Into the Hurricane of Consumer Negativity

 | Aug 02, 2011 | 6:35 PM EDT
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An old axiom on Wall Street, one often mentioned by the "Oracle of Omaha," Warren Buffett, is that you should be greedy when others are fearful, and be fearful when others in the market are exhibiting maximum greed, as was the case in October 2007.

The contrarian in me wants to desperately apply this lesson to investing around the U.S. consumer. For most of the past month, the chorus has been singing loud and clear that the consumer is in poor health. Macro data points are at the heart of chorus, and they represent actual, negative, on-the-ground happenings across the country.

In the last week alone, second-quarter GDP and previous periods caught a bad case of the government revision flu. This was highlighted (or low-lighted) by the continued plight of consumers as they dig themselves out from under a mountain of debt and encounter near-term headwinds in the form of endless price increases by various providers of goods and services. Above all else is the feeling of being boxed into a small room. Prices are higher, and income growth and job prospects are muted.

Today, another set of clues was dropped like a 500-ton bomb on a market that was bracing for only a 200-ton bomb. In June, personal income and spending underperformed personal income growth for the third consecutive month, and in July it actually went into negative territory. So in spite of a personal consumption expenditure measurement that clocked in at a decline of 0.2%, consumers chose to sit out the dance on spending and build savings with the little disposable income they had left over. The personal savings rate has been on the rise since March, and in order for consumption to accelerate, those savings have to be worked down. Alas, this is not happening just yet, and to make the call that this could transpire in the second half of this year is rather difficult.

The Not-So-Fun Facts...

Household debt is at 112% of income, roughly 28 percentage points higher than where it was in the 1990s. The de-leveraging process is alive and kicking, and the household income portion of the balance sheet is failing to keep pace.

GDP growth of 3% or greater is needed to create a strong amount of jobs. Revisions to prior GDP figures were deep, and economists are lowering their estimates for the second half, and the Fed may soon follow suit. The jobs outlook is murky, especially considering that state government jobs have vanished (in Office Depot's (ODP) earnings call there was sales weakness in California attributed to job reductions). And now federal jobs are in play (also a ripple effect -- for instance, cuts in the defense budget may trigger job losses at various contractors).

By no means am I trying to be a downer here. Without question, I would have loved to pen my initial publication about personal spending <I>growth</I> in June and the probability of an upside surprise in non-farm payrolls this coming Friday. Over time, you will notice that I "keep it real" on data interpretation and how to invest around the macro themes (this is likely a nod to my lower-middle-income upbringing).

All of the arrows point to a continuation of volatile reads on the consumer as we proceed through the third and fourth quarters. The only constants at the moment are:

1. No pressing need to construct a portfolio with overexposure to consumer discretionary names.

2. Dollar stores such as Family Dollar (FDO) and Dollar Tree (DLTR) make a ton of sense after their poorly received earnings reports (in Wall Street jargon, the risk/reward has shifted).

3. The real possibility of seniors catching a raw deal on adjustments to Social Security and Medicare. In other words, grandchildren should say bye-bye to those cash-filled birthday cards, as those dollars are now finding their way into the registers at super-low-end retailers.

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