Wed, Aug 7, 2024|Whitney Tilson

Millions of Americans are being left behind

Macroeconomic data is one thing... but folks' lived experiences are another.

The economic fundamentals... remain solid. Yes, the economy is slowing... but as I wrote a week ago, "keep in mind that this softness is coming after the economy was white-hot, which the Federal Reserve deliberately cooled by raising rates rapidly to bring down inflation."

And inflation remains muted. In the July 11 report for June, month-over-month prices declined 0.1% – the first monthly decline since May 2020. And the core price index, which excludes volatile prices of food and energy, increased 3.3% year over year – the lowest yearly increase since April 2021.

Every time I write something like this, I hear from readers who say that, for millions of Americans, the economy is not doing well for them and/or they are being crushed by inflation.

I think they're right – and there are profound implications for our country, economy, and stock market – so I'd like to discuss this in depth today...

As a starting point, here's a recent Wall Street Journal article on this topic: The Haves and Have-Nots at the Center of America's Inflation Fight. Excerpt:

The stock market is soaring, household wealth is at record levels and investment income has never been greater. At the same time, some families' pandemic-era savings are running dry, and delinquencies on credit card and auto-loan payments have jumped.

Warning signals are flashing for more low- and middle-income Americans, exposing a division between people whose gains are being whittled down by elevated inflation and borrowing costs and those who are benefiting from high asset prices and bond returns. The crosscurrents are scrambling the outlook for the U.S. consumer – a bedrock of economic growth, corporate business plans and Wall Street investments.

And as the article continues:

America's economy continues to defy expectations of a slowdown and muscle ahead of other wealthy nations. The U.S. job-creation machine has boosted wages, recently outpacing inflation. Investors are now growing more hopeful that the Federal Reserve can tame inflation without wreaking widespread havoc.

But that could hinge on the continued resilience of consumers – and whether spending by high-earners can counteract slowdowns elsewhere. As economists await interest-rate cuts that could relieve pressure, the cumulative impact of higher prices and borrowing costs is starting to curb some Americans' ability to keep up.

This line in particular in the article stuck with me:

"This is the most money we've ever made and this is the brokest we've ever felt," said Nicole Lewis, a mother of three who lives north of Flint, Mich.

For a more in-depth, long-term look at the hollowing out of the American middle class, I highly recommend this two-hour PBS Frontline documentary, Two American Families, which reader Eric G. flagged for me. As Eric wrote in an e-mail:

It's heart-wrenching and is a great window into the last 30+ years and why the American economy has left so many people behind.

I agree 100% with Eric that it's heart-wrenching. The documentary traces two families from Milwaukee, one black and one white, over the past 33 years. Both follow an all-too-familiar, tragic trajectory...

In 1991, the men of the family both had $18 to $20 per hour union jobs with benefits that supported a solid middle-class life for them and their families. And then both were laid off by the large corporations they worked for, who relocated their jobs/factories to the non-union South or overseas and/or replaced them completely by sourcing from China.

The men and their families spiraled down into the working poor and have never recovered. The men could only find a series of no-benefit jobs paying not much more than minimum wage, less than half of what they used to. And the women had to go to work doing things like being a nurse aide, also at near-minimum wage... this despite both husbands and wives taking various educational and training programs to learn new skills.

The black family's neighborhood fell apart because so many of the men lost good jobs, and gangs took over. The children (now adults) struggled due to poverty, homelessness, and absent parents (because both were working so many hours).

Both families had health issues that essentially bankrupted them, they lost their homes, tried to start businesses (that failed), fell into debt traps by the predatory lending industry, etc.

It's especially devastating to see this because: a) these are people who worked hard and played by the rules... and b) they are not outliers – you can find the tragic trajectories of these families across the middle class all over this country. Chew on these statistics from recent years that I've come across:

From 1979 to 2020, productivity grew by about 65%, but hourly compensation only grew by about 15%.
Across the country, the costs of essential goods and services – such as housing, health care, and education – have outpaced wage growth.

For example, according to the U.S. Treasury Department, from 2000 to 2020 both median rents and median house prices rose faster than overall inflation in 77% of U.S. counties – home to a whopping 93% of America's population.

Middle-class households are increasingly burdened by debt. As of the second quarter of this year, households' non-housing debt in the U.S. stands at nearly $5 trillion, with significant portions coming from student loans, auto loans, and credit-card debt.
In 2019, about 66.5% of all bankruptcies were tied to medical issues, either due to high costs for care or time out of work.
Millions of Americans aren't adequately prepared for retirement. Fewer than half of working-age households have any retirement savings, and the median retirement account balance for American families stands at just $87,000.
For two years, from early 2021 to early 2023, as inflation surged, wages didn't keep up... so average wage-earners fell behind. Take a look at the chart below from this recent WSJ article: The Hottest Job Market in a Generation Is Over:

Lastly, while inflation has come back down and wage growth has now outpaced inflation every month for more than a year, prices are now a lot higher... which makes people feel like their spending power has declined.

