How Traders Can Win

How Traders Can Win When the Personal Savings Rate Drops

The Trader's U E-Letter: Issue #154

Wednesday, September 28, 2005

How Traders Can Win When the Personal Savings Rate Drops

by D.R. Barton, Jr., Chairman, Trader's U

The news was grim. In August, it was announced that Americans, for the first time ever, were spending every nickel they earned.

This was a big story, and was carried by most media outlets. Talking heads jabbered on about it. Some claimed that it was the end of the world, and others - citing the flawed calculation methods of the government - suggested the statistic was meaningless.

Then the news came earlier this month that the personal savings rate for Americans had actually dropped below zero.

The good citizens of the U.S.-of-A. were spending, on average, more than they were making. Not only were there no savings for the month, we were actually spending our old savings, or taking on even more debt.

I guess the story had run its course back in August, because not much was made of this new revelation.

Today we'll look at the implications of this situation… and two types of investments that could end up taking a beating.

Little-to-No Savings = Living Life on the Edge

Before I go on, let me clear up two issues about the numbers. First of all, the negative personal savings rate had nothing to do with our recent hurricanes. The data are announced two months after the revenues and expenses occur. (I guess it takes a little while to tally up the trillions of dollars of earning and spending.)

Another issue that needs clarification is the exclusion of some retirement accounts from the savings rate - accounts that people usually equate with savings, but are not included in the government's numbers (401(k)s, Simplified Employee Pensions, and Individual Retirement Accounts).

Does this make a real difference in our discussion? Well, yes and no. Yes, because if these accounts were included, the savings rate would probably still be positive. But the better answer is no, because we are comparing historical numbers and trends, and the accounts have never been included. So what we are seeing are data that show personal savings rates at an all-time low in the U.S.

There are two distinctly different ramifications from a falling savings rate in the U.S. The first is personal and the second is national. But they're linked conceptually.

On a personal level, when savings dry up, we live with no financial cushion - no margin for error. If a household has spent everything it's made, there are few options when unexpected or emergency expenses crop up. If the savings account is empty and a car breaks down or a refrigerator blows up, the only option is borrowing to pay for required repairs and replacements. And with consumer debt growing at a much faster pace than personal income, a crisis in consumer debt spending could be looming.

On a national level, we see a slightly different problem from reduced (or non-existent) personal savings. As the U.S. goes deeper into debt, it is no longer our citizens (or institutions funded by personal savings) who are buying that debt. Instead, foreign countries are buying U.S. bonds. Both Japan and China are major holders of U.S. debt. The growing U.S. dependence on foreign cash to finance our investment requirements puts us in a tenuous position.

If foreign governments decided to stop buying U.S. debt (for market-based or political reasons), we could see an immediate shock to our financial system that could include a severe decline in the value of the dollar, an equities market swoon or crash, etc. So in a sense, a diminishing personal savings rate in the U.S. moves our national financial picture toward a place that is similar to individual households with little-to-no savings - a position where there is little margin for error.

Retail and Bond Market Reactions for Traders and Investors

The American consumer has taken personal deficit spending to levels heretofore unknown in our country's history. While ramifications on a national scale may be slow in developing, individual markets are likely to react in the coming months. Two items may be of special note for traders and investors:

1. Consumer spending will slow as debt continues to grow. Unlike governments, households can't keep up deficit spending indefinitely. And the first area that will be hit when spending slows is the retail sector. It has already been hit hard over the last two months, and the pain could well continue. Avoiding this sector, or piling onto the downward momentum, are the most sensible plays. For a chart depicting the current woes of the retail sector, see "The Chart of the Week" below.

2. U.S. debt instruments should struggle. U.S. bonds have other problems to deal with, including massive borrowing that will be required to rebuild after a devastating hurricane season that is, unfortunately, not over yet. The reduced personal savings rate is just another straw that will burden this camel's back. Again, avoiding or shorting this market, which should suffer the pains of oversupply, seems to be the sensible course.

Today's TU Tips & Tricks

Advanced Trader's U: In "The Chart of the Week," we'll look at the Retail HOLDRS. This relatively new investment vehicle - the HOLDRS (commonly referred to as "holders," for obvious reasons), are gaining in popularity. And for a good reason. These stocks, traded on the American Stock Exchange, allow people to invest in sectors, thus mitigating "single stock risk" (the risk that one stock can have a big move against you based on bad corporate news, etc.). They also have the advantage of allowing traders and investors to sell them short without waiting for an uptick. "HOLDRS (HOLding company Depositary ReceiptS) are securities that represent an investor's ownership in the common stock or American Depositary Receipts of specified companies in a particular industry, sector or group. HOLDRS allow investors to own a diversified group of stocks in a single investment that is highly transparent, liquid, and efficient." For more information, visit http://www.amex.com.

The Chart of the Week

HOLDRS

As described above, there are some fundamental reasons why the retail sector should continue to be weak. Selling strength would be a useful entry technique. Another would be to short breakdowns below the key $90 and $86 price zones.

Great trading,

D.R.

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