Homemade economic indicators

It was the summer of 2006, my wife and I had been married a year and we were going on our first real vacation since our honeymoon.  It felt very grown-up.  As a young-20s married couple the offer of a free hotel room at a relative's hotel in Florida was too good to pass up.  I'm not sure we could have afforded anything else.  We packed up our late-90s model Accord and headed down to the Sunshine State.  What we saw when we got there blew us away, and I'm not talking about the blue waters and palm trees.  We arrived in an area that was in a manic state of construction.  There was a palatable euphoria in the air.  Everyone was getting rich on real estate, and developers were building anything anywhere there was a bare patch of sand.

On that trip I had two unshakable observations.  The first was I had trouble envisioning where all the people were going to come from to buy these new construction condos and houses.  The second was I couldn't believe how many banks there were.  On most street corners stood four branches, all different banks.  Again, I couldn't understand what I was seeing.  How could there be enough money to support hundreds of different banks?

It turns out my questions were justified, a mere two years later the bottom fell out on the Florida housing market.  The state's overextended banks were dragged with housing into the abyss.  For a while we were annual visitors to the same free hotel north of Palm Beach and I watched the whole crash and recovery unfold.  In 2006 a condo oceanfront in a tower cost $500k. In March of 2009 condos in the same building were for sale for $150k, and in 2013?  They were back up to $500k.  Most of the bank branches closed, some were redeveloped into Mexican restaurants or stores, others bulldozed, and others still standing with "For Sale" signs.

What I witnessed in 2006 was the euphoric stage near the top of the market.  I didn't know what I'd seen until later, but when looking back it became clear.

I've encountered the same thing a few other times.  In 1999 I was a wide-eyed college student studying computer science dreaming about working for a start-up and becoming rich through options.  I remember going to a party at a frat house with one of the frat brothers bragging about their start-up.  The guy was so convinced he was going to change the world that he took us into his room to show off a 36" TV, which at the time was impressive itself.  It was a Gateway Computer TV, and the TV was hooked up to a computer.  This alone screamed success to everyone in the room.  This guy was creating a website where people could order pizza online and have it delivered.  You wouldn't have to pick up the phone anymore.

I'm curious by nature.  I want to know how and why things work.  This was definitely true when I saw the pizza website on the giant TV.  I was thinking about how much faster calling would be compared to dialing into the internet and waiting for the modem to connect and then the webpage to load.  I even had the gall to ask this guy about it.  He made some broad statements about how great the future would be and how no one would use phones.  It didn't make sense, especially in the age of modems.  And sure enough this guy was out of business a year or two later.

I didn't know what I was witnessing in 2001 when the dot-com bubble bust because I was too young. But I had a vague sense that what I'd seen in the years prior wasn't sustainable.

The last boom I saw was recently, the oil and gas boom in Western Pennsylvania.  The formerly lonely highways I'd take to West Virginia to ski became clogged with water, fracking trucks, and giant diesel pickups.  I had friends from small towns where farmers were leasing their land to gas companies for $5k/acre per year just so they'd have the right to drill.  When drilling took place the farmers would make even more.  Hotels appeared in the strangest places to accommodate the gas workers.  It was a boom scene.

At one point in 2014 I met with a hedge fund manager who started a fund that only invested in banks that did business in Eastern Ohio and Western PA.  Specifically banks with heavy oil and gas exposure.  The manager marketed his fund as the best way to play the gas boom.

Gas prices finally crashed and along with it the roads emptied out and drilling activity slowed to a crawl.

In each of these three boom situations I was observing something that I couldn't quite put my finger on.  The hysteria was real, it was tangible, and it seemed like it couldn't go on forever.  But the energy was such that it's hard to believe something good like that might end.

I was talking with a friend recently and I noticed myself sharing stories that sounded like boom time stories again.  The more we talked the more I realized that I've been seeing some of the same things I was seeing in 2006 and in 1999.  My experiences and observations are all anecdotal, and maybe this is something only happening in the northern suburbs of Pittsburgh.  But what I'm seeing here is crazy, and as an investor a bit scary.

