'Wealth Effect' Has Lost Its Mojo
“Does a person get richer when the prices of the stocks he owns increase.”
This is among the questions posed by Dr. Kurt Richebacher in his August newsletter.
“Of course, his or her personal wealth has accordingly risen,” says the economist. But what has really changed? Is the view out his office window any more pleasant? Does his luncheon hamburger suddenly acquire an added flavor? Does his wife appear more attractive? Are his labors eased or is his care-worn brow soothed?
The answer: well…maybe. A few more dollars in Warren Buffett’s account will make no difference. Nor are George Soros or Donald Trump likely to upgrade their standards of living. At the upper reaches of the prosperity curve, money no longer matters – except, as Bunker Hunt once put it, “as a way of keeping score in life.”
But as you travel from Park Avenue to Queens, or from Kennebunkport into rural Maine, the marginal utility of money increases. The average American can use a few more bucks. And when the bucks appear on his portfolio statement – he is happy to spend them. But, as we will see, when they don’t appear – he begins to act Japanese.
“People are not going to move out of stocks anytime soon,” said my brother-in-law at last night’s dinner. “Yes, they’ve taken some losses this year…but over the last five or ten years they are so far up it is unbelievable. Their lives have been changed.”
The Dow ended the first half of this year down almost 10%. The Nasdaq did better – down only 2.5%. Still, the habit of 20% plus annual gains is hard to break.
“Almost everyone now has a 401(k) or something similar,” he went on. “If they had $50,000 in the plan in 1995 – they might have $250,000 today. They are waiting for the next big pop. And they’ll wait years before they give up.”
My brother in law is not giving up. Like most Americans, I suppose, he has a house with a mortgage in an expensive suburb. He works in Manhattan and commutes an hour and 15 minutes. He has a mortgage – at about 8% – and a portfolio of stocks that has risen 400% in the last few years.
“I didn’t begin as a tech investor,” he explained. “I became one because those are the stocks that went up. Sun, Intel, Nortel – I’ve had good times and bad times, but overall, I’m way ahead of the game. And now these stocks make up maybe 80% of my portfolio.”
Hmmm…I thought…maybe you should take some of your profits off the table…pay off the mortgage…
“And we’re looking at a relatively long time horizon,” his wife added. “We’re not worried if the market goes down for a year or two. We have 20 years to make it up. We don’t believe anything is better over the long term than stocks. We’re in for the long term, so we’re in stocks.”
All across America, there are millions of people who think like this. It is a reasonable line of thought. And I am in no position to argue with it. My investment returns, over the last five years, are a lot lower than those of my brother in law.
Still, as the SEC is fond of advising us, past performance is no guarantee of future results.
The lives of millions of people have changed in more ways than one. First, they discovered that savings were a net loss. A dollar invested in Qualcomm was worth five or ten dollars in a money market account. So, why save at all? It was stocks that made people rich – not savings.
As reported Friday, the savings rate fell from 8.7% of disposable income in 1991 to 0.6% in the first quarter of 2000. This decline in savings – not technology, innovation, nor productivity – is perhaps the real reason for the financial boom of ’95 – 2000…the boom of which Al Gore is so proud.
Much of the money that would otherwise have gone into savings went into stocks. These were regarded as better than savings accounts (if you had the proper long-term orientation), because the rate of return was higher. Billions poured into stocks – which lifted stock prices and seemed to confirm the idea.
Second, people looked at their account statements and discovered that they were richer than they ever had any right to be. It was easy money. But they recognized that the gravy train would come to a halt if they took their ‘savings’ out and spent them. So, they took out only what they needed – which wasn’t much, thanks to the reckless generosity of the consumer credit industry.
“Consumer spending surged as a share of GDP,” reports Dr. Richebacher, “from a long-term average of 66%…up to 94% in the first quarter of 2000.” The poor Japanese, by contrast, can’t seem to get on the “bullet train of the New Economy.” The silly losers keep saving their money.
Even in Europe, credit cards are rare. I’ve been here, off and on, for nearly 5 years. I have yet to receive a credit card offer in the mail. Instead, people use debit cards – with each purchase immediately debited from their bank accounts. And lending in Europe is done by stodgy, conservative banks. The free-wheeling, aggressive credit industry of the U.S. does not exist.
