Barron's Cover


On the Rise


A lost generation? No way! The Millennials are finally poised to start spending, which is good news for the economy and stocks.


The kids are alright. More than alright, in fact. Widely dismissed as a lost generation with few job prospects, towering student loans, and a bleak future, the so-called Millennials, most of whom have reached adulthood since 2000, could surprise America and the world in coming years with their economic might and spending power.

Industries from housing and autos to retailing and financial services could be transformed by their collective demands and desires, while their growing wealth, coupled with their doubts about the future of government entitlement programs, could usher in a new era of saving and a bull market for stocks.

Things haven't been easy for the members of this generation almost since the day musician Kurt Cobain, one of their patron saints, died in 1994. They've known two U.S. wars, mass shootings, terrorist attacks, the financial crisis, and the lean years since, which coincided for many with their graduation from college and frustrating attempts to launch themselves into adulthood and careers.

Brad Trent for Barron's

Yet the Millennials are far from the slackers the media and popular culture portray -- a generation of adult children living at home with Mom and Dad, texting away and refusing to grow up. The evidence suggests that their march up the career ladder hasn't been aborted so much as a delayed by economic circumstances and personal choice. Once they get going, however, and marrying, starting families, and moving into their high-earning years, their influence could approach that of their baby-boom parents.

FOR ONE THING, THE MILLENNIALS -- sometimes called Generation Y, and defined by many demographers as ranging from ages 18 to 37 -- make up the largest population cohort the U.S. has ever seen. Eighty-six million strong, it is 7% larger than the baby-boom generation, which came of age in the 1970s and '80s. And the Millennial population could keep growing to 88.5 million people by 2020, owing to immigration, says demographer Peter Francese, an analyst at the MetLife Mature Market Institute.

This echo-boom generation totals 27% of the U.S. population, less than the 35% the boomers represented at their peak in 1980. When the baby-boom generation drove the economy in the 1990s, growth in gross domestic product averaged 3.4% a year. As the Millennials hit their stride, they could help lift GDP growth to 3% or more, at least a percentage point higher than current levels.

The Millennials already account for an annual $1.3 trillion of consumer spending, or 21% of the total, says Christine Barton, a partner at the Boston Consulting Group, which defines this cohort as ages 18 to 34. As the economy pulls out of an extended period of sluggish growth, helped in part by this rising generation, annual growth in consumer spending is likely to revert to its long-term average of 3.5% to 4% from about 2% now. Likewise, consumer spending on durable goods could rise sharply.

The Millennial generation has already made a big mark on one industry: education. The number of students enrolled in college in the U.S. climbed by 30% from 2000 to 2011, helping to fuel a building boom on campuses across the country. But that's something many schools could regret in coming years, given the past decade's sharply declining birth rate.

Owing in part to the Millennials' surge, apartment demand is strong around the country. Housing could be the next major industry to benefit from their size and maturation, but Wall Street could reap the biggest rewards. The MY ratio, which compares the size of the middle-aged population of 35-to-49-year-olds with that of the young-adult population, ages 20 to 34, explains why.

Middle-aged folks have higher incomes than younger people, and a greater urgency to save for retirement. They invest their savings, which drives up stock prices. When the MY ratio is rising, meaning the older cohort outnumbers the younger, the stock market typically does well. The ratio has been falling since 2000, which has exerted a drag on stock prices.

Alejandra Grindal, a senior international economist at Ned Davis Research, notes the MY ratio will bottom in 2015 and then rise through 2029. It is one of several reasons the firm is bullish on stocks. According to financial-services providers, the Millennials already have started saving, spurred in part by fears that dwindling Social Security payments could make their retirements largely self-funded.

THE BABY BOOMERS FOUGHT IN VIETNAM -- and fought against the war there. They gave us flower power, rock 'n' roll, civil rights, The Feminine Mystique, and Bill Clinton. Having transformed the culture, they are now reinventing retirement -- as a second adolescence, but with worse knees.

Their children, who are also entering adulthood in fraught economic times, are highly educated, ethnically diverse, and team-oriented, says Neil Howe, an economist, historian, and author of several books on demographic and generational trends. They trust government, and voted for Democrats in the past three elections, sending President Obama to the White House twice.

