The Writing on the Wall

Many times people’s eyes glaze over when it comes to macro analysis and I get it. Macro analysis is by definition: Macro. It’s like watching a glacier melt and it only becomes of concern when the glacier structure collapses and you just happen to be in front of it. And then everybody says: Nobody could’ve seen it coming.

Yet following the macro pieces is so incredibly important and I continuously try to dedicate some time to dissect the big data pieces and the data keeps screaming the same message: The Writing is on the Wall.

For reference I keep track of these observations in NT blog.

Here’s a few that stuck out in the past few days.

Goldman Sachs sees red ink everywhere, warns US spending could push up rates and debt levels

Goldman Sachs sees a tidal wave of red ink — and it may drag the U.S. economy into its undertow.

Federal deficit spending is headed toward “uncharted territory,” the firm said on Sunday, suggesting that the Trump administration and Congressional Republicans may not be able to count on the economic boost of tax reform for very longer. Goldman Sachs warned that the economic impetus from tax reform may have diminishing returns after this year. “The fiscal expansion should boost growth by around 0.7pp in 2018 and 0.6pp in 2019, but will likely come to an end after that”—listing a litany of reasons why spending and debt would conspire to undermine the world’s largest economy. 

Goldman’s analysts wrote that the “growth effect comes from the change in the deficit, not the level, and further expansion would put the U.S. onto an even less sustainable long-term trend. Second, some of the recent deficit expansion relates to changes unlikely to be repeated, such as the temporarily large effect of certain tax provisions.”

Lastly, “there is a good chance that control of Congress will change after this year’s midterm election, likely making it more difficult to further expand the deficit,” Goldman added.

Recently, the Treasury projected a virtual sea of red government ink, saying it would have to borrow close to $1 trillion this year, and above that level in the years to come. Goldman underscored that fact by saying the Treasury is borrowing at record low rates, but couldn’t expect to do so indefinitely.

The Treasury’s need for more debt is inauspicious, given the recent surge in U.S. yields and a Federal Reserve that’s expected to begin a campaign to hike borrowing costs and withdraw liquidity.

We expect rising interest rates and a rising debt level to lead to a meaningful increase in interest expense,” Goldman said. “On our current projections, federal interest expense will rise to 2.3 percent of GDP by 2021,” and could hit 3.5 percent by 2027.”

The message here is simply this: Nothing, and I mean nothing has been done to address the structural issues facing this country. I already mentioned that the Tax Cuts will come back to haunt everybody. Short term gain for long term pain. The current political climate has devolved into such a toxic mess, void of any substantive solutions or even a desire to tackle key issues, that the growth construct remains trapped in a sea of obligations, unfunded, unmanageable and subject to a nasty reversion when the business cycle ends.

Where are the tax cuts going? Buybacks:

The recent lows were marked by buybacks being the primary driver of buying, not organic demand:

“The corporate buying — they were basically the only buyers last week,’’ Matt Maley, a strategist at Miller Tabak & Co, said by phone. “Whenever we have forced selling take place, the buyers disappear and the sellers have to sell no matter what. And corporate buybacks are not going to be enough.”Investors bailed from stocks, with equity funds seeing record redemptions of $33 billion during the week through Feb. 7, according to EPFR Global data. After a blowup in volatility-linked products and fears of inflation stoked investor unease, risk aversion overtook greed.

Corporate buybacks, the biggest source of demand for U.S. stocks during the nine-year rally, picked up as a slump sent the S&P 500 to 17 times forecast earnings, the lowest valuation since early 2016. Companies are also boosting repurchases as the fourth-quarter earnings season nears its end, concluding a blackout period that can restrict share repurchases”.

Buybacks are of course a prime example in financial engineering and drivers of wealth inequality. While perfectly legal they are not an investment in the future or growth, but benefit shareholders and provide an ultimately distorted picture of EPS earnings as shares outstanding shrink. And for now they are the next free money put placed underneath markets.

The primary financing mechanism of buybacks has been debt:

Time to recite Goldman again:

“We expect rising interest rates and a rising debt level to lead to a meaningful increase in interest expense”. 

Cue the consumer throwing all caution into the wind of rising rates:

“Interest rates are on the rise, but that hasn’t curbed Americans’ appetite for consumer debt.

If anything, consumers are borrowing more on credit cards or through auto loans than they have in years, and lenders seeking growth are happy to oblige them.

Abe Schilling, a 33-year-old car salesman in Great Falls, Mont., said he signed up for more than five credit cards over the past year, from issuers including Capital One Financial Corp. and Discover Financial Services , after he received offers in the mail. He also took out a $36,000 loan to buy a new Jeep Grand Cherokee. Mr. Schilling, who currently rents his home, said the offers have been arriving as his credit score has improved. He previously had dozens of collections and other negative marks on his credit reports after failing to pay back bills. With a steady income and months of debt counseling behind him, Mr. Schilling says he feels confident in his ability to pay for his debts.

So do plenty of other Americans. In the fourth quarter, consumer debt, excluding mortgages and other home loans, rose 5.5% from a year earlier to $3.82 trillion. That is the highest amount since the Federal Reserve Bank of New York began tracking the data in 1999. Moreover, consumers’ non-housing debts accounted for just over 29% of their overall debt load, also the highest amount on record.

The shift to nonmortgage debt, including credit cards and personal loans, carries some drawbacks for consumers, including higher interest rates. “This type of debt is problematic,” said Cris deRitis, senior director and economist at Moody’s Analytics. “It should really be temporary,” but for some consumers “it can be hard to get off that treadmill.”

The writing is on the wall: The debt construct is not sustainable and higher rates will end it. This conclusion is clear. The only question is the when and where. When is the timing, the where is: Where will you be in relation to the glacier when it decides to move?

Related Reading:

The Rate Puzzle Coming Together

Tax Cut Hangover

Rising Debt + Rising Rates

For the latest public analysis please visit NorthmanTrader. For our market products please visit Services.

All content is provided as information only and should not be taken as investment or trading advice. Any investments, trades, and/or speculations made in light of the ideas, opinions, and/or forecasts, expressed or implied herein, are committed at your own risk, financial or otherwise. For further details please refer to the disclaimer.

Categories: Opinion

Tagged as: , , ,

21 replies »


This site uses Akismet to reduce spam. Learn how your comment data is processed.