The New Year's Resolution Paradox
As a new year begins, millions of us have renewed our souls with vitality, optimism, and those notorious goals referred to as "New Year's Resolutions". The question on everyone's mind is, "Will 2009 be a good year for the economy and stock market?" Although we are not in the business of predicting the future, we can look at present trends that can impact the year ahead. So let's look at a common New Year's resolution and how it could impact the economy and stock market.
Just like the holiday binge eater starts the new year with goals of diet and exercise, the American consumer is finally starting a fiscal diet following one of the greatest ever spending binges. As retailers have noted lately, the American consumer has started to cut back on spending. Some spending cuts can certainly be blamed on job losses and salary cuts. However, a modest trend is emerging... Americans are starting to save. From July 2008 to October 2008 the United States savings rate has climbed from 1% to 2.4% and is expected to level out at 5%. After years of negative savings rates, this trend is certainly good news and can be good for the economy in the long run. However, an increase in savings rate does not always bode well for the economy in the short run.
Economist call this odd phenomenon the "Paradox of Thrift." The paradox occurs when an entire society begins to save at the same time, and the more they try to save the less they have to save. You see if I decide to cut back a little it sparks a chain reaction. For instance, my daughter wanted to order pizza Friday night. Since my children know how to ask with that "look" I have no choice but to say okay. But, we are trimming our budget, so we decide to walk. It's just a few blocks, a nice evening, it saves gas, and it's exercise (another New Year's resolution). Not only did we save money by walking, but instead of buying the $20 pizza, we ordered the $15 pizza. The consequences of our Friday night behaviour is that both the convenient store owner and the local pizza joint owner made a little less money from me. Both of these store owners now have less money to spend themselves, and ultimately, less to save. As more and more people begin to cut back, they will actually end up with less to save, thus the paradox of thrift. Savings is good on the individual basis, but self-defeating if taken on by the whole.
In the long run, money will be saved. It is estimated that a 5% savings rate in the United States would add up to $5 trillion in ten years time. Without argument, an extra $5 trillion will go a long ways to strengthen the economy and our finances. However, a 5% saving rate could translate into a sluggish economy for 2009. With a US stimulus package coming soon and world wide efforts to shore up economies, the economy could surprise us either up or down. As noted in previous articles, the stock market doesn't always follow the economy. Historically, the stock market starts to recover six months before a recession ends. And that exact point can only be seen with the benefit of hindsight. At times like this, it is always helpful to look at what certain Wall Street legendary investors are doing. Investors such as Warren Buffet and Jeremy Grantham have unprecedented track records of ignoring market noise and investing successfully for the long term. The following are a few exerts I have collected over the past few months.
Bullish Buffett. The billionaire chairman of Berkshire Hathaway, Warren Buffett, has already started buying American stocks that he thinks are undervalued. In a New York Times op-ed piece on Oct. 17, he wrote that, "Equities will almost certainly outperform cash over the next decade, probably by a substantial degree. Those investors who cling now to cash are betting they can efficiently time their move away from it later. In waiting for the comfort of good news, they are ignoring Wayne Gretzky's advice: 'I skate to where the puck is going to be, not to where it has been.'"
Looking-Up Leuthold. Steve Leuthold, the usually bearish investment manager for the Leuthold Group, was recently interviewed by Barron’s Magazine. His firm looks at 28 different factors including price-to-earnings (P/E) and price-to-sales ratios, and they are quite positive, in his opinion. He notes that the P/E ratio is in the 15th percentile over the past 55 years, and that has been where markets have often bottomed out. He believes that on a valuation basis the market is cheap. He likes both domestic and non-domestic stocks.
Going-Global Grantham. Jeremy Grantham of the $200 billion investment firm GMO is convinced that by October 10, global equities were as cheap on an absolute basis and cheaper overall than at any time in 20 years. In his two-part quarterly report, Grantham explained that while foreign stocks are even cheaper than domestic stocks, American equities were also cheap when the S&P 500 was at 900. Recently, the S&P dropped as low as 818. Lest you get too excited, he acknowledges that markets tend to overreact both on the upside and the downside. Thus, while the S&P might look cheap at 900, he thinks it could go lower. It's noteworthy that he is buying even though he thinks the market could go down significantly further in the short term.
We can't control recession, society's savings rate, or the stock market, but we can control our own behaviors and attitudes. To kick the new year off right, we have created several useful tools for budgeting, savings, and eliminating debt to keep those New Year's resolutions on track. You can find them on under the Calculators tab on our web site at www.SynergyOnWallStreet.com. Feel free to download and share them with anyone who could benefit. As for our attitudes, we view 2009 as a year of opportunity, family, and friends.
Wishing you a prosperous new year.