They grew up in an era when children were rediscovered -- often in soccer uniforms in the back of a minivan. Child safety was a parental priority, and helicopter parenting became the norm in many families, facilitated by the ubiquity of cellphones, which encouraged constant communication. That alone separates the new generation from Generation X, which grew up as divorce rates soared. Gen Y, on the other hand, "is sheltered and expects to be sheltered," says Howe.

Millennial women could be a particularly powerful force in coming years, says Francese, and one that marketers ignore at their peril. They have more education than the men of their generation, and in about a third of marriages, they have higher incomes.

Above all, the Millennials are connected -- to the Internet and each other. They brought us Facebook and popularized YouTube, Twitter, and phrases like 24/7, which describes how much time they spend on the 'Net and personal electronic devices. Nielsen estimates that 74% of young adults between the ages of 24 and 34 own smartphones, up from 59% in mid-2011. According to Advertising Age, consumers in their 20s switch between communications platforms and devices 27 times per nonworking hour.

THERE IS NOTHING NEW about worrying about future generations. Chances are, even the cave parents did it. To be sure, many Millennials got a bum deal by coming of age during the great recession, but a multitude of statistics suggest their prospects are improving.

Take unemployment, which remains high for young adults between the ages of 20 and 24. Last month's 13.3% unemployment rate for this population was down, however, from January's recent peak of 14.2%.

As for those ages 25 to 34, the unemployment rate was 7.4% in March, below the national average of 7.6%, and well below 8.9% in January 2012. Dick Hokenson, an economist who heads ISI Group's Global Demographics Research team, says 25-to-34-year-olds have recovered almost 75% of the jobs they lost to the recession. "They're finding jobs; they're moving out and doing normal things," he says.

Again, the numbers tell a cautiously hopeful story. Nineteen percent of U.S. men ages 25 to 34 live with their parents, says Mark Mather, a demographer with the nonprofit Population Reference Bureau. But that is up only five percentage points from 2007. The percentage of 25-to-34-year-old women still living at home is 9.7, up from 9% in 2007.

There is almost $1 trillion of student debt outstanding in the U.S. today, which could limit the purchasing power of Millennials. "These people have a mortgage and no house," Francese says.

But here, too, total figures are misleading. The average student loan among Gen Y-ers is $25,000, and the median loan is nearly $14,000, according to the Federal Reserve Bank of Kansas City. Less than 1% of student loans are larger than $100,000.

AS THE MILLENNIALS' EMPLOYMENT situation improves, more young adults living at home will pack their bags and move out. That could spur an increase in U.S. household formation, which turned negative in 2007-08. Since then, the number of newly created households has recovered to about a million a year, still well below an annual average of 1.5 million since the 1970s, according to Census Bureau data.

Greater financial security could mean an increase in the birth rate, which typically slumps during economic downturns. Francese sees the average birth rate for U.S. women rising to 2.1-2.2 in coming years from a depressed 1.9 recently. "A lot of Millennials put off having babies, and now they will get to work," he says.

That suggests they will also start buying homes. Pat Tschosik, a consumer strategist at Ned Davis Research, figures there will be more home buyers than sellers in the 12 years ending with 2019, giving the housing market a boost.

Robert Turner of Turner Investments agrees. "We're big believers in this housing recovery," he says, noting his firm has invested in Home Depot (ticker: HD), the home builders Lennar (LEN) and Toll Brothers (TOL), and mortgage companies. "The leverage in these companies is underappreciated," he says.

The National Association of Home Builders market index has risen 163% in the past two years, an indication that the industry's sunny prospects haven't been ignored. Dennis McGill, director of research at Zelman & Associates, sees more gains ahead, and is bullish on Pulte (PHM), Toll, and Lennar. The firm also likes Home Depot and Lowe's (LOW), as well as Sherwin-Williams (SCH), Fortune Brands Home & Security (FBHS), American Woodmark (AMWD), and carpet maker Mohawk Industries (MHK).

