Banks, Tanks & Angst - How Long Will America Idle?
Banks, Tanks & Angst – How Long Will America Idle?
Subtitled: A Collection of Reflections on an Economic Direction Correction during an Election
(A Confection of Rejection NOT to be Confused with a Recession)
With all of the craziness in the economy today, I felt it might be time to have a nice fireside chat to help explain what’s going on in America, and WHY all of these things are happening. Are you ready? Then let’s begin.
First, I have a confession to make – I voted for Ross Perot. I was young. It was my first election. He was a short guy with bad hair, I thought we had a lot in common. The real reason was for the graphs. Here was a guy with the audacity to think he could run America by PowerPoint. Actually, that was pre-PowerPoint, so if you remember, he used giant charts and graphs. So for tonight’s fireside chat, I’ve decided to imitate his presentation style and have prepared an homage to Ross Perot and entitled it Banks, Tanks, and Angst - The NEW American GRAPH-iti – How Long will America Idle?
But before we talk about the NEW American GRAPHiti, let’s remember the original. The original American Graffiti was a “coming of age” movie directed by George Lucas 35 years ago back in 1973 and featuring aspiring young actors including Richard Dreyfus, Ron Howard, Harrison Ford, and of course, Wolfman Jack - all of whom went on Hollywood fame, fortune, and male-pattern baldness, except, of course, for Wolfman Jack. Just as this “coming of age” movie provided a nostalgic look back at life in the 60’s, tonight’s fireside chat will attempt to provide a nostalgic look at life in our country over the past 10 years…the 10 YEARS when EVERYTHING CHANGED for the American Consumer. Tonight we’re going to trace how we went from Goldilocks to Gridlock in 12 short months, and how it wasn’t 3 bears but 6 that eventually conspired to kill the longest bull market in US history – and those bears are named Healthcare, Housing, Heating, Hotels, Higher Education, and Travel. (Sorry, I couldn’t find another H word). I wish I could say this is going to be a just another fairytale – that I could just Mother Goose these numbers and make everything better – but I can’t, and I’m afraid now that America’s nest egg has been poached, even if all of the kings horses and all the kings men went to the government’s discount window, we still won’t be able to put Humpty Dumpty back together again.
What I’d like do tonight is to paint a portrait for you of the American Consumer – some parts are going to be general, and some are going to be very specific – to provide a true and accurate representation of the psyche of our populace, how we got here, and where we’re headed.
CHAPTER 1: Higher Education
Since the year 2000, tuition costs for college have skyrocketed 60%! In fact, just from 2001 to 2006, average tuition at public universities jumped 35% after adjustment for inflation, the largest five-year increase on record, according to the College Board.
According to a March 25th article in MSN Money, “When you include tuition, room and fees, the total cost of attending an elite private university, like Harvard or Columbia, hovers around the $50,000 a year mark.” According to FinAid.org, between 1989 and 2005, the college inflation rate was DOUBLE the general inflation rate.
HOW did we PAY for this? In the April 8th 2008 Wall Street Journal, according to the College Board, in 1997 parents and students took out $1.5 Billion in private loans to pay for college. Ten years later in 2007, they took out $17 Billion in private loans to pay for college:10 TIMES MORE!
Here’s the bottom line: Over the past 10 years, the COST of Higher Education has more than DOUBLED, and the Consumer’s INCOME hasn’t. To capture this data point visually, I have prepared this graph - but in the event you can’t see it - you’ll just have to imagine, two lines on an XY axis, starting from the origin, and extending out 10 years. Or better yet, picture the face of the clock, and the positioning of the hands when the time is 1:13, with the short hand pointing at the 1 - representing the skyrocketing cost of Higher Education, and the long hand pointing to 13 – representing the sluggish growth in Consumer Income.
CHAPTER 2: Travel
Over the past 10 years, America has quietly become a nation ENABLED by cheap travel – and now it’s GONE. For as far back as we can remember, gas and oil and travel have been relatively inexpensive. So what did we do – we built cheap travel into our lifestyle. We’ve created far flung families, enabled by cheap flights on Southwest Airlines to keep our Christmas and Thanksgiving and Easter family reunions intact. We’ve become accustomed to $49 hotel rooms and $99 a week rental cars. Many people now live 50 to 100 miles from work – “extreme commuters” they call them - who say they HAVE to live that far from downtown in order to afford the right housing and go to the right schools.
The Bad News – you already know. Over the past few years, the spigot for cheap travel has quietly been turned off. $126 for one barrel of oil! In the second week of May, gas hit an all-time high of $3.71 a gallon according to AAA, up 21% over last year, and now it’s up significantly more! During the first 2 weeks of April, 4 airlines filed for bankruptcy, including ATA, Skybus, Frontier, and even Aloha airlines waved goodbye for the last time, citing the high price of fuel. For the airlines that remain, it’s getting so ugly that, according to USA Today, ticket prices jumped 60% over the past 12 months, and they’re STILL losing money! In fact, in 2007, there were 23 airline price increases. In 2008, we’ve already had 14 increases, and that’s just the first 4 months - with the average fourth quarter airfare now rising to $331 according to the Department of Transportation. So, those $49 flights of yesteryear now cost almost $350 IF you can get a seat, IF the flight departs on time, heck, IF the flight departs at ALL! Not since the Wright Brothers has air travel been so wrong, with over 25% of all departures delayed last year, prompting airline executives to launch their new “Better Late Than Never” marketing campaign. Flight delays and cancellations, plus charging $6 for seat assignments and $25 for extra bags have all contributed to an increase in customer complaints of 60% in 2007 according to the Airline Quality Rating report, prompting frequent fliers to launch their OWN slogans including “United We Sit” and “Delta – It’s DELAY without the Tea or explaining the Why.” Add to this the skyrocketing price of hotels and you know why thousands of truckers went on strike and walked off the job in April, as diesel fuel increased over 15% in MARCH ALONE, causing them to actually LOSE MONEY on every delivery they make. It’s amazing – I mean – what I pay to FILL my Malibu is what it USED to cost to FLY to Malibu! What I pay to FILL my Monte Carlo, is what it USED to cost to FLY to Monte Carlo. What I pay to FILL my Saturn is what it USED to….well, you get the point. In short, Americans are spending more to put gas in their furnace AND gas in their Focus – meaning they’re putting more in the tank, and less in the bank.