Let me share a few stories.  A few weeks ago my wife and I had a babysitter scheduled and the event we needed the babysitter for fell through so we decided to go to dinner instead.  It was a Wednesday night, and with her being pregnant I decided to let her pick the destination.  She wanted a blooming onion at Outback.  I'll say upfront that I'm not a big Outback fan, but it was a night away from the kids, so you take what you can get.  Outback shockingly had a wait, the waiting area was full and there were people outside.  It was going to be 45 minutes to an hour for a table.  We looked at each other and agreed that Outback isn't worth waiting that long for (or in my mind at all, but I digress).  We then hit up a number of other restaurants in the area and they all had similar waits.  It was simply crazy that on a weeknight these average restaurants would have so many people trying to eat.  The thing is this trend has continued, restaurants are mobbed now, we're back to pre-2008 wait times everywhere.

Another area I like to keep an eye on is my local craigslist.  I will buy and sell on there when I see deals, and I browse to keep a pulse on the market.  The prices have gone nuts in the past year.  Twenty year old F150s with rusted out bodies and 200k miles are selling for $5k, about $2500 too much.  RVs are similar, late 1990s RVs are selling for a few thousand dollars less than models 10 years newer.

Beyond RVs and trucks I like to look at rural land as well as heavy equipment and businesses for sale (can you spot the trend? Items with titles..).  A few years ago I picked up an acre of forested land in Northern PA for $300, and I've been on the hunt for larger tracts in the 10-20 acre range in the same area.  A year ago there were a few sellers who wanted $1,500-2,000/acre for forested land, but there were always caveats.  The places would be next to a sewage treatment facility, or there were easements.  Now in the same area prices have jumped to $10,000/acre.  Same types of lots, same location, just 5x more expensive.  Right before the oil boom you could buy almost any tract for $1,000 an acre or less, when gas crashed I went hunting again.  While prices fell demand remained strong as people looked for lots for second homes.

Even worse is the housing market here.  I sold a house last year, a nice 1,300 sq ft starter home for $160k, what I thought was a reasonable amount.  Similar houses are now listed a year later for $200k, a $40k jump in a single year.  What's worse is some of the stock at $200k needs another $25-30k worth of work to make it livable.  That is unless you like living in a house with decorations circa 1975.  What's crazier is these places are selling almost instantly.  We have friends whose house sold the day it was listed, they're having trouble finding a place because everything is either an overpriced dump or is selling the day it lists.

I find myself asking the same questions again.  How can people at their first job afford a $230k house?  Who's paying $5k for a 20 year old truck that will probably need another $2,500 in parts and a hundred hours of labor?  Is there really demand for this stuff?  And what is the demand that pushed starter home prices up 25% in a year?

As we discussed some of these stories my friend suggested a theory.  The demand for these items is coming from the marginal overtime dollars of middle class and lower middle class workers.  These are hourly jobs that pay $20-25/hr in wages.  Now that the economy is hitting on all cylinders a company might ask employees to pick up a few extra hours a week before they hire additional employees.  For someone making $25/hr ($1,000/wk) picking up an additional five hours of work per week is a 12% pay increase.  Where does that additional $500/mo go?  It creates demand for restaurants, for vehicles, for RV's, for vacation properties, for houses.  Some are using it to pay down debt, but when everyone is offering all the neatest toys with low monthly payments there are a lot of takers.

This isn't just seen in the hard goods realm either.  Where are the net-nets?  Where is the distressed debt?  Where is anything that isn't having the best quarter and year ever?

If you believe in efficient markets then this doesn't matter.  Because the good times are here to say, they're "right" and "perfect" after all.  I know there is a large contingent of investors who believe that we're just starting a giant bull run and this euphoria won't end.  Maybe it won't.  On the other hand trees don't grow to the sky either.

The problem is when you're in the middle of a situation it's hard to gain a large enough context to make a macro decision.  You can observe and go with your gut, but you can't really ascertain what's happening until after it's happened.  Once it's happened everyone is an expert and everyone has seen it, but in the midst no one knows what they're seeing.

