consumers and the willingness for financial institutions to take more risk. Credit card debt outstanding has increased 300% since the 1990s. Figure 2.10 highlights the huge increase in outstanding credit card debt over both the last decade and the prior decade.
There was a time when consumers routinely paid cash for automobiles, then three-year auto loans were extended to five years to spur sales by lowering monthly payments. Today seven-year loans are very common and zero percent financing is a common selling point for auto companies that have created financing subsidiaries that would not exist if the markets were not willing to take risk in a search for yield. Student loans have delinquency rates over 50% and many students expect (hope) their loans will simply be forgiven by the government, which given the importance of consumer spending and avoiding deflation may be a likely outcome.
FIGURE 2.9 30-year average US fixed mortgage rate (1997 to November 2019)
FIGURE 2.10 US outstanding credit card debt (1997 to October 2019)
In total, the average US consumer has benefitted by approximately $1,000 per month since the 2008 financial crisis due to low rates and easy credit access. This is massive stimulus considering the average median income in the US is approximately $60,000 and has barely risen this decade. An increase of $1,000 after tax per month is more than a 25% after-tax income increase for the median household. If mortgage, auto loan, and credit card rates were to increase back to historical levels, consumer spending would drop precipitously causing significant problems for the overall economy.
The increased after-tax income has been spent in the 2010s driving the S&P 500 consumer discretionary sector up over 400%, as seen in Figure 2.11. This gain includes the many retailers that have been disrupted due to e-commerce competition. If there had been any recession or consumer spending slowdown during the last ten years, dozens of additional retail chains would have closed their doors. In the 2020s decade, there will be many more retail store closings, as both disruption and a slower economy combine to add stress to the retail industry.
Americans have been the beneficiaries of all this credit through increased consumption. From the perspective of an investment manager all consumer-related companies have been major beneficiaries and have had success beyond historical standards. This, again, lowers the contribution of security selection due to their being little benefit in avoiding weaker companies. Going forward, any changes in the cost or accessibility of consumer credit should be closely monitored by investors. Low rates and credit accessibility have pulled consumer demand forward, as buyers take advantage of cheap credit opportunities. At some point in time, there will be a contraction in credit accessibility or consumers will become more concerned about their future earnings potential and consumer spending will slow from these historically high levels.
FIGURE 2.11 S&P 500 Consumer Discretionary Sector Price Index (2009 to October 2019)
The US consumer has been the most resilient part of the American economy in the 2010s buoyed by the central bank–driven low rates and credit accessibility. As evidenced in the University of Michigan Consumer Sentiment Index (Figure 2.12), sentiment rose from 2010 to 2016 and has now plateaued. Sentiment is cyclical and does not generally last for more than a decade. Eventually consumer sentiment and demand weaken. Consumer companies will face slowing revenues, increasing margins, and industry disruption after a decade of strong consumer spending and cost savings driven by the globalization of supply chains.
FIGURE 2.12 University of Michigan Consumer Sentiment Index (1994 to October 2019)
The power and breadth of low rates has clearly been the most important driver of financial markets in the 2010s, but technological disruption is a close second, and there is a synergistic relationship between the two most prominent forces of the 2010s.
CHAPTER 3 ACCELERATED PACE OF TECHNOLOGY = DISRUPTION
Innovation adoption tipping point
Innovation and financial capital
Outperformance potential with unprofitable but disruptive companies?
Private markets overheating?
Contrarianism and paradigm shifts
Capitalism has always been about change and disruption. Joseph Schumpeter, the well-known Austrian economist, formulated his theories on innovation and capitalism back in the early 1900s. Popularizing the term creative destruction, Schumpeter conceptually described the path of innovation and its effect on the economy, specifically economic growth. Innovation comes in waves or cycles with every major innovation producing disequilibrium in the economy. At the same time, innovation creates new opportunities as new businesses are born and older business models are disrupted. As one innovation goes from idea to production to early adopter to mass use, the original innovation spurs new ideas and they develop on their own life cycle, eventually sending the original innovation into decline. There is a continual process of human innovation spurred by a capitalistic system that rewards innovation due to the ability to make money. This process of creative destruction has been occurring for decades and is generally positive for society.
At the heart of capitalism is creative destruction.
—Joseph A. Schumpeter, economist
The question for investment managers is,
Why is the faster pace of creative destruction more important to active investing today?
What Schumpeter could not have had much insight into was how these waves of innovation would change in length of cycle and the amplification of their effect on economic development and disruption. There are two major factors that determine the speed of new innovation and their speed to mass use: technology and capital.
Many leaders in the technology field believe the nature of recent technologies themselves are shortening the length of innovation cycles. New technologies and discoveries are building on themselves to quicken the pace of innovation and adoption. Gordon Moore of Intel formed the hypothesis that the number of transistors in an integrated circuit would double every two years, and this theory has held in the electronic circuit industry. It may not