Here’s the bottom line: Over the past 10 years, the COST of TRAVEL has more than DOUBLED, and the Consumer’s INCOME hasn’t.
Let’s see if I have a graph – oh, here we go – it’s the same graph from before.
CHAPTER 3: Healthcare
Healthcare – UGGH – where do I start? I only put one log on the fire tonight, so let’s see if we can keep it simple. If only I had a graph – oh wait, here’s one – it’s the same graph from before. The cost of HEALTHCARE has more than DOUBLED over the past 10 years, and the Consumer’s INCOME hasn’t.
The entire issue of healthcare can be summed up pretty simply, and it all comes down to this – Who’s going to make the decisions on what’s best for your body: YOU or the GOVERNMENT. The problem in America is this – we want it BOTH WAYS. Let me illustrate it this way.
What if a man was speeding through your neighborhood every day, and every day a cop pulled him over and gave him a warning, saying you’re driving dangerously and if you keep doing it you’ll kill somebody. What if he did this for 10 years, and then one day a kid suddenly ran out into the road and the man killed him because he was driving too fast. Who’s responsible? Who should have to pay for this? This man’s repeated behavior over a long period of time created a situation where tragedy was virtually inevitable. It’s the same with health. If you’re 20, 30, or 50 pounds overweight, and the doctor tells you every year for 10 years during your annual physical to lose weight, eat healthy, and exercise, then one day in your 40’s you have a heart attack, or are diagnosed with diabetes, who should have to pay for that?
People want the authority to make their own healthcare decisions, but don’t want the responsibility or accept the consequences of their high-risk lifestyles. As of 2007, 2 out of 3 Americans were overweight or obese, as are 1 out of 6 children, with projections for this to reach 75% of adults by 2012 – is it any wonder “The Biggest Loser” is such a hit? Perhaps the best solution is a healthcare system which determines cost responsibility based on whether the patient situation is an “ACCIDENT” or an “ON-PURPOSE” - those things representing the accumulation of lifestyle choices, which contribute to the existence of a condition. Heck, airlines have already started charging to carry extra weight; car insurance premiums increase for high-risk drivers; it seems only fair that the healthcare system should advocate personal responsibility by having premiums that reflect the health choices of individuals. Universal healthcare would effectively penalize personal responsibility and reward personal irresponsibility. It’s about time Americans understood that the key to HEALTH is to CARE for yourself first, and if our nation doesn’t get this problem fixed soon, we’ll soon become a two-tiered system – offering either “Wealth-Care” or Welfare. (In fact, if you think healthcare is expensive now, wait till it’s FREE!)
Here’s the bottom line: The net result of the past 10 years of health choices is that healthcare costs are now DOUBLE what they were 10 years ago, with more and more employers either passing along the cost or refusing to offer healthcare coverage at all, resulting in 47 million Americans with no healthcare insurance at all.
CHAPTER 4: Food
With global food prices rising 75% since 2000, and wheat prices increasing 200%, commodity investors everywhere are finding it hard to go against the grains. According to CNBC, rice and soy have also hit record highs, and with its bushel price up over 50% from last year, suddenly EVERYONE knows why Jimmy cracked corn. In addition, the National Restaurant Association reported that the price of cheese has jumped 25%, flour prices have doubled, and eggs are up 70% over the last year ALONE. As a result, wholesale food prices rose over 7% in 2007, the fastest rise in 20 years. 7% in JUST ONE YEAR! With costs over $3.50 a gallon, it seems like both milk AND gas are in a neck and neck race to break the consumer. Speaking of which, I wonder what it would cost for a barrel of milk?
Here’s the bottom line: Over the past 10 years, the COST of FOOD has more than DOUBLED, and the Consumer’s INCOME hasn’t.
Let’s see if I have a graph – oh, here we go – I believe you’ve seen this one before.
CHAPTER 5: Housing
I’ve saved Housing for last, because it gets the most attention, and it should. Why? Because it represents the LAST STRAW. Housing was the ONE THING that bought the American Consumer a little more time. If housing values hadn’t skyrocketed since 2001, the consumer would have hit this tipping point shortly after the dot com bust, and many have suggested Fed Chairman Alan Greenspan’s policies show that he was fully aware of this. The housing frenzy simply bought us a little more time, a “stay of execution” if you will, but now even that’s gone. The Amazing Appreciating Home served as Americans’ personal ATM for a good 4 years, as people refinanced and re-re-financed and took out home equity loans, treating their dwelling like a bottomless piggybank to pay for things beyond their paycheck, including the increased cost of Higher Education, Travel, Healthcare, and Food just discussed.