I guess what I'm saying is that we're in the midst of something, it looks like a movie I've seen before, but I'm not sure.  I've had stocks run like crazy since Trump was elected and I'm starting to take money off the table as prices rise.  Unfortunately it's putting me in a spot where I'll have excess cash that needs to be put to work.  Some of it will sit on the sidelines until I find deals on land again.  But for the rest I'll have to look abroad to countries that aren't running as far and fast as the US.

When I consider everything I'm seeing it's easy to say that we must be nearing a market top.  But it was another two years from what I witnessed in 1999, 2006, and 2014 before the top finally blew off. Oddly I've been consistently two years early in noticing these trends, so maybe the bottom won't fall out until 2019?

It's been hard to find deals both in the market and out of the market.  Every official government indicator says it's clear skies and sunny ahead, and maybe it is.  But what I'm seeing on the ground has me questioning things.  Is this demand sustainable?  Can it just last forever?  How many new retail strip malls can be built?  Especially when there is vacancy in prime locations and the world is moving online?

In the end I just don't know.  What I do know is I'll continue to sell as positions become fairly valued.  There are pockets of value here and there, but one needs to dig very deep, or get involved in complex situations.  Maybe in two years I'll look back and this and think "I saw it again.." or maybe I'll be thinking "I wonder how big of a house can I buy with my Tesla gains?"


28 comments:

  1. Interesting article, it's the same situation here in England. At the moment, London is booming and there is a huge amount of money/credit sloshing about and going into cars, houses, anything really! Even in the depressed economic region in northern England where I live, things are much less bad than they usually are. Restaurants are full, and usually perennially unemployed labourers are picking up plenty of casual work.

    Just on the point you made.

    "Oddly I've been consistently two years early in noticing these trends, so maybe the bottom won't fall out until 2019?"

    I suspect you are likely to be early to the party in noticing these trends. Should be an interesting ride over the next 2 years.

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    1. I'm almost positive I'm very early on this. But what's interesting is all of the comments are similar. You're in England, the one below you is in Germany, and below that in Canada. All similar.

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  2. Very interesting thoughts, thank you for sharing!

    Same situation here in Germany: real estate is booming, people are buying even sub-prime houses and flats. Prices doubled (and sometimes tripled) during the last 5 years. I’m 30 years old and see friends with middle incomes buying houses for up to 500k EUR. Many properties are sold before they were built. This is completely nuts in my opinion. Mother-in-law is asking which stocks have potential – it feels like 2007 again. I'm wondering if this situation will last 2 more years?

    There is definitely something going on - maybe the time has come to short equities. In my opinion all developed world markets are overvalued with US techs leading the way.

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    1. Seems like this is a worldwide thing. What will prick the bubble and cause it to pop?

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  3. If you want to see a euphoric housing market, come to Canada.

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    1. This is a good point. When I was in Toronto last year it was madness, towers going up everywhere.

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  4. Hasn't the market been more bipolar this time around? Barely a year ago it thought China was doomed and now we're in a crazy bull again.

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  5. Thanks for relaying your views from in the trenches. Also, I would like to applaud your ability to "trade yourself" when you noted that you tend to be two years early. This is good stuff.

    I think your views are valid and probably common across most of the country. I live in Seattle and I heard yesterday that we have more cranes than SF and LA combined. People aren't flipping homes to the extent that they were in 2005, but the real estate market it cookin' nicely.

    I note the arrogance of the technology employees here in Seattle. Most noticeable is Amazon. I also notice the same situation with the restaurant scene. My wife and I like to go to restaurants but the food industry boom here seems to have depleted the well of quality service employees. So, the experience degrades while prices don't. We have trouble getting reservations, partly because the restaurants here don't accept reservations unless you have a large party >6 people. Also, the largest restaurant "empire" here (Tom Douglass Restaurants) has proudly implemented a mandatory 20% gratuity across all restaurants. Remember what I said about service quality?

