By Yael Tangir, Staff Writer
Have you ever asked yourself what the correlation is between consumer spending and an economic downturn? During a recession, a wide array of factors result in a persistent decline in spending. To cut costs, businesses earning less money lay off workers and when people are unemployed, they have less money to spend.
Consumer spending can be split into two categories: essential and discretionary. As the term itself indicates, “essential spending” is the purchase of certain items needed on a day-to-day basis like putting food on the table and paying bills The second category, what economists call “discretionary spending,” which is quite applicable to the expenses of the average teenager nowadays, refers to spending money on extra unnecessary goods and luxuries. Interestingly enough, when looking at discretionary spending, there are multiple indicators that the economy is in the early stages of a downturn.
When looking into recession indicators, there are many clues in the ways monetary expenditures are cut that could indicate that an economic recession is around the corner. More surprisingly, though, there is one discretionary product that is bought more when times are tough: lipstick. This phenomenon was first noticed by Leonard Lauder, the chairman of the cosmetic empire Estee Lauder, in 2001. The sales of most other products, meanwhile, declined in volume.
At the time, the most recent recession had been in 1990, and sure enough lipstick sales had risen noticeably. The Wall Street Journal reported Leonard’s findings on November 26, 2001, very shortly after the tragic events of 9/11. At the time, there was a lot of speculation about whether the U.S. was going to fall into recession. Leonard believed a recession was coming because his lipstick index (which tracked sales across Estee Lauder brands) had gone up since the terrorist attacks. Yet, it wasn’t just his company that experienced this; MAC lipsticks sales rose 12% in the three weeks following the attack and Borghese Cosmetics also saw a 12% rise in mid-September that year compared to the previous one. Perhaps the most shocking part of the story published by The Wall Street Journal was that the next day, the US officially declared that it was in a recession.
Leonard Lauder explained that when women needed to cut back on their luxury purchases, they tended to spend more on smaller items like lipsticks. “When lipstick sales go up, people don’t want to buy dresses,” he told The Wall Street Journal. Perhaps that is the reason why the most trendy products that girls are buying this year are Summer Fridays and the Rhode phone case, which allow one to take lipstick everywhere without having to carry extra items.
A deeper look into analyzing the economy also reveals that bonds are a good indicator of the current economic trends and future conditions. A bond is an asset that pays a fixed payment called a “coupon” over a specified time period. The annual coupon divided by the price of the bond results in the bond’s yield, which is how much an investor would earn as a percentage of their upfront investment. Since the coupon payment is fixed, changes in the bond’s yield are caused by changes in the bond’s price. A higher price means a lower yield and vice versa. Specifically, the 10-2 year bond spread focuses on two specific types of treasury bonds, one that matures in two years and the other in ten years. When the U.S. government needs to borrow money, it issues and sells these bonds, as well as others of different lengths from as short as one month and up to 30 years.
The 10-2 spread simply takes the yield of the 10-year government bond and subtracts the yield of the 2-year bond so the difference in yield can be tracked every day going back for years. Most of the time the spread is positive, meaning the yield on the 10-year bond is higher than the yield on the 2-year bond. The most widely understood reason as to why this occurs is called “The Liquidity Premium Theory,” which says that the longer one’s money is locked away, the higher the associated risk.
In order to compensate for that risk, one must demand or earn a higher yield. Occasionally though, the spread briefly goes negative, meaning the 2-year bond offers a higher yield than the 10-year bond. However, since both of these bonds are government bonds, investors only care about how long the invested money is actually locked away. Therefore, it might seem irrational that during some periods of time, people are willing to lock their money away for longer and accept a lower yield at the same time.
There hasn’t ever been a U.S. recession that has occurred without the 10-2 spread first going negative, and there hasn’t ever been a negative 10-2 spread that wasn’t quickly followed by a recession.
Both the 10 and 2-year bond yields tend to move in the same direction, but a negative spread can occur when the yield on the 2-year bond rises faster than the 10-year bond. To put it more simply, bond yields across all different lengths of bonds rise slower because more people want to lock their money away for longer, which they tend to do if they believe an economic slowdown is coming. However, the 10-2 spread not only exhibits investors’ expectations, it is also a self-fulfilling prophecy, as a change in expectation directly leads to a change in spending and investment habits
Today, the 10-2 spread is negative, the 10-year yield having dipped under the 2-year bond yield about two years ago. However, from an investor’s perspective, those facts cannot be used in the investing process. Every time that the frame has been different in the past, people could take advantage and sell their stocks and then buy back in after the market crashes.
It will certainly be fascinating to watch the economy, specifically the 10-2 spread, over the next year to see if it has indeed predicted a recession once again. However, even if economists study bond yields and spread charts intensely, sometimes the most telling signs of a recession can be found right in front of your bathroom mirror. So, keep in mind this the next time you’re applying a fresh shade of red lipstick: the state of the economy might not be as bright as your lips.
Photo Caption: Lipstick sales may determine whether a recession is coming
Photo Credit: Unsplash