Over the past 10 years, there has been an uncoupling of the relationship between the median income and the median price of a home, and that uncoupling started accelerating around the year 2001. According to MSN Money, “Across the country, housing prices have RISEN an average of 45% over the past 6 years according to the National Association of Realtors, while the median income for working-age households is DOWN 4% since 2000 according to an Economic Policy Institute analysis of Census Bureau data.” So much has been written about this over the past year, I don’t know which is greater – the red ink taken on financial balance sheets or the black ink by pundits writing about it! In fact, I have to include myself in that number, as my recent articles, “Is Wall Street Smarter Than a 5th Grader?” and “Homes and Homers: Life After Steroids” both investigate the nuances of the real estate boom and bust, or as I put it, “The biggest pyramid scheme since the Egyptians.”
As any psychologist will tell you, there are 5 stages of grief: Denial and Isolation, Anger, Bargaining, Depression, and Acceptance. The fact that neither the President nor the Fed Chairman can scarcely utter the “R” word without a giant helping of caveats, demonstrates where they fall in this continuum. I mean, you FIRST have to be able to SAY the word “Recession” before you can begin the 5-step program towards recovery, and this is true for home sellers as well. You can quickly determine where in the “5 Stages of Housing Grief” a seller falls, just by listening. If they keep referring to “comparable sale prices” from homes sold in 2006, they are still in denial as to the radical re-pricing of the real estate market, as U.S. housing markets dropped in February at the fastest rate EVER! According to Standard & Poor’s home price index of 20 metro areas, year over year prices in February were DOWN 12%, with prices in Cleveland falling 9% and prices in Las Vegas falling a startling 22%! For those STILL in denial, I’ve included a few more statistics on the hemorrhaging housing market to help them accelerate through the grieving process towards “Acceptance.”
The median price of a new home in March - compared to a year ago - FELL by the largest amount in nearly four decades.
The median price of an existing single-family home was down 8.7% year-over-year, the largest drop on record.
The Commerce Department reported that sales of new homes plunged by 8.5 percent in March to a seasonally adjusted annual rate of 526,000, the lowest level in 16 ½ years.
According to MSN, home sales declined 23% from January 2007 to January 2008, according to the National Association of Realtors. The slide has continued month-over-month this year, even as prices continue to fall, and the National Association of Home Builders reports a 10-month supply of new homes on the market, compared with a 4.5-month supply in 2005.
Having gone on a nationwide housing price BINGE, we are now enduring the inevitable PURGE process, as home prices undergo a painful but necessary reversion to trend. From 1982 – 2001, median existing home prices grew at a 4% per year trend rate. Once the Fed dropped the funds rate to 1.75% in 2001, home prices surged, growing 8% per year all the way through 2006, double the previous 19-year trend pace, and putting them almost 40% above trend in 2006! Home prices have started to correct, with a 2 ½ percent drop in 2007, and 7% already this year, but they still need to fall another 12% if they are to revert to trend by next year AND if they are to begin to approach affordability thresholds in this new era of mortgage loan accountability. And while home pricing more aligned with income is ultimately a GOOD thing, the unfortunate byproduct of this reversion to trend is that over 8 million American homeowners are now “upside down” - stuck with a mortgage amount greater than the worth of their house.
Here’s the bottom line: Over the past 10 years, the COST of HOUSING has nearly DOUBLED, and the Consumer’s INCOME hasn’t.
Let’s see if I have a graph – here’s a slightly used one right here – showing a startling increase in the COST of HOUSING, and a comparatively paltry increase in consumer INCOME.
CHAPTER 6: Mind the Gap
The phrase, “Mind the Gap” is repeated hundreds of times daily on the London Underground rapid transit system, as a warning to train passengers reminding them of the sometimes significant gap between the train door and the station platform. Unfortunately, the same warning now needs to be applied to our economy, except this time to apprise political and financial leadership of the SIGNIFICANT GAP created over the past 10 years between consumer COSTS and consumer INCOME. The Gap Analysis outlined via graphs and narrative in the first 5 Chapters describes just SOME of the factors contributing to the new economic period we are about to enter – an era I’ve decided to call LAGFLATION. In short, LAGFLATION describes our current, unprecedented, and precarious financial situation where the average American income LAGS the cost of the average American lifestyle. It is this GAP that will define America’s next economic cycle.
Having spent the first 5 Chapters outlining the CAUSES of LAGFLATION, let’s take some time now to discuss the EFFECTS of LAGFLATION, and then wrap up with a strategic discussion of the best way for businesses, consumers, and policymakers to proactively position themselves for the tough years ahead.
The first and most logical effect of the LAG between consumer income and consumer cost is the decision to incur DEBT to fill in the GAP between consumer cash inflows and cash outflows. According to Bill Hampel, chief economist for the Credit Union National Association, “The run-up in home prices in the middle of this decade led consumers to take on much higher levels of debt than in the past. As long as home prices continued to rise, homeowners were able to tap into home equity lines of credit, but with home prices falling and credit suddenly tight, many households have lost this extra source of income. He continues by saying, "What happened in the short space of the last five years was pretty scary - household debt rose to about 125% of income. It hadn't ever been 100% before that. It took consumers a long time to get into these conditions and it's going to take a long time to get that fixed.”
