Demand = Catalyst

Demand = Catalyst

Catalyst = Profits

Profits = Spending

Spending = GDP Growth

As I read the government release of the household wealth gains/losses I can’t help but immediately think about what this means to GDP growth in the US.  70% of the US economy is propelled by US consumer spending.  For the US GDP to grow above the inflation rate there has to be demand from these very consumers.  This consumer must have discretionary money to spend outside of their normal cost of living.  When there is demand from the consumer, there is a catalyst for companies to expand, hire and make new and innovative products to sell to them.  When this catalyst is present and companies’ sales are increasing, this creates profits on both the company level and for the people investing in them, as well as creates employment expansion.  When the US population has money to spend, this ultimately will cause the US GDP to grow.

As I look through the government release on income and wealth over a four year span from 2007 – 2010, the biggest thing that stands out is the 38.8% decline is median net worth.  We can say that the average income is down by 7.7% because there is a plethora of people looking for work, so employers can be stingier with salaries.  In terms of net worth being down 38.8%, this tells me that the average US working citizen is now behind the retirement eight ball.  This very citizen now has to take that extra money they might make and save it to try to get that retirement nest egg built back up, which in turn means they have less to spend elsewhere.

The other part of this equation is housing and the amount of equity lost during this time.  People spend a lifetime living in their home and expect it to gradually increase in value.  Yet, now many of those baby boomers getting ready to retire have had most or all of this nest egg wiped out.  Many of these people do reverse mortgages, sell or gift these assets.  This has a trickledown effect as their beneficiaries no longer have an asset coming to them.  In this very middle class, I am seeing a lot of these people having to be taken care of by their children as they no longer have the net worth to keep the lifestyle they did only five short years ago.  How do home prices move up again, you might ask?  Well it is complicated because in the US we have a couple of decades worth of housing inventory sitting out there empty.  And getting new buyers to enter the market is difficult because you have to have a large down payment to qualify for a loan, and that equity went bye-bye.

In summary, there will be little to drive demand in both housing and the US economy for a long, long time.  To get stocks moving, you need corporate America growing and this is not happening.  Many judge stocks according to their P/E ratio (Price/Earnings) and look to history of where this P/E falls as to whether it is a buy/sell.  In order for the P/E to increase you need the E to increase.  Given the weak environment we don’t and won’t have this for some time and therefore the P, price of the stock, will likely not go up.

What do you do in this case of gut wrenching news and a weak forecast for equities?  We believe your best alternative is to buy high yield corporate bonds in an actively managed portfolio.  This way the manager can pick companies/debt securities that will perform in this economic environment and you are not relying on market expansion to get that P (price) to increase given the contracted bond maturity.  And through this cycle, you can still receive tangible income via the coupon payments.

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