THE MILLENNIALS ALSO could have a big impact on Detroit, which saw annual vehicle sales plummet to 10.4 million in 2009 from an average of 17 million a year in the early to mid-2000s. This year sales are likely to recover to 15.3 million, before rising gradually to 17 million in 2017, says Jeff Schuster, senior vice president of forecasting at LMC Automotive, formerly a division of J.D. Power & Associates.

Whether higher sales volumes translate into fatter profits for car makers is another matter. When the Millennials become parents, Ford Motor (F) expects that they will be looking for low-cost, fuel-efficient utility vehicles, says Erich Merkle, U.S. sales analyst at the auto maker. Ford's response, at least for the 2014 model year, is the huge and boxy Transit Connect Wagon. Retail prices for the Transit Connect are expected to start at $22,000, a few thousand dollars below starting prices for minivans such as the Toyota Sienna, a mammoth people mover favored by boomer parents.

As the generations shift, new retailers could have the wind at their backs. These include merchants specializing in children's apparel and furniture, and companies that offer value, such as Family Dollar Stores (FDO). But other concerns, with more appeal to teens and mature, high-income adults, could encounter head winds. Among them: Abercrombie & Fitch (ANF) and American Eagle Outfitters (AEO), as well as Tiffany (TIF), Nordstrom (JWN), and Coach (COH).

Macy's (M) defines the Millennials as 13 to 30 in age, and estimates that they control $65 billion in spending. Last year, the department-store retailer outlined plans to use more technology in stores and online to create a "fun" and convenient shopping experience that it hopes will attract and retain Gen Y customers. Among other things, the company will step up its use of QR codes and tap-and-go transactions.

THE GOOD NEWS FOR Wall Street is that Millennials know they need to save, and they're not afraid of stocks, which account for more than 70% of their portfolios, according to Vanguard. They are also poised, along with their Gen X predecessors, to come into some serious money as the boomers age and die. The two younger generations combined could see their wealth grow to $28 trillion in the next five years from $2 trillion now, as they earn more and claim their inheritance, says Christopher Tsai, head of Tsai Capital in New York.

Banks and money managers aiming to woo this generation must embrace technology, as Citigroup (C) is doing by opening branches with media walls that display news, local weather, and event listings. Financial advisors pursuing the Millennials need to brush up on blogging and Webcasts.

As the Millennials become parents, expect them to focus on grown-up financial products such as life insurance and college-savings accounts. In other words, it is only a matter of time before this slow-to-launch generation resembles -- you guessed it -- Mom and Dad. 

This Summer Slowdown Will Be Different Than The Previous Three

Apr 28 2013, 07:01

by: Lawrence Fuller

For three consecutive years, there has been a correction in the stock market that began in late April and ended during the summer months, bringing credence to the "sell in May" mantra. Each correction was followed by an approximate 300 point gain in the S&P 500 index. The most recent correction began in spring 2012 with the S&P 500 (SPY) bottoming on June 1 at 1,278. It now stands nearly 300 points higher at 1,582.

We can point to different adverse economic and political factors on both the domestic and international fronts as reasons for each of these corrections, but I think most investors will agree that the one constant and pre-eminent factor was the conclusion of the quantitative easing [QE] program that was underway at those times. Consequently, it was the announcement and implementation of a new QE program that ignited, and possibly fueled, the subsequent rallies. The pattern depicted in the chart below can't possibly be a coincidence.

(click to enlarge)

It is still debatable as to whether or not a new correction in equities is underway. We have only realized a 3% pullback from the April 11 closing high of 1,593. Still, the deterioration in the economic reports that we have grown accustomed to seeing in the spring of each year is without question happening again. April's high-frequency economic data has been a steady drumbeat of declines, short falls and missed expectations that even seasonal adjustments are unable to gloss over.

Following a very weak employment report for March, we learned that wholesale inventories recorded their biggest decline in 18 months in February. We also saw consumer sentiment fall to its lowest level in nine months, and retail sales for March decline .4% when a gain was expected.

(click to enlarge)

The regional manufacturing indexes for the Empire State and Philadelphia both declined, falling below expectations, with the Richmond Fed survey moving into negative territory. Also surprising the consensus, the Markit US flash purchasing managers index fell in April from a previous reading of 54.6, to 52.0, which was the lowest reading in six months. The Chicago Fed's national activity index further confirmed the deceleration, showing slower economic growth that was led by declines in production and employment-related indicators.

