SmallCap Sentinel Analyst

With consumers driving 70% of our Gross Domestic Product (GDP), the widest measure of our economic strength, many are starting to wonder what’s happening to them.

A few years ago, the consumer seemed invincible. They were buying bigger homes, taking lavish vacations, upgrading their automobiles and spending in almost every conceivable method while racking up high levels of debt along the way. This debt was brushed off largely due to decade-low interest rates, rising equity in their homes and increasing incomes.

Fast forward to the present day and we see a very different picture. Rates are up from their lows, the equity they thought they had in their homes has dwindled or disappeared entirely and those high paying jobs and bonuses have been reduced or even downsized. These changes have caused many consumers to be pushed to their breaking point. This tends to be a natural economic cycle that occurs time and time again. Why then do we continue to get lured into these bad habits that can endanger our financial vitality?

Unfortunately, we are largely valued as individuals not by how much we produce but by how much we consume. Over many years of advising clients, I have noticed that spending habits largely fluctuate based on how “wealthy” they feel. The former Federal Reserve chairman, Alan Greenspan, referred to this as “wealth effect”, stating that stock owners react to rising stock values by spending more.

The problem is that they take on larger liabilities during prosperous times and end up paying for them, literally, in economic downturns. They become slaves to the economy, toiling away at unprecedented rates so they can afford to consume more or pay for what they’ve already purchased. It’s this flawed thinking that causes consumers to spend based on emotional feelings instead of economic soundness.
We must change this process and learn to spend wisely and more importantly, save in the good times knowing they won’t always last.

Why is this so difficult to do? Why are we encouraged and even guilted into spending?

Simple answer: A reduction in consumer spending can bring on a recession.

If people spend less, there will be less demand for goods and services. With demand dropping, production will be decreased. When production is decreased, cost-cutting measures will be implemented. People are laid-off, the economy retracts, etc…. Make no mistake, consumer spending is the backbone of our economy.

This is sort of a chicken-and-egg dilemma. Do consumers slow down their habits because they foresee economic trouble? Or, does the economic trouble cause them to slow their spending habits?

According to a recent Gallup poll, 7 in 10 Americans see the economy getting worse; a percentage level rarely seen. This would lead me to believe that- at least this time- the consumer is the chicken in the example; curbing their habits in anticipation of a worsening environment.

It’s this forward thinking that gives me hope for the future of consumers and their spending habits. Hey, it only took record high oil prices and the weakest housing market in 30 years….. but at least we are taking action in response to the signs, no matter how obvious they may be.

If we can learn to use debt wisely and live within our means (in good and bad times) then perhaps we will encounter less volatility not only in our lives, but also in the economy.

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