As an example, in 2018, the Centers for Disease Control and Prevention ("CDC") estimated that 37% of Americans eat fast food on any given day... And look what has happened to prices over the past decade – led by McDonald's (MCD), whose prices have doubled in that stretch – in this chart a friend sent me from FinanceBuzz:

In recent years, things have been even worse for young people:

According to a 2023 Harris Poll for Bloomberg, about 45% of young adults aged 18 to 29 are living with family – around the same levels as the 1940s, in the aftermath of the Great Depression – due to student debt, difficulty finding a good job, and housing at its least affordable level ever.
Young people are burdened with high levels of student loan debt. As of 2023, the average student loan debt per borrower was nearly $39,000.
Fewer young people are getting married compared with previous generations. In 2018, only 29% of adults aged 18 to 34 were married – less than half of the 59% in 1978.
Young people are also having fewer children. The U.S. birth rate in 2021 was 11 births per 1,000 people – continuing a multidecade downtrend. The decline is particularly pronounced among women in their 20s.

No wonder "deaths of despair" from drug overdoses, alcohol, and suicide have soared in recent years:

The CDC has estimated nearly 108,000 drug overdose deaths in 2023 (a slight decrease from the more than 111,000 estimated in 2022, but still a very high figure). This overall surge in recent years is primarily driven by the opioid crisis, including synthetic opioids like fentanyl.
Alcohol-related deaths have been steadily increasing. As of 2021, the CDC estimated about 178,000 deaths from excessive drinking each year. This was up 29% from the roughly 138,000 figure from just a few years earlier in 2017.
Suicide rates have been on the rise – up about 36% between 2000 and 2022. In 2022, there were nearly 50,000 suicides – making it among the leading causes of death in the U.S.

All of these "deaths of despair" statistics have been worse for young Americans in recent years:

In 2022, suicide was the second leading cause of death for people aged 10 to 14 and 25 to 34.
In 2019, nearly 37% of high school students reported persistent feelings of sadness or hopelessness – an increase of about 40% since 2009.
The pandemic exacerbated mental health issues among young people. In 2021, emergency department visits for suspected suicide attempts among adolescents aged 12 to 17 increased by 31% compared with 2019. Among girls in this age group, the increase was even higher at nearly 51%.
A 2021 study by the American College Health Association found that 48% of college students reported experiencing moderate to severe psychological distress. Meanwhile, 53% reported being lonely... and 25% had considered suicide.

So despite strong GDP growth, low unemployment, decent wage growth that has exceeded inflation for each of the past 13 months, and a sharp decline in inflation, I'm not surprised that many American middle- and low-income families and individuals feel betrayed, ashamed, exhausted, desperate, and angry that the American dream, which they once had (and their parents and grandparents had), has turned into an "American nightmare" for them (and their children).

And here's the thing... these angry Americans vote in large numbers, and they're concentrated in swing states, so it's not surprising that the winners of the last 11 presidential elections going back to Ronald Reagan in 1980 have been the candidates who "spoke" to these voters – and that both candidates/parties are wooing them once again...

So what are the potential implications of this for investors?

Two big ones – both likely negative for corporate profits and therefore stocks...

First, both political parties are putting up trade barriers like tariffs – and, in particular, getting tough with China – to protect American jobs.

This is one reason – along with pandemic-driven supply-chain disruptions and government funding and tax incentives from legislation like the CHIPS and Science Act – that American companies have tripled their spending on manufacturing construction in the past four years, as you can see in this chart directly from the St. Louis Fed:

This investment is creating good construction jobs in the short run and, in the long run, even more good manufacturing jobs.

But what is good for American workers isn't necessarily good for corporate profits.

For the past quarter century, companies have increasingly moved production and/or sourced from overseas. It's a major reason they have nearly doubled their profit margins, as you can see in this chart from GuruFocus:

A reversal, or even a halt, of these trends, could push corporate profit margins – and earnings – lower.

A second big effect resulting from the struggles of the American middle class is reduced consumer spending, which accounts for nearly 70% of our GDP.

This is a major reason why the stock of retailer Five Below (FIVE) has lost more than two-thirds of its value this year. As I wrote in my July 23 e-mail:

... then-CEO Joel Anderson blamed [the company's first-quarter revenue and earnings miss on] "the macro environment [that] disproportionately impacted our core lower income customers."

Then in my July 30 e-mail, I discussed a conversation I had with a friend who runs a wholesale distribution business that serves thousands of customers that, in turn, directly serve millions of Americans all over the country every day. As I said in that e-mail:

He told me that there's definitely a slowdown – for example, he's now seeing his customers' businesses down 8% year over year in recent months, except for a few that are executing superbly and/or serving high-income customers.

Most companies are still seeing rising costs but are no longer able to pass them along in the form of higher prices because more customers have been feeling tapped out.

This too will likely pressure corporate profit margins and earnings.

This is why you don't want to own average companies – you need to look hard for the best ones, which deliver so much value to customers and/or have such strong competitive positions that they can continue to grow while maintaining margins.

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Best regards,

Whitney

P.S. I welcome your feedback – send me an e-mail by clicking here.