According to the watchdog group Demos, homeowners tapped $1.6 trillion in home equity from 2001 to 2006 to access cash, and the Washington Post reported on March 27th that consumer debt has doubled in the past 10 years, from $1.3 trillion to $2.6 trillion, with consumers spending 15% of their after-tax income just to stay current on household debt. MSN Money summed it up succinctly in their April 21st article saying, “For the first time since the Great Depression, Americans have a negative savings rate of 4%. Between 2000 and mid-2007, the median home price soared 64.9% to from $139,000 to $229,200, while the median income rose just 16.6%.” To make sure their clients don’t add additional debt onto THEIR balance sheets, America’s largest home-equity lender Countrywide notified 122,000 homeowners in January that their home-equity lines had been frozen because their homes had lost "significant" value.
The American Consumer is already pulling out all the stops to stay afloat financially. At Craigslist, which has evolved into an online flea market, the number of For Sale listings more than DOUBLED to 15 million since last March, and at Auctionpal.com, online For Sale listings rose 66% just from February to March this year, as desperate people liquidate any possessions they can find to buy a little more time. With all other sources of cash gone, consumers are turning in shocking numbers to credit cards. In fact, the Federal Reserve reported on May 7th that Americans’ credit card debt jumped 6.7% in the first quarter to $957 billion, but without the INCOME means to repay this borrowing, debt rating agency Moody’s reports that credit card delinquency rates have already hit a 4-year high of 4.53% in February, with no reason to believe that this trend will improve any time soon.
CHAPTER 7: Foreclosures
With the easy-money refinancing and home-equity cash spigot securely turned off, consumers have become increasingly unable to cover the Cost-Income GAP, with the inevitable result being a historic increase in FORECLOSURES. According to Moodys.com, over 870,000 homes were lost to foreclosure in 2007, and another 1.3 million will be lost in 2008. March marked the 27th consecutive month of year-over-year increases in national foreclosure filings, with the number of homes receiving at least one foreclosure filing jumping 57 percent in March to 234,685, compared with 149,150 a year earlier. CNN reported on April 29th that foreclosure filings in the first quarter of 2008 rose more than 112% over last year, with foreclosures up 178% in nearby Youngstown, OH in February over a year ago.
Real estate information firm RealtyTrac reported that nearly 650,000 foreclosure filings were issued in the first quarter, representing an increase of 23% from the last quarter of 2007, and it could get significantly worse, as a record number of adjustable rate mortgages – worth $362 billion – will reset with HIGHER interest rates in 2008.
CHAPTER 8: Bankruptcies
Drowning in debt, and with their home foreclosed on by the bank, many consumers have had no choice but to declare bankruptcy, causing bankruptcies to soar 27% in the first quarter of 2008. According to Reuters’ May 2nd article, bankruptcy filings by U.S. consumers jumped 47% in April from one year ago, representing over 92,000 bankruptcies in a single month (and a 7% increase over March alone) with current full-year estimates projecting 2008 filings to exceed 1 million bankruptcies.
With all of these compounding issues weighing down on the economy, is it any wonder Reuters discovered that the consumer’s mood tumbled to a 26-year low of 63.2 in April. And a new report by the Pew Research Center on April 8th says that, “About 60% of Americans believe they have not financially advanced over the last five years” - and as we’ve discussed, those were the GOOD years! As of 2006 (the last year for which trend data are available), real median annual household income had not yet returned to its 1999 peak, making this decade one of the longest downturns ever for this widely accepted measure of the middle-class standard of living.
CHAPTER 9: Jobs
Further contributing to the morose mood of the consumer has been the job market, with an April 23rd release reporting jobless claims at their highest level since 2005. According to a May 1st Reuters report, initial jobless claims rose by 35,000 and the number of workers remaining on jobless benefits climbed to a four-year high. Devastated by the housing correction, over 457,000 construction jobs have been lost in the past 20 months – that’s an average of over 22,000 jobs a month lost, just in one sector. Overall, the U.S. economy has already lost over 280,000 jobs in 2008 - an average of 70,000 jobs a month - and it’s only the first week of May.
CHAPTER 10: Businesses
As you can probably tell by now, this fireside chat doesn’t have a happy ending. When 2/3 of the American Economy is based on consumer spending, and when the American consumer is mired in the quagmire of LAGFLATION just described - without enough Income to cover their Costs - there won’t be much of anything left over to spend, and retailers are learning this the hard way, as chain after chain report huge losses OR are forced into bankruptcy. According to an April 15th New York Times article by Michael Barbaro, “The consumer spending slump and tightening credit markets are unleashing a widening wave of bankruptcies in American retailing, prompting thousands of store closings that are expected to remake suburban malls and downtown shopping districts across the country. Since last fall, eight mostly midsize chains — as diverse as the furniture store Levitz, Sharper Image, and Bombay – all have filed for bankruptcy protection as they staggered under mounting debt and declining sales. And just last week on May 2, Linens ‘n Things - with 589 stores in 47 states - filed for bankruptcy.” Even those retailers lucky enough to avoid bankruptcy are shutting down stores to preserve cash. Over the next year, Foot Locker said it would close 140 stores, Ann Taylor will shutter 117, and the jeweler Zales will close 100. In addition, Charming Shoppes, which owns Lane Bryant and Fashion Bug, is closing at least 150 stores, Wilsons will close 158, and Pacific Sunwear is closing an entire 153-store chain called Demo. The International Council of Shopping Centers estimates there will be a total 5,770 store closings in 2008, up 25 percent from 2007, and the vacancy rate at U.S. strip malls rose to its highest level since 1996 in the first quarter of 2008, with big mall vacancy rates not far behind.
