After a stunning 15% surge since mid-November, themarket has
struggled in the past month, trading up and down in a tight 1%
band. Problems in Europe have reignited and many onWall Street
are expecting consumer spending to weaken during the rest of the
year. It is all making the case for abull market very difficult,
except for a key report the U.S. Federal Reserve recently
I am not talking aboutthe Fed 's stance on interest rates, or
whether itwill maintain recordbond purchases. This report is even
more important because it concerns the driver to 70% of the
nation'seconomy and, despite current bad news, it's pointing
But first, a bit of background...
Can Mr. Market climb thiswall of worry ?
They saystock prices increase in the face of overwhelming risk,
that the "wall of worry" is just the daily protest ofmarket
makers . In the past few weeks though, it seems some walls may be
Bonds of European peripheral countries and stock markets around
the world slid in the week of March 18, when it looked like
Cyprus would not be able to negotiate abailout for its relatively
small economy. The fact that the world markets shook from the
stumble of a $22.4 billion economy reminded many investors that
the European debacle is far from over.
Of bigger concern is the fact that manyanalysts forecast consumer
spending will slow this quarter and possibly for the rest of the
year. Consumers have been struggling with the 2% hit to paychecks
from theexpiration of the payroll tax cut in January and rising
gas prices in the first two months of the year. As a result,
monthly consumer spending was basically flat in February, and JP
Morgan expects it to grow by just 1% in the first quarter, well
off the 3.6% pace in the same period of 2012.
Thejob market certainly hasn't helped consumers. Anunemployment
rate still well above 7% means that employers see no need to
raise workers' wages, which increased just 0.1% in February from
the same time last year and actually fell 0.6% from January.
Considering the fact that consumer spending counts for 70% of the
nation's economy, this all paints a pretty bleak picture.
That is, except for one key report.
Seeing the green shoots when they're just
The Fed issued an update to its Household Debt Service and
Financial Obligations Ratios on March 13 and the data could hold
the key to some surprisingly strong consumer numbers in
thequarters to come.
The household debt-service ratio, a measure of debt payments as a
percentage of disposable income shown in the graph below, fell to
10.4% in the fourth quarter of 2012 and was the lowest on record.
The financial obligations ratio (
) adds in automobile lease payments, rents and insurance. The
fact that renters' debt obligations, shown on the right axis
below, have also fallen to near record lows means that stronger
personal balance sheets are not just a byproduct of higher home
Americans have genuinely cut back on their spending in the
past four years, to the point that the debt they owe is well
under the historical average. With debt obligations this low, it
isn't hard to see how retail sales could get a boost from a
consumer wary of cutting back and anxious to splurge.
Beyond the responsible deleveraging, the market may still be
underestimating the rebound in the housing market. That's the
view of Mark Zandi, leading economist atMoody's Analytics, who
recently told Bloomberg that he thinks the market is,
"underestimating the juice [the housing market] is going to
provide to the economy," and could see gross domestic product
growth around 4% in the near future.
The market for housing has entered a virtuous cycle where surging
prices (up 9.7% in the year to January) lead to higher optimism,
pushing prices higher still. With home prices and the stock
market posting double-digit returns in the past year, consumers
are feeling more confident.
Simplyput , they are going to start spending again.
Not all consumers are created equal
Before you rush into retailers and other cyclicalstocks , know
that the coming consumer boom might be lop-sided. Higher
payrolltaxes and prices at the pump have hit lower- and
middle-income consumers disproportionately. This may be evident
in the decline in year-over-year restaurant dining, down 0.7% in
February and 0.6% in January, againstgains across other sectors
of consumer spending. In addition, those renting a house have not
benefited from the increase in home prices and so may not feel as
rich as property owners.
Given this, retailers with upscale brand names could outperform
their discount-retailer peers. These include luxury stocks such
Tiffany & Co. (
, which have some of the strongest brands in fashion. Both stocks
have underperformed the general market during the past year, with
Coach seeing significant weakness after a disappointing 2012
Conversely, discount retailers such as
Shoe Carnival (Nasdaq: SCVL)
may feel the pinch as the scenario drives higher income consumers
to spend at the brand stores, while lower income shoppers
continue to deleverage.
Credit card companies may be the safest play, as they collect
transaction fees no matter where consumers go. While the lower
interest payments on debt may hitcredit card issuers, largely
banks andcredit unions, payment processors like
makemoney despite your card balance.
Risks to Consider:
The larger global headline risks could pull retailers down in
the short-term or cause sporadic sell-offs in any particular day.
These shouldn't be enough to derail a cyclical rebound in
consumer spending, but investors should be ready for increased
volatility untilearnings are released and data affirm higher
Action to Take -->
The great deleveraging brought on by the housing crash may be
over and a rising market is making consumers feel wealthier and
more confident. Investors may want to increase their allocation
to strong brands and high-end retailers beforeearnings surprise
to theupside .
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