The Danger of Extrapolating: Teen Fashion Spending Under Pressure; Buffett Calls Stagflation

Bloomberg reports on teens cutting back on clothes purchases amid higher gas prices and worsening job prospects. Back in May, I posted a quick note on American Eagle Outfitters (or click here for the full valuation report in pdf format). In my report, I was a little squishy on my assessment of AEO due to the uncertain outlook for the American economy going forward. Many money managers assume that this downturn will be brief/shallow and after it’s over, the US economy will be back to its spend-foolish ways — they’re extrapolating the last 20 years into the future. I am skeptical of this on both micro and macro levels.

On the micro level, AEO is nearing saturation point with their core market. The flagship stores are pretty much everywhere already. Their new brands haven’t gained much traction and the few (aerie) that are showing signs of life do not expand their core demographic.

On the bigger picture, the US may be approaching its inflection point. Everyone (except Dick Cheney) recognizes that a deficit economy is not sustainable and while the endpoint has been called many times in the past, it will eventually come. The conditions of the downturn we are now experiencing have the potential to set us up for a recalibration of the American economy, which we desperately need — things like moving away from negative savings, adjusting suburbia (or eliminating it altogether) in the face of peak oil, fashioning a reasonable response to globalization, fixing the healthcare system which stymies businesses and families alike, investing in infrastructure, properly incentivizing consumption (as opposed to basically subsidizing it), etc. If this transition is now happening, AEO could be a bad stock to park money for some time.

On the question of “is it different this time?”, I’ll point out a report that got far less coverage than warranted. Last week, Warren Buffett stated the US economy was in stagflation and didn’t know when it will recover. While I heard one idiotic pundit say this is a contrarian signal to buy US stocks, the truth is Buffett, who, BTW, is one of the great unrecognized “market timers” — witness his timing on liquidating his hedge fund on the eve of the 70’s bear markets, his purchase of silver in the late 90’s, his US dollar call in the early part of this decade — gets it right far more often than not.

Couple this with Bill Gross’ plea for “President Obama” to open a $1 trillion dollar deficit to rescue the US economy and it’s clear that investors now live in interesting times.

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