A new study released by the Russell Sage Foundation analyzes trends in household wealth over the last twenty years, with a focus on the years surrounding the ‘great recession’ of 2008. The study examines changes in household net worth for the median household, as well as for the 95th percentile of households by wealth (the richest 5%), the poorest 25% of households (the 25th percentile) and tiers in between.
Source: Russell Sage Foundation
The results, adjusted for inflation (values are shown in 2013 dollars), show that the median U.S. household remains substantially poorer in terms of total net worth than it was before the recession and is actually now poorer than it was in the mid 1980’s. What’s more, median household net worth has not recovered at all since the great recession. The same trends are evident even for the wealthiest quarter of households (the 75th percentile), although the gains in wealth by this tier of households in the 80’s, 90’s, and early 00’s were sufficiently great that the top quarter of households by wealth is more than 25% wealthier today than in the mid 80’s.
The most striking feature of this chart is the spread in wealth levels. While the median and 25th percentiles of households by wealth are substantially poorer today than they were twenty years ago, the wealthiest 10% (the 90th percentile) and the wealthiest 5%, in particular, are substantially richer today. The increasing spread between the percentiles through time is evidence of growing inequality. The study concludes that much of the divergence between wealthier and poorer households reflects the proportion of their wealth held in homes vs. stocks and bonds. Housing prices remain well below their previous peaks in 2007, while the equity markets have regained their previous levels. For poorer households, homes represents the vast majority of their net worth. This is not the case for wealthier households. The results of this study are consistent with other analysis—this is confirmation rather than being surprising. Nonetheless, each new set of results that are consistent adds weight.
Implications for Investors
The implications of the trends in the table above are substantial. If the median household is seeing declining or stagnant wealth levels—with more extreme declines for poorer households—this will ultimately reduce their capacity to buy and consume goods and services. Indeed, the Russell Sage study concludes that declining household wealth shows that poorer households, unable to support their current consumption with income, are gradually depleting their assets. At the other end of the spectrum, the wealthiest 10% of households has seen a substantial decline in net worth as well, even though this tier enjoyed huge gains in the past twenty years.
Aside from the fact that declining household wealth reduces the ability to spend, there is also the problem of the wealth effect. Households that have disposable income are less likely to spend it if they feel less wealthy and even the 95th percentile of households by wealth is less wealthy than it was just five years ago.
The simplest interpretation of these data are that mid-market retail products and retailers are going to suffer, while the budget products and retailers and the luxury markets will perform relatively better. So, for example, Family Dollar stores (FDO), WalMart (WMT), Costco (COST) and other discount retailers should do well. More broadly, however, the declining disposable incomes for the middle tier of investors suggests that the companies that provide the basic products and services that people depend upon are good bets. Utilities (IDU), oil companies (IGE), and pharmaceutical companies (JNJ, BMY, GSK, PFE) are fairly well insulated from changes in wealth distribution.
The more challenging questions involve discretionary goods and services that are higher-priced and easier to do without or that can be displaced by lower-cost competitors. Companies like Bed, Bath, and Beyond (BBBY), Whole Foods (WFM), Abercrombie and Fitch (ANF), and Express (EXPR) sell products for which there are cheaper and largely indistinguishable alternatives. The winners in this mid-market business are those companies that provide fairly low-cost products while retaining brand appeal to wealthier customers (SBUX, CMG, NKE).
Another theme that looks promising is consumer products that are expensive relative to peers but that represent a low-cost substitution as compared to other types of conspicuous consumption. Apple (AAPL) has successfully capitalized on this trend. The new iPhone may be expensive compared to other phones, but it is fairly cheap as a prestige object. Smart phones also provide low-cost entertainment via product offerings such as Facebook (FB). People who spend their time surfing Facebook or watching Netflix (NFLX) are likely to see cable TV as expensive. This realization is already expressed in the high prices of these firms relative to their earnings, however.
The latest data on growing wealth inequality add support to the conclusion that the middle tier of American families is getting squeezed. The long-term implications for how people spend their money are worth considering. The ultimate losers will be companies that sell fairly high-cost goods or services to the middle class for which there are low-cost alternatives and for which there are up-market competitors that appeal to wealthier families. One class of winners will be low-cost ‘prestige’ brands such as smart phones and Starbucks coffee. It is hard to imagine the average urban millennial substituting his iPhone for generic pay-as-you-go hardware or rushing to the office with a cup of gas station coffee rather than the iconic Starbucks cup. As discretionary wealth gets tighter for the middle tier, low-cost mobile entertainment looks like a winner at the expense of cable and satellite TV.
The discount retailers and providers of basic goods such as fuels and pharmaceuticals are likely to hold up well simply because changing wealth distributions will have little impact on their businesses.