October 31, 2011
The collapse of the housing market is characterized by many as the single event that caused the economy to plunge into recession in 2008. The housing bubble, however, was only a symptom of a much larger problem. Over the last 15 years, household attitudes toward savings and investment have experienced radical changes. For more than 70 years, households saved, on average, 8.5% of their income. This changed dramatically in the mid-1990s as the savings ethic in the U.S. suddenly vanished and the savings-rate plunged to near zero by 2001. No one can be sure what triggered this sudden change in household attitudes and actions, but the abandonment of the idea of saving for the future occurred about the same time that the technology bubble began to expand in the stock market. Households mistakenly came to believe that speculative investing was equivalent to saving. When the tech bubble burst in 2000 and the NASDAQ plunged nearly 80%, this notion of equivalency came under serious review. Unfortunately another asset bubble followed soon on the heels of the tech boom as home prices began a steep ascent. This effectively delayed the return to savings as a strategy for future security by several years. The bursting of the housing bubble, which has been described as the largest bubble in financial history, did have at least one beneficial effect: it dramatically changed consumer attitudes as households began paying down debt and increasing savings. We believe this triggered the end of the debt super cycle and that what comes next will be a new secular bull market for both the U.S. economy and the equity markets.

An Addiction Americans Hated to Love
Debt acts like an anchor on the economy, damping growth, which in turn hurts the labor markets and real wages. This is because excessive debt saps the energy out of an economy as servicing the debt becomes more of a burden. As a result, the labor markets are negatively impacted, which eventually leads to a period of reduced purchasing power and extraordinary slow real growth in wages.

The United States has been saddled with the burden of excessive debt since the mid-1990s. To understand how this happened, one must look at the evolution of the U.S. economy over time. In the very early years of our nation, the economy was founded on agriculture. Later, in the 1920s and 1930s, the nation was transformed into an industrial economy. By the mid-1980s, we became primarily a service economy. It was during this time that the seeds of the next phase for the U.S. economy were being sown as debt expansion began and was underway in earnest by beginning of the 1990s. By the mid-1990s, the economic impact of this excessive debt was already being felt. The economy’s ability to recover from cyclical recession became less robust, as seen in the 1992–1993 expansion and later in the 2003–2006 recovery. It was during that stretch of time that the United States transformed from a service-based economy to debt-based economy. This paved the way for the current era of slow growth, weak labor markets, declining real incomes, low interest rates for savers and subpar performance by the stock market.

The Way Forward Is Through
Our long-term strategy recommendations for investors are founded on the belief that the bursting of the housing and debt bubbles in 2008 marked the end of the debt super cycle period in the United States and will usher in a new era of economic growth. Before we get there, however, the near-term aftermath is expected to be an extended period of deleveraging at all levels, including households, corporations and government. The long-term implications are for the United States to become a more balanced economy as we return to services and are reintroduced to production and manufacturing.

A new reluctance to accumulate debt and a return to a strong savings ethic will be influenced also by the fact that the population is aging. The demographics of the baby boomers are already having an impact as many approach and enter retirement. These Boomers, whose numbers are as significant as the generation’s name implies, are saving even more and consuming even less than other newly debt-conscious Americans. The view of housing is also changing, as the harsh price declines of the past three years argue against using one’s home as a savings or cash account. Lower home prices are a negative for retirees wishing to downsize, and the recently increased difficulty in obtaining a mortgage for first-time buyers is another large drag on housing demand. This has significant ramifications for the economy, which has historically relied on housing to help lead it out of recession through its ripple effect on other industries. In the present recovery, the housing market has remained in recession, making it difficult for the overall economy to gain any measure of traction. (See chart.) 

A New Secular Bull Market
The end of the debt super cycle is anticipated to produce a number of changes from policymakers to encourage growth and support the prospects of a new secular bull market. The foundation required to support and sustain economic recovery is a nation's savings rate and willingness to invest in new plants and equipment. For too long, policy was directed at short-term fixes that encourage more borrowing and more spending. The Federal Reserve also initiated policy that punished savers. Savings acts like a shock absorber on an economy and allows for investment to be financed at home as opposed to being dependent on the kindness of strangers that do not always have our country’s best interest in mind. We are encouraged by the fact that households and many corporations have already changed direction away from borrowing and spending, and many states and municipalities seem to be following suit. It will be important that the federal government soon adopt plans to significantly reduce spending – preferably back to the historical relationship with the size of the economy. We also expect important and significant changes in the tax code to a system that promotes fairness. As a final growth-enhancing goal, we fully expect the United States to put in place, for the very first time, an energy policy that makes full and effective use of our existing natural resources until viable, cost-effective alternatives are discovered and perfected.