In case you’re still not convinced, here are a few more year-over-year comparable sales statistics just released in April:
The Limited – down 8%, Nordstrom – down 9%, Abercrombie & Fitch – down 10%, American Eagle – down 12%, Gap – down 12%, Kohl’s – down 16%, Stein Mart – down 17%, and the stock price for Starbucks, the “poster child” for disposal income consumption, is down 46% over the past year – with it’s 5-year stock chart following a nearly identical path of the housing Boom (hitting a high in early 2006) AND Bust (hitting a 4 year low today). Actually, the retailing sector tells an entire “story within a story” regarding the state of the American Consumer. Over the past 12 months, the stock price of Macy’s, Sears, and JC Penney are DOWN 39%, 42%, and 43% respectively WHILE, during this same period, The Dollar Store was UP 6%, Wal-Mart was UP 19%, and Costco was UP a staggering 34%! Consumers are not walking but RUNNING AWAY from even moderately priced retailers and flocking to the absolute CHEAPEST retailers in town. In fact, the story of Target is the most prescient insight into the current state of the consumer. Long considered a “peer” of Wal-Mart in value-priced merchandising, Target made the exact WRONG decision at the WORST possible time last Spring, as they decided to position their products and brand a little further “upstream” in terms of perceived quality and appeal. Frankly, they should rename this company “Off-Target” as they introduced more costly items at a time when consumers were being increasingly squeezed financially, resulting in their stock dropping 8% over the past year, while their “peer” Wal-Mart did just the opposite – lowered their prices – and increased their stock 19%.
This same dynamic is being played out in EVERY sector and vertical in the market, with brand loyalty becoming a thing of the past and PRICE becoming the singular obsession with the consumer, as further evidenced by bare-bones McDonald’s, UP 22% over the past year, and Brinker International – which owns casual dining’s Chili’s and Macaroni Grill - DOWN 28%. Hence, we should not be surprised that the National Federation of Independent Businesses “Survey of Small Business Optimism” in the U.S. sunk to a 22-year low in March - the lowest reading EVER – as small business owners clamped down on plans to create new jobs and expand business operations.
When the stock prices of Kohl’s, Starbucks, and Target are down, and Costco, The Dollar Store and McDonald’s are up, consumers are sending a clear message of LAGFLATION – and looking for ANY WAY to “Mind the Gap” between their increasing COSTS and lagging INCOMES. In fact, I’m sure that if there were stores offering CHEAPER prices, consumers would immediately flock to THOSE stores.
CHAPTER 11: Four Prophetic Predictions – What Happens Next?
While the first 10 Chapters of this story have been spent painting a contemporary portrait of the American Consumer based on a wealth of supporting and backward-looking facts and data points, the balance of this fireside chat will focus on extrapolating these findings by employing pattern recognition to project behavior and trend analysis of the economy over the next 3-5 years.
Prediction #1: Home Near the Range
As we’ve already established ad nauseam, the average American Consumer is now effectively under “house arrest” – paralyzed by declining home values, a challenging buying and selling environment because of new mortgage standards, and the widening GAP between monthly COST and INCOME. Within this economic context - when combined with high gas, travel, medical, education, and restaurant prices - AND having spent the last 5 years creating their own home “bunker” – complete with gourmet kitchen, exotic patio, home office, home entertainment system, home theatre, home spa, and home security system, it’s not too difficult to guess what Americans are going to do for the next 3 years – STAY HOME! This is bad news for anyone in travel, leisure, and hospitality industries - as cash-strapped families instead create their own “Staycations” close to home - and because the American Economy is now beyond the Tipping Point, this is BAD NEWS for anyone in the service sector dependent on tips. We’ve already turned over all of the sofa cushions and sorted through the french-fries in the backseat of the minivan to collect the last few nickels and dimes to pay our bills, so this will also be a tough time for purchases suddenly reclassified as “luxury items” like XM Radio and other industries where people can get similar experiences for free (fostering a growing surge in library patronage versus Blockbuster and Borders).
Prediction #2: The New Era of “Surgical Shopping”
The next 3-5 years will witness the introduction of a new precision buying strategy called “Surgical Shopping.” In fact, if you were paying attention, you caught the first glimpse of this phenomenon last Christmas. As you recall, our hero, the American Consumer, STILL had the same 10 gifts to buy, but this year they only had $200 instead of $500 to spend. So what happened? People did what they ALWAYS do – they acted in their own best interest. They asked themselves, “How can I buy $500 worth of gifts for $200? I know, I’ll wait for the RIDICULOUS Black Friday 6-hour deals and pounce on them.” Last year, the number of people camping out at retailers for their “Midnight Sales” or 4am openings was overwhelming, but they didn’t stick around. These Surgical Shoppers went JUST for the printers marked down to $25 or other 75% off deals, and then they went home, completely ignoring the other higher-margin products in the store. As a result, the brain trust on Wall Street took this first day turnout to proclaim “Good news of great joy” for the holiday season, but look what happened – the Christmas season was a disaster, the worst in 5 years. So then well-paid analysts said, “Just wait until all of those gift cards are redeemed in January,” and THAT never happened, and then they blamed the MARCH numbers on an early Easter, and then the APRIL numbers on an early Easter, and on and on it will go, until they finally connect all of the dots listed above.
