Wednesday, March 20, 2013

Investing in the Spending Trends of the Wealthy

I have a quick trivia question. What share of US net worth does the bottom 60% of the US hold? Stop for a second and think about the answer. The correct answer is just 4.2% while the top 5% of the US owns nearly 62%.  Now consider an average superstore in an average mall (such a thing doesn’t actually exist but assume it does) and accept that spending correlates strongly with net worth (it does) this would mean that just 5 out of a 100 shoppers is doing the bulk of spending. Meanwhile 6 out of the 10 are doing just 4% of the buying. Now hold that thought.

A Realistic Way to Think About Spending

The reason I am engaging the reader in this kind of thought framing is because it is the reality whereas it is so easy for us to fall into the delusion of misattributing spending trends thanks to the language we use. Analysts and commentators use words like ‘mass’ and ‘luxury’ to describe the retail market. They are useful concepts and I am not in any way arguing that the top 5% only buys luxury goods! However the point is that we should think about retail trends in terms of who is doing the spending rather than just assuming that the conditions of the majority (80% of the US only holds 15.1% of net worth) dictate overall spending.

In order to graphically demonstrate income distribution I’ve broken out the numbers graphically below. All numbers in this article come from research carried about Edward Wolff.


I’ve put the bottom 40% but even then it is hard to see! The top 5% is broken out and as you can see comprises almost 62% by 2007.


A Bifurcated America?

Indeed the trends appear to be slowly getting worse and I’m sure the economy of recent years has accelerated them. For a host of reasons –most of which I can’t go into here- I think that this will continue. My central point is that there appears to be a growing bifurcation in America and it is just not about money. Lifestyles are also bifurcating and at the heart of the reasons for it lie two ideas which I think are mistaken but widely accepted as truth by the constituent groups that holds them. On the one hand one group seem to think that the US lives in a pure meritocracy and taxes and government expenditure are a disdainful burden on them that is intended to punish their success. On the other, another group seems to believe that all men are born with equal attributes and abilities and the purpose of Government policy is to rectify any ‘unnatural’ imbalances via redistribution of resources. This is part of the reason why the US has such large public debt. You can’t reduce a debt by paying less and spend more, yet that is the ‘happy’ consensus that US has been living in for years.

The result of this mess is that the wealthy are getting distrustful of the merits of the public sector while the poorer segments are developing a dependency culture. Moreover the cultural ties that bind America are splitting.

What Does This Mean For Stocks?

Of course many of these observations have been made by Citigroup in its investment research on plutonomy stocks, however the stocks I want to discuss are subtly different. Whilst those stocks were primarily about luxury stocks, I want to focus on stocks that are emblematic of the cultural shifts and that are dependent upon them continuing. For example the wealthy bought Louis Vuitton bags in the 60’s and they do so today but, what about other differentiating trends in wealthy peoples spending habits?

Let’s focus on lifestyle. Take Lululemon Athletica (Nasdaq: LULU) and Whole Foods Market (Nasdaq: WFM). The former appears to be a business without any significant moat and therefore susceptible to margin erosion as rivals threaten to introduce cooler yoga gear. Indeed a quick look at the figures from Yahoo finance indicates that there is a 27% short interest in the stock. While I sympathize with such an approach and find some of the company’s pronouncements over the cultural importance of its yoga pants to be comedic, I would caution against being too negative. It is not pitching itself into the mass market but rather at the kind of wealthy health conscious lady with significant spending power. Her spending priorities are not governed by the same kind of economics as the rest of the athletics gear market.

As for WFM a relatively small number of its customers make up a huge amount (around 20/80) of its revenues. Moreover as long as the trend towards healthy living and differentiation from the eating habits of the rest of the nation continues then I think WFM can convert shoppers to its offering. WFM doesn’t just offer a healthy option, it offers a tangible differentiated lifestyle choice and wealthy people in the US appear willing to pay for this in itself.

Similarly take something like the Boston Beer Co (NYSE: SAM). Beer is as far from a ‘luxury’ stock as you will ever get but SAM does offer premium craft beers and this market is growing significantly in excess of the mass market beers. All it requires is a notable shift in purchasing behavior from the top 10% of the US and there will be a notable marginal shift in demand. Given that SAM has such a small market share it is not hard to see the company continuing to generate double digit revenue growth.

Another area in which we can expect the wealthy to continue to spend is in personalized health care and cosmetic surgery. Stocks like Myriad Genetics (Nasdaq: MYGN) and Allergan (NYSE: AGN) are worth a look. The former develops diagnostic tests for people who want to assess the risk of developing certain diseases (typically hereditary). Admittedly it needs to develop revenues outside of its Bracanaysis (breast and ovarian cancer) test but if the trend towards the wealthy spending money on personalized and pre-emptive medicine then its chances will improve. As for Allergan, as long as the trend towards cosmetic surgery increases among the wealthy then it can expect good sales of its market leading Botox product.

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