Most intelligent people know a lot of facts that aren’t true. For example, one of the best entertainment lawyers in New York once informed me that during the Depression, the film industry continued to flourish because the public needed to be distracted from the miseries of daily life. My parents said my friend was right. Not true. The film-makers went bankrupt at a far higher rate than most companies.
Another example: a smart New York lawyer I know was insisting as late as this spring that you couldn’t lose money in high-end real estate. I have to introduce her to some Greenwich and Palm Beach real estate agents, who could use the morale boost.
Susan Sterne, the eminent consumer economist whose Greenwich house is not among the many awaiting bids, has heard the same delusions before. “Rich people don’t have to cut back on their spending. But they do,” she says.
The general public is finally accepting the real estate bust as fact, a long time after it began. The consequent wariness among the investing public is leading to a search for safe-haven industries.
Given that many people, including smart people, put much more credence in folk wisdom than research, they’re looking for the “recession-resistant” parts of the consumer sector, since everyone will keep buying their basics and rich people will continue to be rich. So, on this argument, Tiffany’s jewellery and Coach handbags should do better than Wal-Mart shoppers buying Carhartt pants. But this argument might be wrong.
Susan Sterne has a different perspective. “People are confusing luxury goods with discretionary goods. Coach and Tiffany’s products are much closer to being discretionary goods than luxury goods for the really rich. So-called luxury goods have been pushed down into groups whose resources are much more problematic with higher interest rates and lower home-equity extraction. The losses have to be taken somewhere, and we are seeing that – and will continue to see that – in vehicles and other big-ticket items.”
Gasoline costs have also hit the upper-middle to lower-upper consumer more than one might think. They can still fill their tanks but they don’t enjoy the process. Yacht charters for the moderately well off are very, very soft, according to those in the business, who blame the cost of fuel.
Being an unimpressive consumer myself, I have to rely on data rather than impressions to reach conclusions about the wealthiest consumers. That’s a problem, as Ms Sterne points out. “There is not a lot of good data on the really high-end group,” she says. “We know that the top 4 per cent who earn more than $228,000 a year do 12 per cent of total consumer spending. Those are the readers of the Financial Times’s How To Spend It magazine – real luxury such as Gucci products with four-figure price tags.
“But the real expansion in spending has been just below that. The $100,000 to $150,000 people do 16 per cent of total spending. And when you get to the $80,000 to $100,000 bracket, you will definitely see some trading down.” Many of the women who buy five Coach bags a year – apparently, that is normal behaviour – fall into those two groups.
These groups were a bit slower to take the hit from the present slowdown than those who earn less. “We’ve already lost the bottom 40 per cent,” says Ms Sterne. The expectations of non-prosperous working people are already lower than they were for their peers in the recession year of 1991. In contrast, the top 20 per cent have the same expectations as they did in 1995, which was a sort of “on pause” year before the acceleration of the late 1990s. The lower-income groups spend a lot on gasoline to get to work and the kids to school. Last month, gasoline accounted for 11 per cent of retail sales, up from 7 per cent three years earlier.
In an older, richer society such as the US, net worth and the perception of net worth are more important drivers of behaviour than income. I believe the financial sector is grossly overbuilt but it has made it much easier for people to turn illiquid assets into cash. That is continuing to support spending as people are able to extract some equity from their homes even in weak markets. Also, the stock market has more earnings, dividends, buybacks and takeovers to support it than would be the case if we were facing an imminent crash.
Ms Sterne thinks we will be hitting a bottom in the middle of next year. “I see the second quarter of 2007 as the low point but you have to keep your fingers crossed. Right now we are at 1.4 per cent growth for 2007, half the Fed’s number. There is a belief that capital expenditure and non-residential construction will make up for the consumer weakness but mathematically that is hard to see.”
There is already a fair amount of gloom. I think there is a chance for a short-term rally in market and consumer sentiment, as in two or three months of bounce. For one thing, gas futures prices have dropped by 50 cents a gallon, while prices at the pump are down by only 13 to 15 cents from their recent highs. That suggests a 35 cent drop in the next month or so, which should lift spirits, at least temporarily. And the stock market, which seems to drive consumer sentiment even among non-traders, is due for a short-term rally.
Unfortunately, that won’t encourage the Federal Reserve to cut rates as quickly as it probably should. The US is in a bad position and the trend in the prices of our big assets will be down for a while.
Is there any bargain hunting to be done in what is already a black-and-blue consumer sector? Ms Sterne thinks it is still early. “The first place to look will be for stocks of companies serving the Wal-Mart customers,” she says. “More of the bad news is already incorporated in the stock prices. Look at the staples, like food and drugstores. Don’t look at the high-end retailers. And don’t think home builders. It’s still too early.” Tobacco and liquor stocks have little appeal for Ms Sterne.
If this is a three-year recession or slowdown, the good news is we’re already a year into the deceleration. So we have two thirds or, who knows, three quarters of the way to go to before the recovery starts.