For the next 3-5 years, Surgical Shoppers will continue to “cherry-pick” retailers, going in for their weekly or seasonal “loss leaders” and then, simply, leaving. After a few months of this, retailers will begin to notice the trend and start to label these shoppers “Loss Leavers” – where the customer buys just the sales items, the retailer takes the loss, and then the customer leaves. In this new economy, the Surgical Shopper will still go to Bed, and take a Bath, but they won’t be able to afford much BEYOND that (in fact, Bed, Bath, and Beyond just reported quarterly net profit in April that fell 16% and gave a first-quarter earnings outlook WELL below Wall Street expectations).
Surgical Shoppers DON’T CARE about wide aisles, decorative lighting, and the fake wood flooring in your Wine Shelter (I’m talking to YOU Heinen’s). I’ve been to those stores this year and guess what – they don’t NEED wide aisles because the store is EMPTY! Do you know what stores have people waiting for them to open at 8am? The ones with the tiny aisles and the bad lighting and no deli – but they’ve got LOW PRICES (I’m talking about you Marc’s). Remember, today’s consumer is deciding where to buy milk based on who has the lowest price this week, and they watch the daily movement in the price of crude oil to determine which day to buy gasoline – so they won’t be cajoled into shopping at your high-priced grocery store just because you’re offering samples of pomegranate on melba toast…but 75,000 people WILL wait in line for 3 HOURS for a 23 cent pizza from Papa John’s!
Prediction #3: A Cultural Shift to “Good Enough”
At Berkshire Hathaway’s annual shareholder meeting on May 3rd, CEO Warren Buffett repeatedly warned investors to lower their expectations saying, “Anyone that expects us to come close to replicating the past should sell their stock; it isn’t going to happen. We’ll get decent results over time, but not indecent results. We are very happy at making money at a rate in the future that’s much less than the past…and I suggest that you adopt the same attitude.” Arguably the most famous investor of our time, Warren Buffett effectively summarized a seachange in not only the financial, but also the cultural tenor of our time. The next 3-5 years will be marked by a radical shift to “Good Enough” in nearly every facet of society, as companies strive to retrench financially and a nation of desperate housewives strive to live within their fiscal means. For businesses, this will mean switching from Hilton to Hampton, Overnight FedEx to 2nd Day or snail mail, and Coach instead of Business or First Class – IF they still decide to take the trip in the first place (which will be good news for web meetings and teleconference providers).
For consumers, the “Good Enough” shift has already begun. Private hair salons are laying off stylists, while Great Clips – offering $5.99 haircuts – ranked 19th in Entrepreneur Magazine’s Top 500 Franchises of 2008, as consumers decide that a $5.99 haircut is Good Enough and a $50 salon visit is no longer required – and ditto for Starbucks. According to the Plain Dealer, if the first quarter numbers in the automotive industry hold true for the year, it will be the worst sales year in a decade, and Ford has already called it the worst March in 15 years. In fact, when I saw a TV commercial on April 6th advertising, “Buy one Kia, get one free!” I knew the Good Enough shift was already in full gear, as auto companies were willing to GIVE AWAY A CAR just to make a sale. As the sales statistics continue to demonstrate, Americans as a nation have decided that they no longer need a brand new car and/or that they no longer require a premium brand badge, as evidenced by Hyundai’s sudden surge in popularity – offering Lexus-level quality at a fraction of the price. In the Good Enough era, firms like Hyundai -which allow consumers to continue to enjoy the premium features they have come to love but at a much lower cost – will be best positioned to weather the growing economic headwinds (and this would go for much of the used car market, used video game stores like GameStop, and consignment shops as well).
The Good Enough mantra will be also be applied around the home, as people increasingly eliminate or reduce grass cutting and house cleaning services (deciding instead to save money and do it themselves) and kids will hear a word that many have never heard before: NO! No you can’t have a new laptop, $90 sneakers, $40 sunglasses, iPods, fancy cell phones, a new video game every week, private oboe lessons, private college, and the American birthright of a car on your 16th birthday. There will be little help for the remodeling and construction industry, as people cancel or delay putting in new pools, decks, and kitchens; golf country club memberships will go un-renewed, and executives won’t relocate for a new job because either they can’t sell their homes OR they risk losing significant equity in the transaction. Movie Box Offices shouldn’t expect the consumer to obsess about trying to keep up with the Indiana Joneses’ this year (with North American movie attendance already down 6.5% from 2007), instead opting to save the $48, wait 4 months, and see it for $4 on their home theatre, and far-flung vacation destinations should expect the same, as consumers avoid the high cost of air travel and decide instead that a 3-hour drive for an old-fashioned vacation on the lake is now Good Enough. Finally, I expect the nationwide malaise of LAGFLATION to slowly spawn a corollary condition called NAGFLATION, as frustrated housewives start demanding, “Why don’t you take me out anymore? Why don’t we go on nice vacations anymore? We haven’t had a new car in 6 years,” (which could have the unfortunate consequence of causing men to pursue their OWN version of “Stagflation.”)
Prediction #4: Wall Street Will Simultaneously Have Both an Identity Crisis and a Mid-Life Crisis
Let’s face it – “Wall Street” is an oxymoron, a figure of speech that combines two normally contradictory terms. In fact, the word oxymoron is derived from the Greek word ‘oxy’ meaning sharp, and ‘moros’ meaning dull, making the very word oxymoron – an oxymoron. It’s the same for Wall Street. Well – which is it? A Wall? Or a Street? Just as the phrase “Wall Street” presents a literary impasse, so the sudden onset of LAGFLATION presents an economic impasse for this - the world’s financial hub.
