We Americans find ourselves in a fine economic pickle of our own making, even if we don’t want to admit that we are in some way responsible for the current crisis.  And as much as we would all like it, it would be disingenuous to suggest that we can or should get back to the boom time economy of 2007.  We at Bellevue Financial believe that we are in the midst of a Great Adjustment not unlike that which our grandparents experienced - but different because we got here differently.  As we walk through today’s landscape, please keep in mind that there is always a light at the end of the tunnel.  While we want to explain some of the economy’s current hazards, we believe that there will still be ways to make money throughout this malaise.

The big question that everyone is trying to answer is how to get out of this mire in which we're muddling.  In President Obama’s February 22^nd speech he talked about 'new common sense rules of the road.'  We like common sense.  We believe in common sense.  But increasing lending in order to bolster the economy is disconcerting.  He mentioned that it was only through borrowing that Americans could buy homes (we agree), buy cars (can't we buy cheaper cars?) and attend college (a little help is fine, but kids coming out of college with over $100,000 in debt will be paying off those loans for years.)

The banks have almost completely shut off the faucet. For businesses. For consumers. For everyone. That's not good. We know what happens when there is no credit - there is no economy.  We don't like that. You don't like that.  No one in the world likes that.  On the other hand, when credit flows too easily problems also ensue.

U.S. consumers have been consuming too much, have collected too much debt already, and are going to be digging out of their self-created holes for a long, long time.  Every indicator we can find shows the U.S. consumer is tapped out, swimming in debt, and drowning in stuff that they really didn't need.

Home mortgage default rates (delinquent loans as a percentage of total loans) are over 5%. Over the past 30 years the average percentage of Americans who own homes has been 65.8%.  Because of free and easy credit homeownership peaked at 69.3% of the population, and even with all the foreclosures we're still at roughly 67.5% homeownership.  As of the end of January, there were enough homes on the market to supply 9.6 months of sales, and 45% of sales in January were of distressed properties.

We all know about the problem with subprime loans (light green bars on the graph above), but no one is really talking about the next pig in the python: the Option Adjustable Rate Mortgage problem that is staring us in the face. These Option ARMS (light yellow bars on the graph) are even more toxic than the subprime mortgages and the number of these mortgages resetting in the next two years is mid-boggling - which may be why no one wants to talk about them.
 While the levels are a bit off their highs, consumer credit as a percentage of personal income is over 21%, and by definition consumer credit excludes loans secured by real estate.  Back in 1974 we were closer to 15%. Of course, we didn't all have fabulous designer handbags and great technological toys to buy back then either.

 
Many people have decided over the past few years that their home is their savings account. Great thought until home prices fall 20%. A better place for savings might be…wait for it…a savings account. But as a culture we apparently don't believe in those either, maybe because they don't give you the rush that the housing market had recently. Then again, they also don't turn your stomach like the housing market is now.
 

In the graph above is the personal savings rate as a percentage of disposable income since 1959. The average over that time period is indicated by the gold line across the middle: 6.9%. It doesn't take a statistician to see that the average is only that high because of the early years in the graph. In fact, since the beginning of 2005, the average is only 0.8%. No, that's not a typo. Less than 1% of our disposable incomes are being saved. No wonder our country is living on debt - we don't have anything in savings for emergencies. And up until last quarter, a sale at Macy's qualified as an emergency.
 
So when the tap got turned off by the banks and it looked like they were really serious this time, is it any wonder that retail sales took a nose dive?

The graph above shows the year over year change in retail sales since 1992. That drop-off on the right side? Unprecedented.  Ugly too.
 
So we have no savings in our homes or savings accounts.  We have lots of credit card debt.  We have lots of people defaulting on their mortgages and more to come.  We're a consumer economy (70% of the economy is consumer driven), and we're not buying any more... because we can't. 
We’re not saying we won't get out of this, because we will.  But anyone who believes it will be quick or easy is fooling themselves.  We don’t have all the answers, but we are pretty sure we can't leverage ourselves out of it this time.

So how do we position investment portfolios for this environment?  Carefully.  Very carefully.  While equity markets have fallen significantly off their highs, we believe that valuations may still be too high.  As we have said, we don’t expect the consumer to rebound in any significant way any time soon.  In general, we would rather be a bit late to a stock market rally than participate meaningfully in further declines.  The good news is that somewhat overblown fear of corporations and municipalities has created some fixed income opportunities in those areas.  And, as the market has gone down, investments in gold have done well.  While the phrase “there’s always a bull market somewhere” might be an exaggeration these days, we do continue to diligently seek out opportunities.

We would love to have a discussion with you about how we can help you with your investments.  Please feel free to contact us at your convenience for an appointment.