What Happens to the Economy When People Lose Confidence?

Paul Winkler: Welcome. This is “The Investor Coaching Show.” I’m Paul Winkler, talking about the world of money and investing and the news of the day, along with Mr. Ira Work.

I had a good video to talk about this time. I’m going to save it until after I talk about this article because it fits with it. So an article from the Wall Street Journal this week, “People Have Money, but Feel Glum: What Does That Mean for the Economy?”

Now, one of the things that I was happy to see in this article was not necessarily the title, “People Have Money but Feel Glum.” You don’t want to see people feel glum because that’s not fun.

What Will Happen to the Economy?

“What does that mean for the economy?” is the question that they asked.

PW: You don’t feel glum, do you?

IW: No, I don’t feel glum at all.

PW: Ignorance is bliss. We don’t know what’s coming right?

IW: Maybe I don’t have enough money to feel glum about.

PW: So anyway, what I like is that they said, “What does that mean for the economy?” The reason I say that is because we so often think, “Oh, people feel glum, that means the stock market is going to go down.”

No, it just means that people feel glum and maybe they’re going to start to slow down their expenditures, and the stock market went down in anticipation of that. Because if you look at it, it’s been kind of one of those years.

I mean, what I always preach against, having too much of your money in large U.S. growth companies and all the hot names, is worse than everything else. But everything, to some extent, is bad.

IW: Well, I don’t know if you realize it, Paul, but the last time the market was negative for the year was 2018.

So, I mean, we’ve run three years with an up market.

PW: Is what you expect right?

IW: We would expect it to be down this year.

PW: Well, you can’t predict it. Don’t take that too far, I’m talking about the people out there because sometimes people hear that and think, “Oh, so it’s going to be down the next three years, then it is going to be up the next year.”

You can’t predict when the market will have a downturn.

IW: Yeah. So I’ll spell that out just a little bit. Historically, we can see the market going down once every three or four years, but we never know what the timing is going to be.

PW: It might be up for six, even eight years in a row.

IW: So for example, from 1994 to 1999 was 6 years that the market was straight up. From 2000 to 2002, which is three years, it was down.

PW: Well, not in every area though, which is interesting.

IW: No, not every area.

PW: Largely stocks were down.

IW: Right. And that’s what most people follow and that’s really where most advisors tilt their client’s portfolio toward.

PW: Exactly. Yeah, exactly. It sounds like we’re arguing. We’re not; we love each other.

IW: Like moss on a tree.

PW: We’re always doing this, correcting each other.

IW: Well, it says iron sharpens iron, right?

Economic Activity and the Market

PW: I like it. That is so true. So anyway, more than two-thirds of the U.S. economic activity is tied to household spending, but they’re basically saying inflation’s melting away the value of household paychecks.

So even so, household finances are as strong overall as they’ve been in decades. Thanks to money saved during the pandemic, debt paid off over the past decade in a strong job market.

And it is, I mean, true people are very, very happy. Now, Chad made a comment as he was talking to a client and his comment was about companies and expenditures—just how unusual this particular market is, in that if you have an economic downturn, typically what is it?

What comes with it right away is people’s expenditures start to drop. When you start to hear people feel glum, what do you think? You think people are going to stop spending money.

We assume the worst when we hear of an economic downturn.

And of course Friday’s data came out and said that the economy actually grew. But Chad made this comment. He said, “Companies are in kind of a conundrum in that they cannot stop spending.”

Because we look at why stocks go up and down. You have sales minus cost to goods sold, minus operating expenses, minus interest expenses, minus taxes equals earnings. So you have all of that stuff down there.

If the stock market goes down, maybe it means the sales went down, or it’s anticipated that sales are going to go down.

More accurately put, it would be that sales went down more than was what was expected. That would be the more accurate way of saying that.

If you think about it, there are a lot of little pieces in that little puzzle. You have spending, what people actually spend on things.

You have the cost or what the sales were, of course. Then you have the cost of goods sold. You have operating expenses. You have interest expenses.

Now, what just went up? Interest expenses. One of the things that would drive stocks down.

But it also has the interesting effect that not only does interest expenses going up drive stocks down because it drives earnings down, but it also drives down future consumer spending.

Future Expenditures

Now here’s the interesting part about it with future expenditures—right now spending’s pretty strong and when spending is strong, what happens is that companies have to keep producing things, because people are buying them.

Companies can’t stop producing stuff, which means they can’t reduce the cost of goods sold and they can’t reduce their operating expenses. So hence that is a reason that we’re seeing what we’re seeing.

So people feel glum, what does that mean for the economy?

When people feel glum, it means that the economy may go through a contraction soon.

Well, it means that the economy may go through a contraction in the future, but the stock market has gone down in advance. So it doesn’t mean it can’t go down further, but a lot of areas of the market are down a whole lot.

I mean, prices in some market segments are as low as I’ve ever seen them in my entire career.

And you look at over 30 years, that’s a long time that we’ve gone through a lot of junk.

But anyway, more than two-thirds of the U.S. economic activity is tied to household spending. So if you think about it, a lot of the economy is what everybody out there spends buying things.

That’s going to be a big deal right there. Spending surged during the pandemic, but shows signs of cooling.

There are some that people are slowing down a little bit. One lady thought, “Wow, we saved so much between canceled date nights, a postponed honeymoon, federal relief checks, and getting a higher-paying job.”

