bind again. If that means saving cash like a deciple of Clark Howard or Dave Ramsey so be it.

  • Report this Comment On July 13, 2010, at 11:50 AM, ChuckWoolery wrote:

    I didn't think saving could hurt me. I am a 26 year old guy and I see a glimpse of my future. No social security left, no liquidity, high debt in our national government and more jobs exported.

    If I were a prudent person, I would save as much as I can now and rely on my own income to help me in tough times ahead.

  • Report this Comment On July 13, 2010, at 2:37 PM, BuyerAdvocate wrote:

    It's just about finding effective ways to spend your money. If your scared of the stock market at this point, and I can understand why you would be, why not look into investing in yourself and buy a small to midsize business.

    Right now is the perfect time to buy a small to midsize business. This economy has left a whole lot of businesses out there selling for less than their worth. Now is the time for people who want the most out of life to grasp on and take the plunge.

    Anyone interested in the buying of a business should check out The Business Buyer Advocate blog at http://www.businessbuyeradvocate.com/ . It is a great blog full of must have knowledge for anyone thinking about taking the plunge. It’s frequented by quite a few experts in various aspects of the field that can help you with any questions you might have or perspective you might need.

    Buying a business very well could be the most important decision you ever make in your life. You have to make sure you buy the right business the right way.

    If you are on the other side of the fence and looking to sell a business or just want to get the other perspective check out their sister blog The Business Seller Advocate at http://www.businessselleradvocate.com/

  • Report this Comment On July 13, 2010, at 6:30 PM, rfaramir wrote:

    'The first thing to do is to explain that the "paradox of thrift" is simply wrong. This "paradox" is based upon the belief that if people increase their savings during an economic downturn, they consume even less, thus driving the economy further down. People respond by saving even more until the economy implodes into a perverse "equilibrium" of high savings, low spending, and widespread unemployment.' -- William L. Anderson http://mises.org/daily/3384

    see also:

    http://mises.org/daily/4193

    http://blog.mises.org/8413/is-deleveraging-bad-for-the-econo...

    http://mises.org/mobile/daily.aspx?Id=3445

    http://blog.mises.org/10850/the-keynes-solution/

    in short, "There is no paradox of saving!" Keynes was provably wrong, and anyone who quotes Keynes is really not worth listening to, unless you really WANT socialism like he did.

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