Outlook

Demand for Debt limited, Outlook for Supply no better…. “How can I profit from this scenario?”

INVESTMENT INSIGHT: Invest in HIGH QUALITY companies – strong balance sheets – cash flow rich

“Despite various forms of support from the Bank of England and from Government, it is clear that the lending capacity of the banking system, in the UK and elsewhere, is impaired and will take some years yet to recover. Some banks need to continue de-risking and de-leveraging.” (Paul Fisher – Executive Director Markets and member of the Monetary Policy Committee – Bank of England)

 

As discussed, the outlook for the demand for debt is not looking rosy. Consumers, companies and governments are all focused on reducing the amount of borrowing on their “books”.  (See \”Isn\’t the consumer dead?..\”). On the other side of the equation, the supply of debt is also limited. Despite record stimulus packages, the amount of money that has reached the end user has remained muted.

In the US, commercial and industrial loans have fallen at an unprecedented rate.

 

Commercial and Industrial Loans at All Commercial Banks. Source: Board of Governors of the Federal Reserve System. Shaded areas indicate US recessions. 2010 research. stlouisfed.org

 

And in the UK, earlier this year, less banks stated they plan to increase supply of credit in June than March (BoE). Between Apr ‘11 and Jan ‘12 lenders are due to repay £185bn[1] raised under BoE special liquidity scheme. Furthermore, any banks that are able and willing to lend are being deterred with the threat of stricter global capital requirements looms as well as a tightening of credit scoring criteria.

INVESTMENT INSIGHT: Invest in high quality names, those with strong balance sheets, cash flow rich and therefore less likely to struggle needing to raise finance and instead more likely to have the capital to make value-adding acquisitions / increase market share

 

 

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What is a “Structural limitation to growth”? How can I exploit it?

 

The ageing of the populations within, for example, the US and UK is a structural limitation to the growth of the economy. (See “isn’t the consumer dead?” for an insight into the amount of the country’s net wealth this part of the population account for and the degree to which they are ill-prepared financially for retirement).

 

Source: Office for National Statistics

 

Within the UK, the percentage of the population aged over 65 (retirement age) increased from 15% to 16% from 1984 to 2009, over the same time span going forward this is to increase from 16% to 23% by 2034. This is a substantial decrease in the percentage of the nation generating an income, spending and boosting the economy and instead increasing the proportion of the populace reliant on healthcare, a state pension and other costs to the government.

 

INVESTMENT INSIGHT: to exploit this long term secular trend, invest in specific healthcare companies, nursing homes etc. Be wary that they may underperform a raging bull market due to their “defensive” nature but as a long-term play they may “pay dividends” (excuse the pun!)

 

“Isn’t the consumer dead..?”

 

“American households have shifted their cash flows from illiquid real estate and consumer durables to paying down mortgages and consumer debt…It is this rapid rise in aversion to illiquid risk that explains a large part of the anaemic recovery in the US.” Greenspan

 

Highlights

DRIVER OF REVIVAL: The US consumer has historically been a crucial driver of economic renewal

PRECARIOUS POSITION: Many worried about employment, have under-saved for retirement

STIFFLED STIMULUS: The propensity to spend (and boost the economy) will be limited

 

 

Answer

The importance of the consumer and the concerns surrounding the structural headwinds they face are undeniable. Consumer spending accounts for approximately 70% of US GDP (although I’ve read an interesting piece by Darren Marron arguing this figure is actually nearer 60% when spending on imports are dealt with more appropriately[1] but nevertheless, this is still a significant percentage). The magnitude of the problem has been well described by John Maudlin who pointed out that versus the last recession, we have seen “double the asset deflation, triple the job loss, coupled with a collapse in credit.” It doesn’t look likely that the consumer will be bouncing straight back!

 

Conference Board Consumer Confidence Index down 57% since 2007. Source: Bloomberg

 

On the subject of unemployment, although it is universally monitored, what has been missed by many is what the rate does not take into account. Salaries have been cut and working hours reduced. This adds to the misery of many consumers. Furthermore, it is these people who are working part-time that will be hired back into full-time employment before companies reach out to the many unemployed. This must be assessed within the context of an expanding labour force where a substantial amount of new jobs are needed every month in the US.

 

Looking forward, another key limiting factor on the consumers’ propensity to spend is the move to save instead, as they look to fund their retirement / non-wage earning years. The “Baby Boom” generation is expected to account for nearly 60% of net US wealth by 2015, according to a study by McKinsey,[2] and their turnaround from spending to focus on saving will be magnified by the fact that they have historically under-saved. The aforementioned report identified that as low as only 25% are “financially prepared for retirement”, thus the decrease in the spending habits of the vast majority will be significant.  Inside Europe the story isn’t much brighter and the UK pension gap (the difference between the income needed to live a comfortable retirement and the actual income individuals can expect from their current pensions) has been heralded as the “biggest in Europe”[3] by national papers. The OECD sets an average pension at around 59% of the earnings built during a full working career, a stark comparison with the UK’s 31%[4]. With relatively small public pension, an individual will need to make extra savings to ensure their standard of living does not drop dramatically as they move into retirement. This is not an outlook that will encourage the spending that will boost or even support the economy. (For a deeper insight into the ageing populations of the developed world see What is a \”Structural limitation to growth\”? How can I exploit it?)

 

 

Savings Rate, US. Source: McKinsey Global Institute analysis

 

ECONOMIC IMPACT: This points to a muted recovery instead of a “V” shaped bounce-back.

INVESTMENT INSIGHT: Look at companies which aren’t as heavily reliant on the Developed Consumer but with an international reach and operations within Emerging Markets. To exploit the ageing of the “Baby Boomers” within Developed Markets, see What is a \”structural limitation to growth\”? How can I exploit it? and invest in companies positioned to benefit from an increased reliance on healthcare, nursing homes etc.