So she’s looking at spending it on a Peloton exercise bike, and nobody else is buying them. I guess somebody needs to buy them.

She has basically waited until after everybody wanted them to buy one. Recently, however, inflation has shifted her perspective because of rising costs.

She says she’s cut back on luxuries, new clothes, manicures, haircuts, trying to avoid eating out. So basically cutting back spending a lot of different ways. Now a lot of Americans said that they used their federal relief checks to pay down debt, according to surveys.

People are actually in much better financial shape than typically what you see going into a recession, which would explain why we’re not seeing that reduction in spending. Now it says until stocks fell, the household wealth was abundant.

The Wealth Effect

When stocks go down, you have what’s called the wealth effect. When people see their wealth go down, they tend to pull in a little bit.

But again, they’ve got so much in savings in other things besides stocks that they’re not feeling that. Executives at Levi Strauss said last week that they’re seeing moderation in demand for lower end brands.

That’s what’s called the substitution effect. That’s what makes it so hard to figure out what the real inflation rate is, because what people do is they substitute.

And to the extent that people can substitute and buy other things, you don’t necessarily have the economic growth and the crazy expansion happening in the places that was happening before.

So talking about consumer psychology, it says it is an ingredient in spending decisions, and consumers’ nerves right now look more afraid than their bank accounts. And this one guy from the New York FED says that people really hate inflation, and they do.

People find ways around inflation through substitution.

But people find ways around it through substitution. The University of Michigan, which has been surveying households for decades about their beliefs about spending, inflation, and the economy, finds consumer sentiment deeply depressed.

That level is typically associated with a recession, even though the majority of Americans say they’re better off than five years ago and expect to be better off five years from now. Now why does anybody want to conjecture?

Why might people feel that they’re going to be better five years from now? Because what will happen between now and five years from now is a couple of congressional elections. Go ahead, Ira.

IW: That’s exactly what I was thinking, but I was going to try to avoid getting into political talk.

PW: But it’s not political to say that an election will happen and somebody, it may not be the current president, it may be somebody else because there are a lot of people urging him to not run again. So there, I have sidestepped the political. That was very adroit.

IW: But I think either way, two years from now, two and a half years from now, half the people will be happy with who won and half the people will be unhappy with who won regardless.

Inflation and Jobs

PW: It is a remarkable finding because a survey by the conference board finds the share of households who believe that jobs are easy to get is near the highest in decades thanks to historically low unemployment. And the problem is of course what?

The jobs that are out there are not necessarily high-paying jobs. So that’s the problem, that’s why people don’t necessarily feel great. In this case, inflation, not lack of jobs, is the driving force behind the household, but the reality of it is inflation.

And if you have inflation and you have jobs that aren’t the highest paying out there, because I’ve talked about this in previous weeks where we don’t have what we had in the late ’70s where you had so much inflation and it was due to the fact that you had so many union jobs that the price of labor kept going up regardless. I mean, you couldn’t do much about it.

IW: Well, you also had the beginning of the biggest influx of people entering the job market with baby boomers.

PW: Yeah. But you know, you have Gen X and it’s just as big. If you think about it and you look at the data on it, it was like 93 million or something like that.

It’s a big bunch of people, and the only reason I knew that is because I’ve actually looked at that before. Anyway, a survey in April from New York FED found that nearly a third of the 1300 respondents planned a vacation in the next four months.

A lot of people are still planning on vacation. They’re going to go out. They said there’s pent up demand for services like vacations.

So people are getting out there spending money.

If you look at stock investors in a brutal stretch, they have rarely been this pessimistic, which is always something that’s a good sign to me when I see lots of pessimism. It’s like Warren Buffet always said, “I’m greedy when people are scared and scared when people are greedy.”

If you constantly obsess over the stock market, you’ll likely end up making mistakes.

A watched pot never boils. And that is the thing about the stock market that is so challenging. Because if you look at your investments every day, if you look at the market every day, if you watch things every day, it can seem like an eternity, an absolute eternity.

Markets Recover

But the reality of it is markets when they recover, they do it so blazing fast that you better be there. Now, there is some data, I don’t know that I have it with me, but the data was absolutely mind-boggling that Chad had pulled up in the office regarding market recoveries.

According to the data, if you had $10,000 and you invested it, it grew to a very, very nice amount over like 30 years. And if you missed the five best days, it was like half growth or something like that. And then if you missed the 10 best days, you were just barely above what you missed.

If you look at that, you can see what a huge deal it can be when you miss a few days, and you might think, “Wow, so what does that tell you about markets and making sure that you are there when markets actually make their turns?”

It tells you that you had better be there or else you’re going to be in big trouble. And the thing is, if you try to figure out which days are going to be the ones where it takes off like that … nobody knows.

The pros don’t know, and the amateurs don’t know.

No one can predict what will happen with the market.

Now in the example we’re using, $100,000 grew to $324,000 over 20 years, just 20 years. That’s it, 2000 to 2019.

If you missed the best five days, instead of $324,000 a year, you’re at $214,000. If you missed the best 10 days, you’re only at $161,000, and if you missed the best 15 days, you about break even.

If you missed the best 25 days, you lost about 18% of your money. You lost 18% of your money just by being out those days.

And you just don’t know when those best days are going to be. One study out there tells us that 0.6% of trading days make up 96% of returns. That’s 2.2 days per year.

We don’t have a clue what those days are going to be. No one does.

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