The financial crisis bore two kinds of impacts on our economy.  The first was a deep recession, which while painful, is only slightly more annoying than any other recession.  But what may have really caused the most long term harm has been the slow recovery.  A recession can end quickly and the economy would come roaring back, this is what most of us would have expected given all the different types of stimuli we received.  But a recovery that drags on, and conversations every six months double dip recessions, causes perhaps more damage than the recession itself.

Case in point, Citi’s investment arm  noted a couple of years ago that investors should focus on companies that sell well to the highest income earners, and the lowest.  It’s essentially their way of saying the middle class has been eroded away and if you want to make money you need to cater to the upper and lower income ranges.  Their theory has kind of worked, and their index of stocks for this theory has outperformed the market considerably since its inception.  Citi calls this the “Consumer Hourglass Theory”.

The idea is that the highest income earners have weathered the recession just fine but the middle class have not.  Everyone is spending less and opting to shop at stores and buy products typically targeted at the lowest income earners.  Elements of this theory are visible everywhere.

Luxury retailers have seen their best sales with their most expensive products.  Traditionally this retailers could make a lot by targeting products on the low end of their product portfolio to the materialistic upper middle class.  Think low end Audi instead of a VW.  But now the sales of the high end goods are driving profits, and the low priced luxury goods collect dust.  Everyone in the middle class have traded in their VWs and Audis for whatever can be found at the $5k used lot.  There’s a race to the bottom with low end goods.

Companies that have traditionally catered to the middle class are in new territory with lots of products with decent margins and no customers.  Sure Target always does fine, but have you seen how many dollar stores have sprung up around them in recent years?

Should we worry if this is permanent?  Do we have a real change in consumer behavior or will we rebound?  The problem is that in inflation adjusted income, the middle class is actually making less today than it was a decade ago.  We temporarily filled the gap with debt.  There is truth to the claim the rich have gotten richer while everyone else, including the middle class, have gotten poorer.  It’s measured with the Gini Coefficient.  Don’t confuse this with an exclamation that the government should try to fix this with a tax on the rich, only that our buying habits and incomes reflect this reality.

This is permanent as long as the middle class continues to suffer.  Will a rebound in the economy fix this?  I don’t know.  Since GDP is just a measure of economic activity, it doesn’t necessarily account for where that income comes from.  We need a direct rebound in not only middle class employment, but middle class income.  We can’t do that without a stronger economy, but that alone won’t fix this problem.

Read more about the hourglass theory and the changing behaviors of the middle class below. If you don’t have access to WSJ.com just Google the headline and WSJ.com will give you a free preview of the article.

As Middle Class Shrinks, P&G Aims High and Low (WSJ)

Image: bogenfruend

categories: business, economics, personal finance