Long road from here to normality for stocks: James Saft

-- James Saft is a Reuters columnist. The opinions expressed are his own --

By James Saft

LONDON (Reuters) - Looking for the foundations for the next bull market in U.S. stocks? Wait until you see consumers who save much more, have a lighter debt load and can actually sell their houses. In other words, bring a book: it may be a bit of a wait.

Even after its recent rally, the S&P 500 is down about 12 percent this year and is at levels seen in both 2001 and 1999, leaving many investors sitting on paltry gains or losses for the past decade.

On top of that the United States is arguably in recession, a state of affairs that won't be helped by the rapid deterioration of economies in Europe, Britain and Japan.

Fair enough, you say, but a heck of a lot less useful than telling us when we might expect an improvement.

David Rosenberg, the U.S. economist at Merrill Lynch in New York, has three conditions he is looking for before he becomes more bullish on U.S. stocks: a rise in the savings rate to about 8 percent, a fall in the number of houses on the market to about 8 months of supply and a big drop in the amount debt payments sap from American household budgets.

The good news: all three happening would only represent a return to historic norms.

The bad news: we are a long way away from historic norms.

Interconnected bubbles, first in stocks and then in housing, convinced Americans they were richer then they were, and could borrow and spend freely but needn't save much.

This belief was fundamental not just to the bubble in housing, but in underwriting huge swathes of the economy. The travel industry, the service industry, even the number and size of cars Americans bought all benefited from the collapse in savings and the concurrent rise in debt.

It is hard to see the funding side of the spree contract without these suffering too.

On the Commerce Department measure personal savings were 2.5 percent in June, up from tiny levels below 1 percent or even negative seen in recent years, but far beneath the 8 or 10 percent common since World War 2.

"What is the normalized pre-bubble savings rate? You don't have to dial back to the Jurassic period, just the late 80s or 90s," Rosenberg said. "Before we became addicted to asset bubbles the savings rate was roughly 8 percent."

A tripling in the savings rate from here implies a lot less consumption, and a huge hit to corporate profitability. Housing too needs to stabilize, a process that is being slowed by the credit crunch. Right now there are about 10 months worth of supply of existing homes for sale, down from 11 months recently but still very high historically.

As long as housing is falling, bank balance sheets will continue to suffer and the self-reinforcing credit crunch merry-go-round will continue.

John Kemp, economist at RBS Sempra Metals in London points out that the vacancy rates on both U.S. rental and owner-occupied homes are high historically, at 10 percent and 2.8 percent respectively.

THE NEW FRUGALITY

Americans also have a huge amount of debt, which looked like a good thing when asset prices were rising and banks falling over themselves to lend, but is now, well, a drag. Americans are spending 14.1 percent of their disposable income on debt service, near an all-time high.

Rosenberg at Merrill Lynch would like to see that number hit 10.5 percent, levels associated with recoveries from recessions in the 1980s and 1990s. "We've never been in a recession with the interest ratio where the household side is today," Rosenberg said. He points out that Japan went into its legendary recession in the 1990s with a savings rate of 14 percent, a fat balance that it ran down to 3 percent to cushion its fall.

To get the U.S. figure down towards 10 percent, a huge amount of debt has to be either paid back or walked away from. "You are talking about the need to eliminate $350 billion of debt service. About $2 trillion of household debt has to be totally eradicated."

This implies spending less, saving more and selling assets. But the trouble is everyone, the banks and consumers alike, are trying to de-leverage at the same time.

It is looking a bit like a race to the bottom in asset prices before solid groundwork is laid for the next bull market. It is not impossible, it doesn't even mean a terribly long recession, though we are likely in for a long period of sub-par growth.

What it does imply, unless the Federal Reserve can somehow pull a new bubble out of its hat, is the return of boring old parsimony.

Stocks will struggle during the transition from excess to frugality, but once we are there the rally could be huge. After all, by that point stocks will have more than a decade to make up for.

-- At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. email: saft@thomsonreuters.com -- --

(Editing by Ruth Pitchford)