2010 - Year of the Relapse?

While Our Man has stated his central belief is that this is a credit crisis caused by an over-leveraging of the consumer, he hasn’t really explained why. As everybody knows, a major driver of the US economy is the consumer…and the US consumer (including Mrs. OM!) loves to shop, can’t get enough of it in fact! Some might even say that the US consumer over-consumes! And we’re not talking too many Happy Meals here; we’re talking the kind of consumption that bears little resemblance to future income (wages, etc) but instead comes from spending the kids’ college fund (or your retirement fund, or taking the equity out of your home to spend it now, or just not bothering to save) and then relying on ever-increasing amounts of debt to support it!

They say a picture’s worth a thousand words, so here’s a picture illustrating what I’m talking about:

Now there are a number of reasons why this debt problem has come around (hello ‘free-market’ neo-classical economic theory that doesn’t really consider the level of debt, bank lending policies & financial engineering, and irresponsible US consumers, to name a few) but that’s not our concern today. Our concern is what does it all mean! Well, Our Man’s firmly in the camp that it means we’re in a credit crisis…that the US consumer instead of over-consuming is going to have try and deleverage and do some of that 'saving', which was popular back in the old days! He also suspects that it also means that this recession (dare he mention the ‘d’ word) is going to end up in 1 of 2 ways; a Great Depression style collapse (quick deleveraging, increased savings but reduced consumption) or a Japanese (sorry Mrs OM!)-style stagnation and lots of w’s (where uneven growth, often driven by government, gives way to another recession as the government steps away…leading to the government throwing $$ at the problem, ad nauseum while delivering takes a longer slower trajectory).

The government’s response has been simple; keep asset prices up (TARP, liquidity to banks, get rid of mark-to-market, etc), try to get the consumer to spend (and taken on more debt, cash-for-clunkers, first-time high buyers credit, etc) and throw money at the problem (Stimulus). Though you’ll notice very little on debt forgiveness and credit write-downs (though, Our Man supposes HAMP was an attempt at this!), it’s also fair to say that they’ve been very successful so far in producing GDP growth. The questions will come when the support is removed and the baton is passed to the private sector.

For the baton to be passed over smoothly it will almost certainly require the consumer to be willing to take on debt (or at least not reduce debt, and take advantage of lower interest rates to refinance/roll-over debt) and resume over-consuming. However, Our Man’s wager is that the hand-off will not go smoothly, and the Japanese W’s will raise their ugly heads. We may see the first signs of this in asset prices, after February when the FED’s move to single-handedly support the toxic assets is scheduled to be withdrawn.

So either way, Our Man looks at 2010 as the year of the relapse…it’s just a question of whether it’s the economy or the consumer who’s relapsing!

What does this mean for the portfolio; well this core view helps create a starting point and from there Our Man tries to consider the “Glimmers of Hope” and the “Slivers of Instability” that could impact the markets and his book. More on that, next time…