Recently, we learned that orders in March for durable goods logged their largest drop in seven months, but much more disconcerting was the year-over-year rate of change, because orders for durable goods in the first quarter of this year have now fallen .1% below the orders we saw in the first quarter of last year. Core orders, which exclude the volatile transportation sector, have fallen .5%. Despite the overwhelming evidence of a severe slowdown at hand, I continue to read research reports from strategists wearing QE-colored glasses that say that these stats are just noise in the underlying data. I'm not sure what underlying data they are referencing, other than the ticker tape.

With an established pattern at hand and evidence that it is repeating once more, I think it is important to note that the economy is in a significantly more weakened state today that it was just prior to the three previous economic slowdowns in 2010, 2011 and 2012. Below you can see a chart of the Institute for Supply Management's purchasing manager index dating back to January 2010, which depicts a series of lower highs and lower lows each year. If this were a stock chart, you would not have it on your buy list. As we enter the fourth consecutive summer slowdown, the PMI is flirting with the level of 50 that marks contraction.

(click to enlarge)

When I examine the outlook our "job creators" have for the US economy, based on the NFIB small business optimism index, it is weakening to levels we last saw at the early stages of recovery in 2010.

I have included the monthly readings in a spreadsheet below the chart that depicts the year-over-year declines in this index for the first three months of this year. Small business accounts for approximately half of our private sector economic growth and employs approximately half of the private sector work force.

(click to enlarge)

Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
2008 91.8 92.9 89.6 91.5 89.3 89.2 88.2 91.1 92.9 87.5 87.8 85.2
2009 84.1 82.6 81.0 86.8 88.9 87.9 86.5 88.6 88.8 89.1 88.3 88.0
2010 89.3 88.0 86.8 90.6 92.2 89.0 88.1 88.8 89.0 91.7 93.2 92.6
2011 94.1 94.5 91.9 91.2 90.9 90.8 89.9 88.1 88.9 90.2 92.0 93.8
2012 93.9 94.3 92.5 94.5 94.4 91.4 91.2 92.9 92.8 93.1 87.5 88.0
2013 88.9 90.8 89.5

The US consumer is now clearly under far more financial duress than at any other point in the prior three years. Real disposable incomes are declining year-over-year, and the savings rate has fallen to just 2.6%. Consider the first-quarter earnings reports for Coach (COH), which performed very well, and Target (TGT), which clearly did not. Which company better exemplifies the spending power of the typical American consumer? Here is another example; we know that Americans like to eat out, so what does it say when they are eating out less today than they did a year ago? The last time this happened was the third quarter of 2007, as depicted in the chart below. Again, Wall Street calls this noise in the underlying data.

(click to enlarge)

Eating at home is clearly not the only sacrifice that consumers are making today. In examining the details of the most recent retail sales report, depicted below, you can see a significant decline in spending on electronics, appliances, and general merchandise, and a second monthly decline in vehicle sales out of the last three.

(click to enlarge)
In addition to the economy being in a weaker state today than in prior years, the stock market faces a headwind it has not had to contend with since the recovery began. We are no longer seeing growth in earnings or revenue.

According to the data provided by S&P Dow Jones Indices in the chart below, S&P 500 operating earnings have now declined sequentially for two consecutive quarters on a year-over-year basis. Even the more forgiving estimates calculated by earnings aggregators like S&P IQ and Thompson Reuters, which exclude pension and option expenses from operating earnings, are showing that the current quarter will be the first year-over-year decline since the last recession. The last time we saw such a sequential decline was in the third quarter of 2007.

12/31/2012 1426.19 $23.15
09/30/2012 1440.67 $24.00
06/30/2012 1362.16 $25.43
03/31/2012 1408.47 $24.24
12/31/2011 1257.60 $23.73
09/30/2011 1131.42 $25.29

I've never witnessed so many high profile companies miss earnings and/or revenue estimates and guide lower, only to see the broad market indices grind higher. It used to be that when bellwethers like Oracle (ORCL), Caterpillar (CAT), McDonalds (MCD), General Electric (GE) and IBM disappointed investors, the broad market would follow. Then again, this is a new era where investors trade stocks, while computers trade the indices and the futures on those indices.