But back in the U.S.A. the credit industry makes money available, when and where you want it. And people wanted it almost everywhere as long as the ‘wealth effect’ was working for them. As long as their portfolio statements showed dramatic improvements, month after month, they were happy to borrow, spend – and pump more money into the market.
This year, account statements have been less pleasing to behold. And the ‘wealth effect’ seems to have lost its mojo. Retail spending went down right along with stocks. Consumer spending increased by 0.5% in January, and 0.8% in February, after a 5.3% boost in all of 1999. But in the next three months consumer spending declined to just 0.2%. (Though yesterday’s figures showed it has been growing again in the Summer of Love.)
Meanwhile, savings followed exactly the same pattern. The savings rate hit bottom in February – with only $21 billion saved. But in May, Americans saved $38 billion.
Is the vast Pacific – which separates the savers of Nippon from the spenders of North America – finally shrinking?
Ouzilly, France August 14, 2000
*** Wall Street looked healthy last week. The Dow rose 260 points – or 2.42%. Friday gave the Dow a big boost – with a 119 point gain.
*** Twice as many stocks rose as fell over the week. And there were 3 times as many hitting new highs as there were hitting new lows.
*** The Nasdaq rose 29 points on Friday. This brought the index to a small gain for the week – plus 2.
*** So, things are looking up. The summer rally continues – with the Dow over 11,000 for the first time since April.
*** Investor’s Business Daily’s mutual fund index – which is probably a good measure of how ordinary investors are doing – is up 3% for the year. This is less than you could have gotten from a risk-free bond. But, my brother in law, an investment banker with Goldman Sachs, explained why people do not pull out of stocks… below…
*** A group of retailers are reporting earnings this week – including Home Depot, Toys ‘R’ Us and Nordstrom. Retail is 2/3rds of the economy, so this is important. On Friday, it was revealed that retail sales rose 0.7% in July, the biggest increase in 5 mo. But Gap shares went down anyway.
*** Dell computer also fell. Once again, we see the same problem – expectations are so high that good results aren’t good enough. Dell trades at over 50 times earnings. You’d have to be growing at 50% per year in order to justify that kind of a multiple. Dell’s operating results have been flat for the last three quarters. The stock fell to $37 and change.
*** Japan has been threatening to raise interest rates. Friday, it finally did so. But no one seemed to notice or care. You may recall, however, that Japan’s zero rate policy has been the source of much of the money that has driven the US boom to grotesque proportions. Traders borrowed yen and bought U.S. stocks and bonds. This ‘yen carry trade’ paid off big as long as the yen did not rise too much against the dollar.
*** Currency markets were mostly quiet on Friday. The euro is still holding above 90 cents.
*** As long as the dollar remains strong, it is probably clear sailing for Wall Street and the U.S. economy. Maybe there will be no huge gains… but there probably won’t be any huge losses either. “The key,” writes economist Bob Anderson, quoted by Gary North, “is trying to identify the catalyst that will precipitate the loss of confidence. My own opinion is that it will come from abroad… the growing foreign asset ownership in this country cannot continue as it has in the past. At some point, the ‘call’ will come, and it will be followed by massive panic.”
*** “The old-economy rules of prudence,” said Alan Greenspan, speaking to a meeting of the Council on Foreign Relations, “are as formidable as ever. We violate them at our own peril.” This does not sound like the same ‘Harry Potter’ Greenspan, the Wizard of the World’s largest banking cartel, who was so recently proclaiming the marvels of the New Era. Gary North explains: “Let it never be forgotten that Greenspan began his academic career at the Julliard School of Music, and then toured with Henry Jerome’s swing band. His is a jazz man. He can carry a tune, but he rarely sticks with it for long. He improvises.”
*** “Just tell me what tat is,” asked one DR reader following my letter entitled, ‘Tit for Tat,’ “and show me where I can trade it.”
*** “A guy gets rich, and suddenly all the busybodies and crybabies who refuse to produce something for a living want to bring him down.” Dan Ferris described an ancient tradition. Among Indian tribes of the Pacific Northwest, a man who failed to give away enough of his wealth might even be killed. Bill Gates can take comfort – he’s getting off easy.
*** And here’s a note in the Financial Times “Megawati set to take more power from Wahid.” The headline, which sounds like it might have something to do with a hydroelectric dam, actually refers to a shift in political power in Indonesia, where the president – a man whose brain has been certifiably damaged by a stroke – is giving up some of his authority to a woman with no obvious mental defects.