Downsizing America

by Barry Ritholtz

For the past couple of years, I have been giving a speech at conferences titled Downsizing America. It discusses a fact of life: America’s economy is getting a little smaller. This “shrinkage” is likely to be a secular – as opposed to cyclical – set of changes.

But that’s a touch of an exaggeration. What it really means is that U.S. consumers are going to engage in less-conspicuous consumption than they used to. The days of consumers making up 70% of US GDP are likely to fade. I expect to see the economy move back toward consumers being 65% – a sustainable level that existed prior to the credit and housing boom of the 2000s.

Out goes the conspicuous consumption of the 1990s and 2000s… Lean and green is in; grotesque and self-indulgent are out. Downsize that McMansion! Replace the SUV with something fuel-efficient! Save, instead of consuming!

This is much more than a philosophical view – it’s what all of the economic data over the past year have been practically screaming.

This will have a significant impact on the overall economy. And businesses are going to have to pick up some of the slack. Capital expenditures are going to have to do their part as the balance between consumer and business consumption reverts to more normalized ratios.

The present environment makes it likely that businesses will focus on investments that can pay for themselves quickly. That means expenditures on items like business intelligence software, ways to become more energy efficient, and the like.

But that’s just guesswork. In terms of actual data, here is what the new, leaner American economy looks like:

• Asset Deflation: Equity portfolios are on average down about 40%. Dividends are being slashed, stock repurchases canceled. Even with the recent rally, stocks are off more than 40% from their peaks. And on a national basis, home prices are down 25%.
• Consumer Spending: Down significantly, after the US had its worst Christmas retail-selling season in 40 years. The paradox of thrift – people saving at a time when the economy needs them to spend – has turned the savings rate positive. Conspicuous consumer consumption has been replaced with conscious capital conservation.
• Retail Stores: Have been extremely hard hit. Many of the big chains are filing bankruptcy like Circuit City, Linens ’n Things, The Sharper Image, Steve & Barry’s, Tweeter, Mervyns, and Fortunoff. The survivors like Starbucks, Macy’s, Sears, and Office Depot are closing stores left and right. In many cases, the surviving chains will see as many as 10–20% or more of their existing stores close. By the time we finally emerge from this recession in 2010, retail shopping will have a much smaller footprint than before.
• Employment: Over 4 million jobs lost already, with anywhere from 2–4 million more to go, the work force and labor pool are also being downsized. Unemployment broke through 25-year highs, to tag 8.1% last month. U-6, the broadest reading of unemployment (including part-time underemployment), was just under 15% in February; this is the highest reading in decades.

The only age cohort seeing employment gains is the 55-plus group. This is due to their ugly realization that the market collapse means they cannot retire. Hence, it’s back to work for the silvered-hair crowd:

• Finance & Wall Street: The Street has been hard hit – look for much smaller revenue, with staff cuts of 25–35%. The asset managers that get paid a percentage of assets under management have seen the value of their assets drop 45–50% – and with that comes a revenue drop of the same percentage. Who are the safest players? Those with green profit and losses, and/or substantial assets under management. And who is at risk, besides finance employees? Everyone else.
• Autos: US auto sales have simply plunged. Annual sales are down 37–50%, depending upon the nameplate – from an annual US rate of 15 million to barely 10 million cars per year. Its not just Detroit, either – Toyota, Honda, BMW, Lexus, Nissan, and Mercedes are also suffering.
• University Endowments: The intellectual engine of America’s brain trust has just taken an enormous hit to the frontal lobe: Harvard, Yale, Stanford, MIT, and others are down 25–30%-plus over the past 6 months alone. These big endowments fund professorships, grants, student scholarships, and pure research. The loss will be deeply felt over ensuing years, and even decades.
• Wages: US wages have been punished by globalization. They have been stagnant over the past 10 years. We are likely to see contractions in wages over the next 1–2 years or longer. This is consistent with our thesis of the downsizing of the US consumer.
• Media: Circulation and advertising dollars at major newspapers are falling. It’s likely that 50% of print newspapers will be gone, or web only, in 5 years. The Seattle Post-Intelligencer just went web only, the biggest such paper to do so yet. Will Fox Business channel, which launched at the peak of the stock market in 2007, manage to survive this onslaught? I’d say it’s less than even money.
• Pharmaceuticals: We witnessed huge 15–20% R&D cuts at several major pharmas (Pfizer’s huge research layoffs most recently). That means staff cuts also. This doesn’t bode well for new drug development and cures; the misallocated resources over the past decade have led to lots of dead ends. I expect to see a lot more consolidation in the pharma area, and more mergers between pharma and biotechs.

What is the sum total of all this? US GDP will contract 5–7% in 2009 Q1 and Q2, 2–4% in the second half of 2009, and will flatten in 2010. Back in 2001, we forecast the US economy could hit $15 trillion by 2010–11; that now gets pushed back to 2015–17.

There is a silver lining to all of this: First, the unhealthy reliance on credit seems to be going away. We cannot grow by borrowing and spending – but we can grow by producing and spending.

Second, the massive misallocation of capital in society has also been revealed. Out goes financial engineering, in comes making money the old-fashioned way – earning it.

Lastly, for those of you who managed to avoid the worst of the bloodshed – you may have moved to cash in early 2008 or (God bless) you were short for some of the run downward – this is a “target-rich environment.” Whether you are looking for value stocks, artwork, rare collectible automobiles, or vacation properties – there is many a deal to be had.

Those contractors who didn’t return your calls in 2005? They are begging for work. Toxic paper at 10–20 cents on the dollar ain’t all that toxic. And the owner of that 40-foot sports cruiser who can’t make payments is a motivated seller.

Note that this isn’t being heartless or greedy. Recessions end when values become so compelling that activity begins to pick up. We are not quite there yet, but we are much closer than we were a year ago.

Distressed sales create opportunities for the cash-rich buyer who was cool enough not to chase the top or get panicked at the bottom. Make a low-ball offer and see what comes of it.

Who knows, you might even help turn the economy.

March 25, 2009

Barry Ritholtz is author of Bailout Nation (Wiley).

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