    Anyway, nice post. I'll keep my head on a swivel for a 2019 bear market :)

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  6. Could this just simply be a sign that interest rates are headed higher? I live in Toronto and its been crazy for a while. Money is just too cheap and no one really thinks beyond what the monthly payment would be (even if that payment is 80% of take home pay...).

    The commonality in UK, Germany, Canada and US is low interest rates. Perhaps we are witnessing early signs of inflation? If rates head higher mkts could get very ugly imo.

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    1. Tim,

      This is a good thought. The ubiquity of low rates is common, and maybe we've seen rates so low for so long that it's almost become impossible to not take advantage.

      What would be fascinating about the inflation scenario is that most people would be rewarded for levering up. That 80% of take home pay payment would drop to 75% then 70% and lower and lower. In a sense that might be the rational move if inflation is the future.

      You're right thought that markets haven't incorporated this into prices. If inflation heats up there will be a blood bath at some point.

      Thanks for the comment.
      Nate

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  7. I don't know that people will be rewarded in that scenario. If you have fixed debt against an asset that cashflows you are correct. Everyday your debt is cheaper relative to the cashflows you receive.

    A house is different. In order to make money you need another buyer. That buyer is then subject to much much higher mortgage rates and therefore would bid much lower than you did for your same house. People think houses are inflation hedges but they really aren't other than you fix what you pay per month. The value of houses should drop imo. Also the US is unique in that you can fix rates for 30yrs. In Germany, Canada and UK you have to renew your interest rate at certain fixed time periods. So the homeowners will have to renew at much higher rates that perhaps they can't afford given how little room they gave themselves. I actually think that we may be seeing peak home prices for a generation (specifically I am referencing Canada) as the overvaluation combined with higher rates in the future, may lower prices for a very long time.

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    1. Tim,

      Valid points on the house. Inflation helps in terms of a monthly payment, and if at some point you want to extract the cash via a home equity loan. I don't understand the home equity thing, but maybe people smarter than myself do..

      I didn't know that the US was one of the only places with fixed home debt. It's an incredible deal, you lock in your price once and then never think about it again. I guess we'll be seeing a lot of recurrent housing issues worldwide as rates continue to rise.

      House prices in Canada are crazy. I took a walk around Toronto through some very nice neighborhoods with detached single family houses. These were not big houses and they were $1m+. This is common on the East Coast, but salaries are higher as well. I looked at some Toronto salaries and they weren't much higher than here. The math on those purchases doesn't make sense. Then compound that with the fact that most other everyday items are more expensive in Canada verses the US and I can't quite figure out how anyone is affording houses there.

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    2. Toronto and Vancouver are boosted by Chinese money. Chinese millionaires are parking some of their money in Canada, which is seen as a safe haven in case things go bad in the mainland. Thus the multitude of high rises, even in the suburbs. A lot of those condos are paid for, but not occupied. Canada looks very favorably on immigrants, especially those who can bring money with them.

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  8. Really enjoyed this post as well as the comments, Nate. Thanks!

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  9. Can confirm the same phenomenon in New Zealand, much like Toronto or San Fran. There may never have been a time in the last 50 years where people can less afford rising interest rates.

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  10. This is a great article as it really gives me a feel for what is happening in the US. I live in Canberra, Australia, and just recently the median house price in Sydney exceeded $1m, so $230 kfor a house in the US seems like a downright bargain ! Wages here seem quite high too :My son earns $20 to $30 ph working in a bar, more at weekends which isn't bad money for someone still at Uni. A rise in the unemployment rate and/or interest rates might end badly for some, as anecdotally I here that a lot of people are sensitive to even a half percentage rise. I recently sold half of my shares in an Australian bank as I'm worried about a potential rise in bad debts. Of course, I'm probably way too early !

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  11. Thanks for sharing, Nate. I agree sometimes you just have to start using your own eyes to figure things out as long as we remember the limitations.

    One thing I would note about housing is that I'm not sure credit is getting loose enough to cause major concern. Credit is very loose in autos, but from talking to people in mortgages not a whole lot has changed in housing. Rates are low and that's really helpful, but standards remain high. But nationwide housing inventory is at an all time low, and that is obviously going to push prices higher. I've heard some anecdotal evidence that suggests prices have been held back in recent years by tight appraisal standards essentially capping price increases (since appraisers use backward-looking comps). Maybe that's shifted in the last year?

