Consumers Still Sticking to the Basics

At the Morningstar Investment Conference in June there was a sense of cautious optimism on the state of the economy. The stock market had lifted off its march lows, and the first signs of stabilization were appearing in the economic data.

Fast forward to this week's Morningstar Stocks Forum and the mood is decidedly more upbeat. Comments from CEOs and Morningstar's analysts at the meeting indicated a consensus that we are starting to pull out of the Great Recession. But almost no one believed the recovery would be quick or that things would end up looking exactly as they did before.

One of the biggest concerns voiced at the forum was the strength of the American consumer. After taking on a dizzying amount of debt during the bubble years, households are now going through a painful deleveraging process. But it's not just the deleveraging that is slowing down spending; consumers are simply afraid of their financial futures.  Realty Income (O) CFO Paul Meurer, whose firm owns retail properties, postulated that until consumers are sure that they aren't going to lose their jobs and that their home values aren't going to fall further, they aren't going to spend on anything discretionary. Indeed, Realty Income has seen consumers hunker down--buying things like gasoline, alcohol, cigarettes, and movie tickets instead of flat-panel TVs and pricey meals.

This theme of sticking to basics was echoed by  General Mills  (GIS) CEO Ken Powell. Consumers are increasingly eschewing eating out and shopping more at the grocery store. Interestingly, General Mills is not only seeing demand for low-end meal kits like Hamburger Helper but also for its higher-end complete frozen meal kits. This implies that even more upscale consumers are choosing to prepare more meals at home.

These trends may be slow to reverse. Even as the economy picks up, unemployment seems destined to remain at very elevated levels for years, and workers aren't likely to feel secure in their jobs anytime soon. As we've seen so far, insecure workers are not going to be big spenders.

There could also very well be a structural change in the way that people think about spending and saving. With shrunken portfolios and housing still on shaky ground, consumers will have to save more if they want to retire, says Morningstar associate director of bank equity research Matt Warren. A higher savings rate necessarily means less spending. This is not all bad. It will help reduce some of the imbalances between America and its trading partners (notably China) and could boost the export sector. But despite these effects, the splashy consumerism that marked the beginning of the decade could quickly be seen as a relic and not as a standard that consumers are looking to return to.

One of the most striking things at the conference was that despite this short-term noise, all of the CEOs are actively planning for the future and believe that in the long-run the U.S. economy will do fine.  Strayer Education (STRA) CEO Robert Silberman believes that the economy will continue its march towards a service-based economy and that more and more Americans will need a college degree. His optimism stems from the ambition he sees in Strayer students, all working adults. Realty Income is signing 20-year leases on retail properties, assuming that non-discretionary spending will continue unabated.

Everyone at the forum agreed that there is still much that ails the U.S. economy. But there is a sense of optimism that the crisis is over, and that the economy is starting to grow again. So what was the biggest takeaway for investors? Stick to the basics. Buy firms that are focused on long-term economic value and not short-term earnings, that have sustainable economic advantages, and that are reasonably priced.