As a leading indicator reflecting the condition of our financial infrastructure, Wall Street has already undergone a fundamental market correction, as the repricing of credit and risk has punished banks and lenders that were over-leveraged, under-capitalized, or took on audacious amounts of risk in pursuit of profit in the lucrative but dangerous subprime market. However, ever since that “Weekend at Bernanke’s” where JP Morgan agreed to acquire Bear Stearns, the market appears to have settled down and has even shown a few weeks of modest growth. Unfortunately, however, just like Wall Street quants didn’t have the foresight to figure out how to avoid hundreds of billions of dollars in write-offs, leading Wall Street voices will continue to be baffled by the markets’ muted performance over the next 3-5 years.
Today’s analysts continue to simply look at market performance in a one-dimensional, linear way – asserting that since stock prices have been marked down and future earnings discounted, that things should start getting back to normal, that any recession or slowdown can be averted, and the nation will simply ramp back up from this temporary “speed bump” with a continuation of our long-running bull market. What they FAIL to understand is a concept that we all learned as kids called “Cracking the Whip.” “Cracking the Whip” was a game where a line of 10-15 ice skaters would hold hands and slowly start turning in a circle, eventually building up so much momentum that the person farthest from the center would eventually fly off the end of the “whip” and go sailing over the ice – whether they wanted to or not! It’s the same with the economy. Wall Street and the associated banks and financial institutions are at the center, and the consumer is way out on the end of the whip, and just like in ice skating, even small movements from the epicenter can have significant consequences as they ripple through the markets. What Wall Street doesn’t realize is that - instead of being small - the corrections taking place at their epicenter have been HUGE, and that the even larger aftershocks are just STARTING to have an effect on the broader economy. All of the bankruptcies, foreclosures, store closings, and retail figures detailed earlier are JUST THE START. While Wall Street firms can belly up to the discount window and effectively “buy more time” to get their financial house in order, consumers don’t have that option, as more and more fall into the GAP between Income and Cost.
I predict Wall Street will undergo an Identity Crisis as the market undergoes an “Un-Bear-Or-Bull” market over the next 3-5 years, as stocks get locked into a narrow trading range, with lots of churning but very little progress to retest the market highs set in October 2007. Investors will grow increasingly frustrated as returns struggle to keep up even with historical return rates, as firms like Goldman Sachs will return to their lower-risk, lower-return “core” business of M&A. Whether we got the “soft landing” the Fed wanted is a topic for discussion, but one thing for sure is now that we’ve landed, the markets will be stalled on the tarmac until they’re Jet-Blue in the face, as any stock dependent on the U.S. consumer will continue to languish for years to come. Because of this, I fully expect another rash of market scandals, as traders and investors – impatient with the lowered stock market performance predicted by Warren Buffett - seek out highly speculative and ultimately illegal trading schemes.
If there’s one final admonition for Wall Street it’s this; for the last time - the problem is NOT Consumer Confidence – the problem is Consumer OVER-Confidence! Do you know how much CONFIDENCE it takes to take out a 40-year loan on a $600,000 house with no money down, with a 2-year Adjustable Rate Mortgage - on spec - when you’re earning $55,000? Do you know how much CONFIDENCE it takes to max out all of your credit cards AND home equity loan AND student loans AND car loans? The American Consumer has more CONFIDENCE than anyone on the planet. TOO MUCH CONFIDENCE is what got us INTO the Countrywide AND country-WIDE mess that we’re in. So please, never again say that the problem is Consumer Confidence (remember, you can’t spell Consumer OR Confidence without the “Con”); the problem now is LAGFLATION – the ongoing and widening LAG – the GAP - between the average American INCOME and the COST of the average American lifestyle.
CHAPTER 12: Your LAGFLATION Survival Guide
Assuming the preponderance of evidence presented in this manifesto has convinced you that LAGFLATION is indeed upon us, and has accelerated your grieving process from Denial through Acceptance, the next step is determine how to best survive America’s abrupt economic transition from “Goldilocks to Gridlock.” For businesses, the secret is to get in front of the curve as quickly as possible, CUT OVERHEAD NOW so that your reserves will last longer, and then CUT COST NOW so that when customers DO shop they will look for you. Make every strategic decision come down to the impact it will have on the PRICE paid by the consumer.
Once price has been identified as Priority #1, businesses should immediately begin launching a series of “no holds barred – outside the box” guerilla marketing campaigns, to reach desired target markets. If you cut hair, try borrowing a rental truck, driving it to a soccer field, and give low-cost haircuts while you wait. If you’re a restaurant, create deals you can’t pass up! No more “Buy One Get One for Half Price with purchase of 2 beverages.” People already know you’re making enough margin on the drinks to almost give away the entrée, and many people have already switched to drinking water when they eat out to save $10 per family per meal. If you want people to show up, offer “Buy One Get One” as a MINIMUM, add bargain-basement Early Bird discounts Friday, Saturday, and Sunday, consider extending Senior Citizen discounts to EVERYONE, and print coupons without the annoying qualifiers like “Valid Sunday – Thursday.” People need to feel like their WINNING with their wallet. In the past, people were looking for any reason to SPEND, now they’re looking for any reason NOT to spend, so your incentive needs to be so compelling that they CAN’T pass it up. Remember, LAGFLATION makes coupons “Cool” again!
