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Moneyball Economics
Vice Spending Slows, Unless You’ve Got the Herb

Moneyball Economics
Vice Spending Slows, Unless You’ve Got the Herb

Andrew Zatlin



April 13, 2015

Vice spending is one of the most seldom used, but surprisingly accurate leading gauges of consumer strength and the economy. Everyone knows that when consumers have more money, they spend it on fun and luxury goods. That includes gambling, prostitutes, alcohol, and narcotics.

And like any other luxury good, vice spending is a leading indicator: demand is quick to pick up when times are good and turns down fast when belt-tightening is the order of the day.

Vice spending leads the way in terms of both inclination to spend and ability to spend. If luxury goods spending is sensitive to shifts in the economic winds, vice spending is even more so.

One thing that sets it apart from other types of consumer spending (besides being frequently illegal) is that it's typically a cash-based transaction. You can't buy pot with a credit card (well, not yet).

And the second thing that distinguishes it: vices are not cheap. A prostitute costs almost two days of after-tax wages. Vegas is even more. The consumer's stack of money has to be a certain height before they can get on that ride.

The vice economy lives and dies according to cash flow – by how much money is burning a hole in the consumer's pocket. 

The Moneyball Economics Vice Index is the first index that quantifies these forms of spending. It has been shown to accurately lead consumer spending by at least two months. 

Right now, it is showing evidence of subdued consumer spending over the past few months. 

In fact, the Index just slipped to 100. A figure below 100 means that consumer spending is actually contracting. No doubt, a lot of the recent sluggishness is weather related, but the trend is undeniable: consumers are spending less on the fun stuff. And that means more belt-tightening is about to occur. 

Pic1

Let's come back next month, by which point we'll be past any weather-related issues that might be putting a damper on playtime… because nothing says pent-up demand like vice spending. 

If the Index continues to signal a pullback in spending is indeed forecasted, then that's a sign that the broader economy is poised to slow. It's time to get defensive with stock portfolios and re-balance closer to the early bear investments like consumer non-cyclicals, healthcare and utilities. 

Hookernomics: Touring Escorts An Ominous Sign

When Van Halen goes on tour, it's to greet the fans and boost the paycheck. Same thing when an escort goes on tour: it's to press the flesh and get some money. Except, in the business of vice, escorts go touring because the local waters have been fished out.

There are several key selling points in the Hookernomics business model which traveling escorts hope to capitalize on:

  • Novelty: "New and Improved" is a standard consumer lure, and it fits the escorting business as much as the toothpaste business.
  • Limited Availability: An escort who announces that they are "visiting and in town for just a few days" is straightforward Sales 101: create a sense of urgency and exclusiveness.

Tours are an expensive proposition (ahem) for an escort and a general pain in her ass. Travel time, hotels, transportation fees, dining out – costs add up fast. And the tour is financially risky: there are no guarantees of profit. This means that the alternative – staying put and fishing local waters – must be even worse. Simply put, escorts go on tour when the phones aren't ringing enough.

In a sign of slower business conditions, more escorts have gone on tour recently in their efforts to drum up new customers in untapped markets. Not a surge like in 2008, but still a noticeable uptick. It's more a yellow light than a red light, one-step removed from being an example of desperate times calling for desperate measures.

Again, there's a sign of slight slowdown but unclear if it's passing (i.e. weather related) or a sign of worse things to come.

Gambling Takes a Loss

Vegas, baby, Vegas…

People like to play the ponies, hit the tables, play slot machines. Timeless and universal, the human desire to gamble is always there, even if the funds aren't. The past few months have seen a definite jump in gambling revenues, the byproduct of the gas pump price dividend. But that jump is focused on the local gambling casinos, not the Vegas destinations.

The reason: local casinos tend to cater to lower income earners, and these are exactly the consumers who get the biggest benefit from recent drops in gas. It's fun money, not a windfall that moves the dial significantly.

But following years of frugality and job insecurity, the tide has turned. Wages are moving up, job security is high, and suddenly $50 unexpectedly comes along. Most people take fun money and go have fun. And for many people, fun money means driving across town to play slots and enjoy 'free' drinks. Especially around the holidays when there's more free time to play.

