Fewer BUT Richer Rich

During recent speaking engagements I have tried to emphasize the bifurcated nature of our economic “recovery”. I have said that the lion’s share of our recent economic gains have accrued to the relatively rich, while moderate- and lower-income Americans continue to suffer from high unemployment, weak income growth, high debt burdens, falling home prices, reduced access to credit, and inadequate retirement savings. In fact, however, the disparity in incomes between the rich and poor has been an ongoing phenomenon for quite a while. One study by Thomas Piketty and Emmanual Saez found that the top 1% of earners captured 52% of total income growth from 1993-2008. These same researchers found that the share of total income accruing to the top 1% of earners reached 23.5% in 2007, just prior to the financial crisis. The economic term for this phenomenon is Plutonomy (impress your friends over dinner and drinks with that one!).The only other time that this percentage has been so high was in 1928, and we all know what happened beginning in 1929.

Source: Piketty and Saez (2003), updated to 2008. Income includes realize capital gains.

I guess my point is that despite evidence that the overall economy is recovering (albeit at a relatively slow pace), the middle class is still in pretty rough shape. An article in the weekend edition of the Wall Street Journal addresses this issue from the perspective of baby boomer retirement savings. The article states that “Since the housing and financial markets began to collapse, about 39% of all Americans have been foreclosed upon, unemployed, underwater on a mortgage or behind more than two months on a mortgage, says Michael Hurd, director of Rand Corporation’s Center for the Study of Aging.” As a consequence of these issues and a longer-term disinclination to save, “the median household headed by a person aged 60 to 62 with a 401(k) account has less than one-quarter of what is needed in that account to maintain its standard of living in retirement, according to data compiled by the Federal Reserve and analyzed by the Center for Retirement Research at Boston College for The Wall Street Journal.”

In response to the lack of retirement savings, the article says that Vanguard, a large provider of 401(k) plans, has increased its guidance for retirement savings to 12-15% of a person’s salary from 9-12% previously (including employer contributions). The increase reflects the lack of savings, poor stock market returns, and uncertainty over the fate of Social Security and Medicare. The increased guidance must also reflect the fact that home equity, once the fallback for a comfortable retirement, has all but evaporated. Consider the following:

  • Over 13% of all mortgages are either in foreclosure or delinquent (Mortgage Banker’s Association)
  • Roughly 27% of all mortgages are underwater (Zillow.com)
  • 18.4 million housing units are now vacant, representing 11% of the total stock of housing (Census Bureau)
  • The average homeowner with a mortgage has just 2.6% of equity in the home (estimate by Stephanie Pomboy, founder of MacroMavens)

The Federal Reserve’s strategy to stimulate an economic rebound seems to be a “trickle down” approach whereby higher stock prices lead to improved consumer confidence, higher consumer spending, job growth, and improved corporate profits. And it is true that a near 100% rise in the major stock market indices off the March 2009 has been incredibly helpful to a lot of Americans. But the overwhelming amount of these benefits goes to the well-to-do. Higher stock prices alone will not get the middle class (and especially retiring baby boomers) back to a point that they resume the carefree spending that got us into our current predicament. Rather, a prolonged period of deleveraging (read: higher savings) is the prescription for the disease. Unfortunately, higher savings rates means slower economic growth. Sometimes the fix is not as easy as Mr. Bernanke would like to think.

It seems clear that markets are due for a pull-back. It may be underway as I write, and that doesn’t bother me. Pull-backs and downturns are normal, and when they don’t happen, I get concerned. Prolonged up or down phases are typically greeted by commensurate reversals. Market pauses shake out the weaker willed and allow shareholder bases to consolidate and regroup for the next ascent. The near-100% recovery from the March 2009 low on the Dow Jones Industrial Average of 6469 has been stunning. With the exception of the “Flash Crash,” there was a 7.2% correction at the end of June, a 6% correction in August, and a 4% correction in November. The unshakable tenacity of buyers since August has had me worried. Reality usually comes at inconvenient and unwelcome moments. My point is that pull-backs while unpleasant are not reasons to panic. They are normal, survivable, and Warren Buffet has seen a ton of them and bought many of them. Ask yourself, “what would Warren do?” I bet he’s not thinking about selling the dips.

In this environment, high-quality blue chip stocks appear attractive for their strong balance sheets, high dividend yields, reasonable valuations, and downside protection. The easy money from betting on high-flying speculative stocks has already been made.

Hang in there,