    Here's a story for you on the topic: This summer I was traveling back to California from a trip to Yellowstone and stopped for the night in Elko, Nevada. Elko is a basically a truck stop and mining town, with a pop of around 20k and nothing around it. Our hotel overlooked a new housing development with lots of homes under construction. My son noticed something and asked, "Dad, if these houses are new, why are there cracks in the streets with weeds growing in them?" I was puzzled but then it hit me. "Because the streets were put in 10 years ago." Pretty amazing when you think of it - construction just stopped for a decade. I think demand has finally caught up to (and is now exceeding) supply and if that's happening in sleepy, depressing Elko, what about in areas with stronger economies? In my area of Northern CA outside Sacramento, we've seen tons of dormant housing projects restarted and new ones proposed in the last 18 months after years of nothing. I don't feel like it's another bubble, not yet.

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  12. I've had the same thought re: markets, but always ask myself whether I'm anchoring. Though I try not to work this way, I'll still do a little bit of work on a stock, conclude it's worth say $10 a share, buy some at $6, then kick myself for not having bought more when it moves to $8...Then I'll look at it again, conclude that the fundamentals have improved, and it's actually worth maybe $12 now. But since in my mind the buy price is $6, I won't get any more, and then it'll move up to $14. The question is, I guess, what was the $200K house selling for 3, 5, 10, 15 years ago? Is its price movement stochastic? Are there more restaurants than there were 2, 3, 4 years ago? And if not, is the scarcity of restaurant table space indicative of some other constraint? Is the high price of a junky used truck indicative of a wealth effect, or its opposite: that people can't afford something new, and so have bid up the rust? That said, I anecdotally agree: we have imbalances building up, of the sort that are usually reset in a cataclysm.

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  13. Interesting post and as usual well put.

    Your experience as well as those of many of the commenters is more anecdotal evidence to confirm what I've been saying for a while: the economic recovery is very uneven depending on place.

    Where I'm from (north GA area, Atlanta, Athens, etc), people tell jokes about how the experts say that the economy has recovered, but they obviously never asked a real person. People say that the recession never ended.

    It seems like a lot of people earn the same or less money (when adjusted for inflation) as 10 years ago. And if you ask people in a bunch of random industries, they'll say that established workers are doing ok, but that it's not like it used to be, and there's less opportunity and job openings for new workers.

    So my anecdotal 2 cents is that not only is there no boom here, but the economy still feels suppressed, at least in the eyes of ordinary people (working people with familes).

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  14. I also want to comment that the middle seems to be hollow.

    I know LOTS of people who earn under $30K a year, and I know quite a few who earn $60K and on up into the $100K+. But I know very very few (like I can count them on one hand) who earn between $30-$60K.

    It seems like the nation's wealth is growing, but it's becoming top heavy. Perhaps this is distorting all kinds of things, including stock prices and housing (depending on the area). It's probably also the root cause of the rise of populism, both on the right and the left side of the political spectrum.

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  15. Hey Nate. Great article. Have you ever found a business that was worth investing in that you found on Craigslist? I look on there sporadically and I only see businesses with little-to-no margins or multilevel marketing schemes. Thanks and keep up with the posting!

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    1. Great question! I had one close encounter. I had found a complete asphalt paving business for sale for $15k, the steamroller, trailer, asphalt machine and bobcat. There might have been a dump truck as well. It was too cheap, well below what it would have cost to get started.

      I debated buying everything but decided against it. I would have been buying a paving company because it was cheap, not because I knew anything about paving or had an interest in it.

      It's interesting to see what's listed and how it's presented. Recently a commercial building was for sale for $6m. The post talked about how great the location was, how there are tenants etc. The building is near a ski resort I have a pass to. The post played up the resort aspect.

      The reality is it's an almost empty building surrounded by other empty land. Someone could come and build the exact same thing next to it if they wanted. The price was too high, but it was interesting to see the positioning given what I knew about the area already.