If we want to know about consumer spending trends as reflected in gambling trends, look to local casinos over Las Vegas for several reasons:

  • Tracking lower income gamblers. These local casinos actually cater to lower income players. Las Vegas requires a higher cost of entry (airfare, hotels).
  • Las Vegas is a destination. A Vegas trip takes time and planning. Local casinos are visited on a whim. 
  • Las Vegas includes international and business visitors. International tourism is a huge boon to Vegas profits, but a poor indicator of the overall US economy.

Sure enough, looking at the data, gambling at local casinos began to rise in December and January. Until weather smacked it down. First, it hit Connecticut gambling in January. Foxwoods Casino is a long drive and even longer in the ice and snow. Then snowstorms hit everywhere in February and gambling retreated.

Pic2

There's a theme here. Prostitution slowed in February. Gambling slowed in February. Even drinking slowed down. According to GuestMetrics (which tracks 10,000 restaurants and bars), boozing at bars was up in January and then contracted in February. The common denominator: bad weather. 

That means that there's pent-up demand waiting to be released. And that's good news for the next few months.

But, looking back at the Vice Index and the long-term down trend, there's a question about sustainability of some surge in consumer spending. 

Colorado Pot Spending Keeps Rolling Along

Colorado has hit another new ‘high’ in tax revenues from retail (recreational) pot sales.

Pic 3

I recently spoke with regulators in Washington State and discussed the cannabis sales life cycle. Turns out, there's a massive loophole in the system of legalized pot: the revenues are self-reported. I could claim any price and the state wouldn't know because they just aren't tracking it.

Regulators focused on tracking pot plants from seed to sale (to prevent minors from buying), but they’ve effectively ignored issues such as money laundering implications of self-declared dollars in an all cash based business. Because cannabis is all-cash. Pot clubs can't use banks. Federal regulations make it illegal for banks to process transactions involving the buying and selling of marijuana. Retailers are overflowing with cash and can't put it into bank accounts, which is incredibly dangerous. It attracts criminals eager to steal the cash and it facilitates money laundering.

Colorado has made some headway on the issue however. On November 19, 2014, Colorado's bank regulators gave a charter to the Fourth Corner Credit Union. By law, the Federal Reserve must give a master account number that will in turn enable them access to the US electronic banking system. This isn't Colorado State taking a moral stand and trying to force the Federal government to legalize pot. The last thing Colorado wants is more competition from other states. But banking regulations are strangling the business of selling pot. Higher insurance is required for businesses handling cash. Extra costs include vaults and armored security cars to move the cash around.

Plus government fears about dirty money can be better addressed if the cash flows through banks. Having a well-regulated bank is better than the alternative.

Yes I Cannabis

Where other vices are slowing, pot sales continue to hit new highs.

But that's because it's a growing business.

Between new services, products, and distribution channels, there's a lot of money yet to be made here. There are untapped opportunities even for mainstream investors.

What Happens Next

A few months ago, when mainstream economists were forecasting ever-higher jumps in GDP growth and a stronger economy, the Vice Index was saying that the bull was being tamed.

Sure enough, the Vice Index was right.

Today, the Vice Index says that the economy is slowing even more. Some of this is due to weather. We are in the 8th inning, and it's time to start thinking about packing up. There might be some action remaining, especially as consumers release some of the weather-restricted, pent-up demand.

That would likely last into June.

But don't be fooled by this head fake: the economy is slowing.

One approach to take is to get ready to sell when the economic data strengthens and the market jumps. That's for equities. For futures, this is bad news. The dollar will continue to get stronger.

But the real wild card remains China.

Chinese demand is slowing fast, crimping prices. Furthermore, Chinese factories have the ability and desire to crank up exports at whatever price they can get.

 

About Andrew Zatlin

Moneyball Economist Andrew Zatlin is a 20-year veteran of the semiconductor and networking world. His www.moneyballeconomics.com forecasts consistently rank at the top of Bloomberg polls and has harnessed the deep understanding of the way modern companies operate to find the key data points that predict which companies are likely to beat or miss their earnings. @MoneyballEcon
















































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