The much anticipated Santa Claus rally finally arrived, only a bit late. The S&P500 jumped 6.8% for the holiday-shortened week, on low volume. As usual, the bad economic data kept pouring in: Case-Shiller home prices dropped sharply, consumer confidence was lower than expected, and the ISM number plunged to its lowest level since 1980. And around the globe, gloomy manufacturing data pointed to worsening economic conditions.
But that didn’t stop the market pundits from declaring a market bottom (yet again) in the prior November and from promising rosy results for the equity markets in 2009. The major reasons behind the cheerful forecasts were: 1) the bad economic data is already baked in to the prices, 2) with the Fed throwing everything but the kitchen sink at the economic crisis, and now that the new administration, with Congress, will throw a massive fiscal stimulus at the problem, the economy and the markets should recover.
What’s odd is that many of these same prognosticators declared that the U.S. economy would slow down (but not fall into recession) in the first half of 2008 and then bounce back–with the help of the $150 billion stimulus package–by the fourth quarter of the year.
OK, so they were a little off the mark.
So let’s consider another, alternative scenario for 2009. What if, as the data suggests is already happening, the U.S. consumer suddenly decides to save? Scared by the 20+% drop in housing prices (so far), the 40% drop in equity values in 2008 alone, and the ferocious acceleration in layoffs and unemployment, the U.S. consumer may finally snap out of a decade long spending spree, where U.S. savings rates fell to zero, and household indebtedness soared.
Let’s say consumers decided to save only 5% of their incomes, a level below their savings rates in prior decades, and a level far below the current savings rates of other developed economies (eg. Germany or Japan). If we’re starting at a zero savings rate, then we can assume that incomes equal spending. And if spending accounts for almost 70% of U.S. GDP (about $15 trillion), then we have almost $11 trillion of income that’ll be available to save. So saving 5% means that consumers would stop spending over $500 billion per year–starting right now.
If the new fiscal stimulus creates a total of $1 trillion in spending over the next three years, then the U.S. consumer’s pullback alone could overwhelm the new government spending. Keep in mind that reduced U.S. business investment and reduced exports (due to a recently strengthened dollar and weaker foreign demand) would also act to push down aggregate demand in the U.S. economy in 2009.
But please don’t tell that to the market pundits. This will be our little secret.