It may be a bit of a generalization, but I believe the US is going into austerity mode and it may last for a while. But is this good or bad? Interesting question. In keeping with the political season that is upon us, my answer is both, at least in terms of how austerity might impact the markets.
An austerity mode is a logical and quite natural result of the credit crunch and powerful de-leveraging cycle that we are currently facing. It’s tough to get credit unless you can prove you don’t need it. Worse over, if you think your home equity line is going to bail you out, you might check on it, as banks have been slashing them unilaterally.
Meanwhile, it’s hard to say which is more painful: buying groceries, or filling up the gas tank. Inflation is real and it may get worse, and even with the volatility in oil prices, my sense is that consumers are anticipating higher inflation and are already making adjustments. For instance, the use of public transportation has increased about 15% over the past year, while motorists are driving fewer miles. Encouragingly, the technology behind hybrid vehicles continues to advance, particularly in regard to battery efficiency. While only 13 hybrid electric vehicle models were sold in 2007, this number is expected to approach 75 in three years. The National Highway Transportation Safety Administration estimates that electric cars will represent 20% of the US market by 2015, up from 2% currently.
Not surprisingly, consumers have reduced discretionary spending much to the chagrin of most retailers. Eventually we’ll get to a point where pent-up demand needs to be satisfied, but my sense is that conservatism will rule the day for a while longer. While in this mode people will look to reduce debt, downsize vehicles and perhaps even houses, and amazingly save more relative to discretionary spending. These are far from minor adjustments for a society that has been on a debt-induced spending spree for decades. Just as the days of conspicuous consumption lasted for most of the 80s and 90s, the era of austerity we are now entering might last a long time. People are finally realizing that it is better to live within one’s means, and that excessive and unnecessary debt is not a good thing. Kind of like how the Greatest Generation lived their entire life, perhaps. Sort of worked for them, didn’t it?
More sensible and conservative spending raises the stakes for companies competing for the same slice of consumer spending. Increasingly, successful products will have to be either essential, innovative, eco-friendly, or productivity enhancing. While this may sound like a simple concept, my sense is that it will be much more difficult in terms of execution.
I think it might be a worthwhile exercise to think about each of these four characteristics of product success, so here are a few thoughts. First, a list of “essential” products in an environment of austerity might look very different than a list generated during the profligate spending period that we have just lived through. This has obvious implications for most retailers, especially the auto manufacturers who are fighting to survive. Second, truly innovative products will garner a big percentage of consumer spending. Apple’s iPhone is certainly a great example of how innovation drives demand. Third, our society is going green. No, not in a straight line and not everyone will get on board right away, but I think this trend has sustainability. Not only because it is the right thing to do, but because it makes economic sense as long as the price of oil stays around or above $80/barrel. My sense is that it does, given long-term trends in global demand and supply. Finally, products that help individuals or corporations save money, or become more productive in their jobs or home life, will likely be successful. Obviously this covers a lot of potential product categories.
The net of all this is that the stakes have been raised across Corporate America. I suspect many companies that can’t figure out how to harness innovation will struggle mightily. Conversely, leading edge companies will benefit disproportionately. The gap between winners and losers during this tumultuous period will be huge.
A firm grasp of the obvious… Everyone is painfully aware that the consumer is tapped out, credit has evaporated, and housing prices have cratered. But longer term, this de-leveraging cycle, this era of austerity, will produce a more fiscally responsible consumer, and that is a good thing for our society and for our capital markets.
Over the next several years it is quite possible that we will all increase savings and investments relative to discretionary spending, we’ll make more sensible and less ostentatious purchases, and we’ll be more sensitive to our impact on the environment, from what and how much we drive, to the square footage of our house. We will also thrive to become more efficient and healthy in all aspects of our life, at the office and at home, and we’ll pour money into innovative products that help us accomplish these lofty goals. I know this part is a reach, but perhaps even our politicians will get on board and work toward reducing the federal deficit. Wouldn’t that be something…