In the new era of LAGFLATION, every mall and every retailer should hang a “Going Out of Business” sign on the front, because if they don’t give people a reason leave their home “bunker” and shop at their store, they WILL be out of business. Once everyone begins advertising discounts and low prices, successful retailers with have to invent increasingly creative value propositions to lure customers, and I predict this will launch a new trend called “Crossover Consuming.” Crossover Consuming will involve a juxtaposition of what would previously be considered “strange bedfellows,” where groups of unrelated retailers will voluntarily come together - out of a need for survival - to offer consumers a matrix of complementary products and services - a self-reinforcing destination of customer value. Karate studios will partner with hair salons and tutoring services to enable consumers to save time by getting multiple services at the same location AND save money on gas by consolidating trips. Malls will fill floor space vacated by Sharper Image and Bombay with free childcare services to give frazzled parents both time and incentive to shop there, and movie theatre stubs will advertise 20% discounts on purchases to reinforce mall patronage. (Note: Some supermarkets are already offering free childcare, and they are fulfilling the human NEED for food. If retailers are to survive, they will have to at least match this level of service to entice people to purchase what many would consider simply WANTS).
Retailers that survive this period of LAGFLATION will no longer be able to just passively wait for consumers to show up at their doorstep and purchase goods. Successful businesses in this new era will also have to complement their “bricks and mortar” establishments with a concurrent and proactive online strategy. Retailers from furniture stores to car dealers need to maximize the productivity of their sales staff by creating online venues for direct sales of their products via the web (eBay, e-commerce, etc.) and equipping staff with tools to directly reach out to target markets, with the ability to immediately get up and service customers when they DO walk through the front door. According to a recent Forrester's study, e-mails sent to repeat customers by stores involve the cheapest marketing cost ($6.85 is the average cost per order), while yielding a high average order value ($120.27). Search engine shopping is also among the cheapest ($8.63 average cost per order) while yielding a high return ($109.73). These cheap marketing tools are already helping retailers maximize profits, by driving the consumers to buy their products – whether online OR in person.
CHAPTER 13: Good Night and Good Luck
Just as the last flame on the last log in my fireplace begins its slow descent, so the embers on the last log in the American economy begin their long smoldering process. When asked what they are going to do with their tax rebate, just 21% of Americans plan on spending it, and based on our previous discussion, that should come as no surprise. While the price of WANTS (like big-screen televisions) continues to fall, the price of NEEDS like wheat, corn, milk, and gasoline continue to rise. In fact, the Labor Department just reported that wholesale prices rose by 1.1 percent last month, the second largest increase in the past 33 years. If people barely have enough money to cover their needs, it doesn't matter WHAT the wants are priced at – people WON’T buy because they CAN’T buy!
The American Economy during this period of LAGFLATION will be like 4 cars that arrive at a 4-way Stop Sign intersection at exactly the same time. Everyone is waiting for everyone else to go. People don’t spend, so retailers lay off, so firms don’t hire, so people go out less, so food prices go up even more, so restaurants close, so firms lay off even more, and laid off people don’t spend, so they don’t buy houses (in fact, they reintroduce the tradition of multi-generational homes), so the prices of homes continue to fall, so they don’t fly on airlines, so airlines go bankrupt, and on and on it goes. In the New Testament, Matthew 11:16, we read, “But with whom shall I compare this generation? “We played the flute, but you did not dance. We cried, but you did not mourn.” For the next 3-5 years, the entire nation will collectively stand around with their hands on their hips waiting for someone else to “go first.” While it’s true that housing pricing will continue to fall to align better with income, without a similar fall in the price of higher education, and healthcare, and gas, and food, and travel – OR a SUDDEN JUMP in median income - American after American will continue to quietly fall into the GAP between INCOME and COST.
In 2007, the nation’s median salary was $36,000, which, after inflation, is nearly 1% BELOW the 2006 median salary. In the past year, the Consumer Price Index rose 4.3%, food increased 5%, hospital services increased 8.6%, and gasoline increased a whopping 35%! In fact, inflation at the wholesale level soared in March at nearly triple the rate that had been expected, as the costs of energy and food both climbed rapidly. Throw in another Katrina or terror attack and you have even GREATER economic pain, and this is without even considering the already critical and compounding crisis in Social Security, Immigration, Medicare, Medicaid, and the fact that our 401’s are NOT OK.
So now you know what will happen. Take it with grain of truth. What you do now is up to you. You can choose to ACT now, or REACT later. Clearly, America has lost its way, which is probably why a record number of GPS systems were sold last Christmas AND why the #1 destination on the web is a SEARCH engine. America’s farmers get it – when you have GOOD crop years, you take the money and save it to cover for the BAD crop years. Our nation has taken the money from the BOOM years and spent it, so now there is nothing left to buffer the BUST years slated for our immediate future. The Fed’s rate cuts have cut the value of the dollar - hitting new lows as oil hit new highs in April – further increasing the cost of commodities, which further impacts the price of food and oil – and further widens the GAP for the American Consumer. The end result of LAGFLATION is that our country will increasingly be divided into a nation of Haves and Have-Nots. A nation of wealthy multinational financiers on Easy Street and multigenerational families living on Main Street. In the end, our nation will ultimately be defined by Wall Street and K-mart. Put them together and what do you have? Wal-Mart.
By Douglas O’Bryon, Soundbite Laureate
May 13, 2008