The well is running dry

Just a quick post while sitting in the airport. I wanted to flag some fresh research from the San Fransico Fed.

The resiliency of the stock market has surprised some this year (even really smart people!) A lot of the credit for that resiliency goes to the consumer.

Economics is called the dismal science in part because it is hardly ever possible to say with any certainty what is going on, but a popular narrative has been that the consumer has held up better than expected because of excess savings built up during the pandemic.

Basically, spending was reduced because everything was closed. Take what we saved there, add in government stimulus, a suspension of other expenses like student loans, etc., and American savings account balances swelled to unusually high levels. That in turn gave the consumer some wiggle room as costs have gone up and economic conditions have tightened.

Just think of the American consumer as a grizzly bear able to sleep comfortably through the cold, harsh winter because of all of the blubber built up during the summer.

The “fat,” in the case of the consumer, was substantial. Upwards of $2.1 trillion in accumulated excess savings, by some estimates.

Alas, it appears that extra fuel is just about spent.

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In a blog post entitled “Excess No More?” the Federal Reserve Bank of San Francisco makes the case that most of that $2.1 trillion has now been spent. The exact numbers are hard to know, but the Fed estimates that perhaps $190 billion remain. And it is going fast.

Or… in the next few months.

This would be suboptimal. This cushion has helped to insulate the consumer from some of the usual nasty side effects of rate hikes. The consumer’s ability to spend has fed into corporate coffers, helping to insulate corporations from making some of the hard choices about costs and expansion that are often made during a tightening cycle.

There’s a doomsday case to be made for this to be the start of a vicious cycle, where consumers spend less, employers cut more, leading to more consumer uncertainty/job losses and even less spending, leading to more cuts, etc., etc. Throw in things like the return of student loan payments and the next few quarters could be the stuff of nightmares.

But this isn’t ZeroHedge, and I don’t buy into the doomsday scenario. There have been some examples of labor strengthening (just look at the new UPS contract) that are a tailwind to the consumer. The job market remains robust and competitive. The industrials are reporting worrying signs of a slowdown, but also slow and manageable signs. Broad portions of the economy appear positioned not to be caught off guard.

In other words, we could fall some from here and still be in decent shape.

Here’s the issue… As we’ve discussed before, I think the rally we’ve seen this year is fueled more by hope and delusion than by reality. And even if the economy is resilient and we are not headed towards a grim downturn, it is hard for me not to conclude that things will get harder, not easier, from here.

I’m not buying or selling anything based on this. And I’m not telling you to do anything, either. I’d advise you to think of investing in increments far longer than a single business cycle, and to buy companies that are positioned to thrive for decades, not quarters.

But it is probably a good moment to do some scenario planning. To talk to yourself about how you would react (and hopefully not react) if things go south from here. Mentally prepare for the worst, so you won’t panic if/when the worst arrives.

Fortunes and made and preserved by the things you do, or more specifically, the things you don’t do, in uncertain times. The Fed data feels like a good reminder to be prepared.

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