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  16. I enjoy your site. Thank you.

    I think the bubble is in ETFs and index funds that indiscriminately purchase stocks, and the stock prices depend on inflows.

    I admire Murray Stahl quite a bit an read everything the Horizon Kinetics people publish. They keep hammering away at the concept of the disconnect between Index funds and ETFs and value. It concerns me greatly.

    Stahl tells the story of a guy that goes to visit some monks. He admires their peacefulness and wants to see how they live. He climbs with a monk up to their monastery using a rope ladder, and notices a rung is frayed. When he gets to the top, he asks the monk how he knows when to replace the ladder. The monk says they replace it when it breaks. To me, that's index funds and ETFs.

    When that bubble pops, it's going to be a massacre.

    I also think that those types of investments present double risk: the underlying equity value and the ETF/Index value.

    Additionally, by rolling up gold, commodities, etc etc into ETFs, the use of some traditional hedges have lost their edge while gaining liquidity. The world is all into the stock market now, especially in the US.


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    1. Ezra,

      I agree and disagree with the premise. I agree in the sense that index funds have the ability to distort. But I'd also counter that we've been through this before.

      In 2008 15%ish of the market was indexed. And an even greater amount was in mutual funds that were hugging the index. I'd argue that at most points in the market you have this same dynamic. What we've seen since 2008 is money come out of the expensive hugging funds and migrate into straight index funds. Investors are saving on expenses, and the market impact is the same.

      When the market starts to crash we'll always see follow-on selling. It's simple psychology. Even value investors start to dump stocks when things get bad. It's hard to be a buyer when everyone is selling.

      I really enjoy Stahl's comments and his writing, but I can't reconcile his ideas with his fund's poor performance. His ideas seem to make sense, but why hasn't he been able to exploit them?

      Nate

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    2. That's fair. I think Stahl focuses on some stocks with high conviction that have a lot of unlocked value. TPL is an example. He held that thing since it was a penny stock and it's gone up like a rocket, but took ages to do so. Same with HHC. I think eventually those investments pay off, but it's certainly a long view. Also, they hold a lot of cash.

      I'm not saying that the number lie, but I do seek ideas from them and think they will be proven correct on the index and ETF distortions.

      One other note, returning to home made economic indicators:

      I've spoken to numerous people, and observed myself in Las Vegas, that malls were totally dead over the holidays. While we have been focused on Amazon destroying retail, I think it's mostly over. It's hard to justify the giant PE on Amazon if they've gutted much of retail and now plan to move back into physical stores for food and such, which I assume has lower margins. Yes, I know they have the cloud business and other angles to make money. I just think that the hope that's priced into their retail dominance is out of sync with the fact that it's mostly a completed transition.

      It's a small observation, but I expect them to continue to miss on earnings for a while and for the disappointment to mount.

      I literally saw more employees than customers the entire holiday season at malls.

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  17. Interesting observation. For what its worth your guess on marginal overtime dollars is backed up by data. Median income was up 5-6% in 2015 (2016 figure isn't out yet). https://fred.stlouisfed.org/series/MEHOINUSA672N

    Doesn't necessarily confirm it is middle class marginal dollar but could certainly be an explaination.

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  18. How far into Mexico can you drive a Tesla?

    Well I guess lots of people have made more money than Tesla, on his name.

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  19. This is brilliant:

    "As we discussed some of these stories my friend suggested a theory. The demand for these items is coming from the marginal overtime dollars of middle class and lower middle class workers. These are hourly jobs that pay $20-25/hr in wages. Now that the economy is hitting on all cylinders a company might ask employees to pick up a few extra hours a week before they hire additional employees. For someone making $25/hr ($1,000/wk) picking up an additional five hours of work per week is a 12% pay increase. Where does that additional $500/mo go? It creates demand for restaurants, for vehicles, for RV's, for vacation properties, for houses. Some are using it to pay down debt, but when everyone is offering all the neatest toys with low monthly payments there are a lot of takers."

    Do you know if there has been any economic studies that dig into the marginal overtime theory?

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