AWM Global Advisors | Stock Market Valuation Weekly Series
Drivers of Consumer Demand
Are we headed for another 2000 or 2007 type correction? While we do not expect a selloff of that magnitude, we are concerned that the stock market has gotten ahead of the economic fundamentals. Last year, S&P 500 went up by over 30%, while the U.S. GDP only grew by 1.9% in real terms. We expect the weak growth in real economy to continue, as we do not see conditions improving that would spur a significant pic-up in consumer spending, which accounts for approximately 70% of the U.S. economy.
In order to put more money in consumer pockets, you would need an increase in workers incomes, lower taxes, lower commodity and energy prices, and easier access to borrowing.
We know taxes went up last year, and are likely to go up in the future.
Let’s take a look at trends in income growth. As you can see from the chart above, U.S. average household income growth has been trending down since 1976. If you factor in inflation, the median household income is still below where it was in late 1990s. On March 19, Janet Yellen voiced concern over the continuing weakness in the labor markets during her testimony to congress. Unless there is a pick-up in employment, wages will continue to stagnate, which will in turn have a negative impact on consumer spending.
Meanwhile, commodity prices have increased by 200% since 2000, and oil price has increased by 321%.
What about access to borrowing? From 2000 to 2006, despite the low income growth, U.S. GDP was still able to grow at over 5% on average per year. The growth was mostly fueled by borrowed money. During this period, housing prices more than doubled, as represented by the S&P/Case-Shiller Home Price Composite-20 Index. However, this ended in 2007 with the collapse of the US housing market. Today, there are still 9.8 million homeowners underwater, and credit standards are much tighter than before. Therefore, it is not likely we will return to this borrowing binge anytime soon. Consumers will have to earn their right to spend.
Where does this leave market valuations? In light of the above, either stock prices adjust to more historic valuation levels, or economic growth increases rapidly and is sustained over several years. Based on our observations, we opt for the stock market adjustment as being the most likely course, as we believe continued low income growth, higher taxes, higher commodity prices, less access to credit, and potentially higher health care expenses due to the Affordable Healthcare Act, will all contribute to less robust consumer demand and economy growth for the near future. Therefore, we continue to believe an under allocation to stocks is the most prudent strategy for the time being.
Please do not hesitate reaching out to us (via email [email protected], or phone 619-225-7600) with any questions relating to this insight. We would love to hear from you!
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AWM Global Advisors | Stock Market Valuation Weekly Series
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