The most prevalent counter-argument to another economic lull is that the housing market recovery will be powerful enough to sustain current rates of economic growth. I'm not convinced. Housing is recovering. There has been an increase in new home construction and a modest recovery in home prices nationwide from the bottom that was established 18 months ago. Still, with the housing industry accounting for just 2.6% of overall economic growth, even when one accounts for the ancillary growth that results when a new home is built, the base is too small to offset the significant headwinds from declines in consumer and government spending.

(click to enlarge)

Furthermore, recent reports raise questions about the sustainability of the strength we have seen in housing over the past year. Sales of new homes declined 4.6% in February to an annual rate of 411k, which was the biggest monthly drop in two years. The modest increase in March to an annual rate of 417k was still below the January rate of 431k. Perhaps this is why the National Association of Homebuilders confidence index declined in April for a third month in a row to just 42 from a reading of 44 in the prior month, well below expectations for an increase to 45.

I believe that the economy is in a weaker state today than at any point in the prior three years, and I am certain that market fundamentals have peaked and are beginning to deteriorate. But what should concern investors the most, should the economy stall and stock prices correct, is that there will be no new QE program to assuage investor sentiment. We will no longer have the excuse that the current program's termination is the reason for the economic malaise. The anxiety in the market that accompanied the maturing of each program will be replaced with an anxiety that there is no new QE program to resuscitate the patient, because the previous one never ended. This is the most significant factor in making what is likely to be a summer slowdown accompanied by a market correction different than the past three years, and in a very disconcerting way.

My expectation and hope is that the public will start to question the efficacy of QE in stimulating economic growth and creating jobs, leading to its end. In my opinion, the Pew Research Center's analysis of recently released Census Bureau data best exemplifies how QE works. During the first two years of recovery, through 2011, the wealthiest 7% of American households saw their net worth increase 28%, while the lower 93% saw their net worth decline by 4%.

The majority of Americans do not have enough wealth in financial assets to benefit from Chairman Bernanke's stock market experiment. Instead, they have most of their wealth tied up in the value of their homes. The problem is that you can no longer spend your home! If we don't figure out a way to bring the 93% along for the ride that the 7% have been enjoying the past four years, the US economy is in deep trouble.

I agree with what seems to be a growing consensus that we will see a stock market correction in the near term. The initial correction, should it occur, is likely to be rather abrupt, because movements in the broad indices are no longer determined by human factors, but instead are dictated by the computer algorithms that provide the market with its only source of liquidity, a liquidity that can evaporate in response to nothing more than a tweet. I can't imagine how this matrix of machines will respond to a significant adverse event or an inundation of headlines that are overwhelmingly negative.

Where I don't agree with the consensus is that a mere 5% decline realigns market prices with the economic fundamentals and presents a buying opportunity in the indices. I don't believe the consensus appreciates how poor the fundamentals are today, which is not surprising, considering that the consensus is primarily made up of the wealthiest 7%. There is also the significant risk that the correlation between QE and financial asset inflation breaks down. In the heat of a decline of 5% or more, will investors still see an investment opportunity when they realize there is no new monetary catalyst to end the decline and resume the uptrend? In other words, how will the market respond when it sobers from its drug-induced state, following a market correction, only to realize that it never experienced the withdrawal associated with the end of its last prescription?

What I am focused on, as we enjoy the short-term fruits of the Fed's largesse and begin another deceleration in economic growth, is how to position for the coming acknowledgement that QE fails to foster the economic growth and job creation that the Fed continues to avow it does. That acknowledgement will undoubtedly bring with it new investment opportunities.

Additional disclosure: Lawrence Fuller is the Managing Director of Fuller Asset Management, a Registered Investment Adviser. This post is for informational purposes only. There are risks involved with investing including loss of principal. Clients of Fuller Asset Management may hold positions in the securities mentioned in this article. Lawrence Fuller makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by him or Fuller Asset Management. There is no guarantee that the goals of the strategies discussed by will be met. Information or opinions expressed may change without notice, and should not be considered recommendations to buy or sell any particular security.