It has been eight years since the financial crisis and the global economic engine is still struggling to get out of first gear. Growth and inflation both remain low, in spite of rock bottom interest rates and massive coordinated global quantitative easing programmes. Why is this the case and what are the implications for investors?
Many have subscribed to the ‘balance sheet recession’ school of thought, a thesis developed by Japanese economist Richard Koo, which suggests consumers retrench and try to shore up their balance sheets by paying down debt and spending less following periods of excessive borrowing. This “debt trauma” description has a proven history, not only in Japan but also in the US proceeding the great depression. The chart below shows the savings rate in the US; the proportion consumers save of their income. With each percentage point change in the rate potentially equivalent to $100bn in consumer spending1, the general rise since 2005 signifies a reversal of the tailwind that has been driving the economy since the 1970’s.
US savings rate – trend reversal?
Source: Bloomberg, December 1949 to December 2015.
One particular demographic group, so-called “millennials” (those born between 1980 and 2000), have borne the brunt of the crisis. Youth unemployment rocketed to its highest level ever in the US (peaking in 2010 at 19.5%)2 and remains stubbornly high in Southern Europe. Millennials typically completed their education saddled with high levels of student debt and found themselves in a job market that was anaemic at best. This coincided with central bankers attempting to stimulate global growth and creating extraordinary asset price inflation. As a result, many millennials have tempered, or at least delayed, their desires of home ownership and pared back traditional durable goods spending in favour of saving for short term goals like trips abroad.
Millennials represent the largest demographic group in the US and are forecast to be the biggest spenders by 2030. With US consumers responsible for more than three quarters of US GDP growth since 2001, the challenges faced by millennials and the subsequent stagnation of retail sales have been a significant headwind on the path to a rejuvenated economy. While partly attributable to this widespread deleveraging, there are also other drivers at work.
One advantage millennials have over their parents’ generation is being at the forefront of the rapid technological advancement and industrial disruption facilitated by the internet age. They not only have access to more information and choice than ever before, but they also stand to reap the most benefits from the ‘sharing’ or ‘gig’ economies heralded by this increased connectivity. New platforms have made it easy for anyone to exchange capital and labour and this is already wreaking havoc upon a number of traditional business models.
This well informed “smarter consumer” has again been in the spotlight following the poor results of retailers Gap, Macy’s and Nordstrom in the US. The new generation of consumers are forsaking traditional department stores in favour of fast fashion retailers, which are able to quickly supply the latest trends, manufactured cheaply and offer convenience through strong online channels and smart logistics. This fact is not lost on Amazon; the retail giant can claim a large responsibility for the continued disinflationary trend of durable goods (see chart below) – the vast economies of scale it enjoys allows it to sell goods at razor thin margins.
Disinflationary trends in durable goods
Source: Bloomberg, January 2002 to May 2016
Amazon’s apparel sector is among its fastest-growing categories and in 2017 it is expected to debut its own fast fashion line, supported by a 46,000ft2 photography studio in Shoreditch, London. As Amazon takes aim at another industry saddled with overcapacity, today’s shop assistants may soon find themselves tomorrow’s stock pickers.
Service sectors and the sharing economy
It is not only the apparel and durable goods industries that are under threat. Segments of the service sector have also felt the impact of the sharing economy, which we have published on previously. Given that users of services such as Uber and Airbnb typically belong to the higher income strata (see chart below), the rise of these services is disproportionately hitting spending on higher cost alternatives.
Moreover, when focusing on the supply side of these labour platforms (such as Uber) it is apparent that the lack of strong employer contracts enables an almost endless supply of jobs with no fixed hours. This may serve as a great tool for people to supplement their income, or as some would argue, may only serve to continue to suppress wages in their respective sectors as cheaper foreign workers are able to meet the increasing demand at lower prices.
US adults (at different income ranges) using the sharing economy
Source: Pew Research Center, survey conducted 24 November to 21 December 2015, May 2016
Given all of the above, it is difficult to forecast a meaningful pickup in inflation sufficient to stimulate wage growth. The economies of scale enjoyed by firms such as Amazon and Alibaba mean traditional retailers with their costly overheads are unlikely to be able to wrest back market share. Technological disruption is threatening to change the face of more and more industries, from banking to telecoms to manufacturing, mostly to make them cheaper and more accessible. To add further pressure, the rise of autonomous vehicles and 3D printing are also projected to threaten jobs in other sectors. And this importantly comes at a time when consumers are increasing their savings for the longest sustained period in four decades.
It is not, however, all bad news. As wider engagement with these new connected platforms takes hold, spending on them should continue to increase. This should provide more primary and secondary job opportunities for society, albeit at lower wages for now. These opportunities have mostly presented themselves at the lower end of the skill spectrum, but we may see them proliferate in other areas as people try and leverage their skillsets to maximize their earnings (or convenience), such as doctors providing ad-hoc online consultations.
Another factor to consider is the rapidly growing “experience economy”. 78% of all millennials would rather spend money on a desirable experience or event rather than a “thing”3. Perhaps this is why the services price level has remained robust as this group of consumers favours spending money on these rather than durable goods. Travel among this demographic has also increased at more than twice the rate of retail sales, as these consumers are travelling further and spending more than their predecessors.
All of these trends might persist and become permanent structural changes and attitudinal shifts. Or, in conjunction with advances in healthcare and longer life expectancies, millennials may simply be responding to the current uncertain economic climate by shifting consumption to later in life.
In our view, the result is likely to be somewhere in the middle. The trend of increasing disruption is not a new phenomenon; the average age of a firm in the S&P has fallen from over 60 years in 1958 to just 12 years in 20154. Creative destruction is truly alive but the difficulty lies in anticipating these changes while remaining cognisant of timing and the surrounding regulatory environment. Our approach to these structural uncertainties is to remain cautious if a firm is exposed to a pro-consumer cycle, preferring to invest in sensible large cap companies with a reason to exist and reliable revenue streams.
1Source: McKinsey, 2009, “The economic impact of increased US savings”
2 Source: Bloomberg data, US Bureau of Labour Statistics
3Source: FT.com, 12 February 2016, Eventbrite 2014 Survey
4AEI & Credit Suisse Research, “The Sharing Economy”, 18 September 2015
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The information in this article does not qualify as an investment recommendation.