Trader’s Narrative

Here’s an a long term indicator that I stumbled on that has been able to time the stock market’s generational buy points very well. It is a ratio of discretionary spending to total US consumer spending.

Click to see larger graph in new window:

Source: Bloomberg

Every time that the US Consumer rediscovers frugality and retrenches by spending less on the non-essentials, the stock market makes a major bottom.

In the early 1960’s discretionary spending as a percentage of the total budget went below 17%. We then had the roaring market powered by the “nifty fifty”.

In the early 1980’s again discretionary spending went below 17%, reaching a slightly lower level. And again, we saw the birth of the 80’s “go go” bull market that was rudely interrupted by Black Monday in October 1987.

In the early 1990’s discretionary spending once again breached 17% and once again the market made a low (in late 1990) that would go uninterrupted until the LTCM crisis in the summer of 1998 and top out in 2000 at the height of the tech bubble.

Which brings us to the most recent - and seemingly the most depressive state of the US consumer. Belt tightening is so rampant that discretionary spending is at an all time low for at least 50 years. No wonder we are constantly hearing today’s economic situation compared to the Great Depression.

But if the previous dark times are any indication, the stock market is poised for a shocking come back.

Every single great bear market has left its own unique mark on the psyche of investors and consumers. While it may be much too early to declare what the effects of this most recent bear market may be, the US consumer may provide a clue.

For the past few decades the insatiable appetite of the US consumer has been the engine of global consumption. Fed by the trifecta of easy credit, loose fiscal and monetary policy and cheap goods from Asia, it went on a binge.

The personal saving rate was in decline since the mid 1970’s when it reached a high of 14.6%. Last year the average US consumer had zero savings. The disparity between the spendthrift lifestyle enjoyed by the average American and the average miserly Chinese or Japanese (or Korean) suddenly became cartoonish.

And then this extreme scenario began to unwind:

According to the Bureau of Economic Analysis (US Department of Commerce) the latest data for April 2009 was a saving rate of 5.7%. While this is a welcomed change, there’s no question this will have a deflationary effect on the economy.

In April 2009 Americans paid down debt at a record rate of $15.7 billion. Combined with $16.5 billion in March and $10.9 billion in February we have a trend. According to Lombard Street Research, this is the fastest decline in credit since 1980 and the largest since 1943 when wartime rationing restricted consumption.

We’ve seen a reduction of consumer credit in every recession but the recent numbers are simply mind boggling:

While the US consumer garnered a fame for profligate spending over the past decade, those days are clearly over as a new frugality becomes the watchword. Those who lived through the Great Depression - even when the worst was over - were changed for the rest of their lives. Similarly, this Great Recession may change the attitudes of a whole new generation towards discretionary spending.