My take: Consumer debt is a massive problem. There are people that don’t see it that way. I think that’s a mistake and I’ll outline my case here with some charts/thoughts and you are of course free to draw your own conclusions.
I don’t think it’s an accident that markets have been reacting negatively to yields spiking. And it’s also not an accident that home sales are dropping in the face of higher rates.
How sensitive to higher rates is the entire construct? Currently every spike in the 10 year invites selling during the day. Jerome Powell’s words led to yesterday’s 10 year spike above 2.9% and it flushed stocks.
Yesterday we also learned that 72% of earnings growth since 2012 was due to buybacks, or financial engineering in short:
“Volatility is an instrument of truth, and the more you deny the truth, the more the truth will find you through volatility.” Over the past decade, there has been no corporate instrument of mistruth more powerful than buybacks, an issue we have dissected in these pages for years. U.S. firms have spent roughly $4 trillion on buybacks since 2009, making corporations the biggest single source of demand for U.S. shares. According to Artemis’s calculations, buybacks have “accounted for +40% of the total earnings-per-share growth since 2009, and an astounding +72% of the earnings growth since 2012.”
That’s a big number and it reveals the extent of the mirage that has been propagated for the past few years. Consumers and the government are drowning in debt and the construct continues to be held up by low rates, hence the sensitivity.
And I think principally people understand this. After all it’s not often that a macro chart goes viral:
“Don’t see build up of leverage among households.” – Fed’s Powell
— Sven Henrich (@NorthmanTrader) February 27, 2018
There are some that claim if you ratio that and right size this it’s not so bad. They are frankly missing the point. We are still in a low rate environment and unemployment is still at the lowest it’s been in a long time. This is not normal. It’s the abnormal.
Unemployment does not stay low forever, its historic mean is always higher:
And yes record debt levels look sustainable in context of still historic low rates:
From my perch taking the most favorable debt conditions, low rates and full employment, and project sustainability into the future is playing tennis without the net.
Rates have been rising and we see stress emerging any way you cut or slice the data.
And sustaining debt payments, which are already rising, in a much higher rate environment is a huge headwind:
So I submit the Fed and markets find themselves in a narrative trap inside the bubble they have created. Hence the Fed’s tinkering with ‘gradual, patient, rate hikes’. Oh just shut up, you know exactly why you are trying to send that calm message because we saw yesterday what happens when the message gets interpreted differently: Stocks drop.
Here’s the reality: Earnings growth is heavily reliant on buybacks which have been financed with debt and now with tax cuts, courtesy unwitting tax payers, but the structural growth component remains MIA.
So let’s take a look at various consumer debt/leverage charts with a view of higher rates yet to come.
Let’s start with the basics:
Expanding consumer debt has been financed with lower rates for decades and a lot of it makes sense as the population and wages are growing.
All this is fun and giggles as long as rates stay low, but when they start rising things change as we just started to see in the past 2 years.
The logical conclusion:
Interest payments on debt have been rising dramatically as well, despite rates still historically low:
Now some say, it’s not so bad because of inflation, more households, higher incomes, etc. Really? I disagree. The message is the same and perhaps even more concerning.
Fact is credit growth has exceeded real wages and real disposable incomes:
Notably that acceleration toward more debt seems to come near the end of cycles:
In conjunction with declining savings rates it suggests people are using expanding debt to sustain spending habits:
Or should I say investing habits?
“Investors have borrowed a record $642.8 billion against their portfolios”
“I was so bullish that I went all in,” said Mr. Diaz. he deposited $2,500 into his account to satisfy a margin call on Feb. 8
h/t @lisaabramowicz1 https://t.co/rb3Cty1ru3 pic.twitter.com/qPNFK2MNNW
— Sven Henrich (@NorthmanTrader) February 25, 2018
What about adjusting for ratios? Well:
It’s still the same message: The trend is up and this is with full employment and rates still low as I outlined earlier.
But the stress is already here:
“Overdue US credit card debt has reached a seven-year high, underlining the difficulties faced by many consumers in spite of the strong performance of the economy. Banking sector data show consumers were at least three months behind repayments or considered otherwise distressed on $11.9bn of credit card debt at the turn of the year, a rise of 11.5 per cent during the fourth quarter. More Americans are also failing behind on their mortgages, for which problematic debt levels rose 5.2 per cent over the same period to $56.7bn”:
Now add 6-8 rate hikes over the next 24 months and what do you get? A vast acceleration in consumer debt obligations which require unemployment to remain at cyclical lows and real wages to grow faster than debt consumption. The message: It has to be different this time, or the math doesn’t work. And if you think unemployment will remain at cyclical lows forever be my guest, but there is precious little evidence that this will remain so.
And if unemployment picks up at some point you’ll have millions of consumers in high debt with limited savings and rising debt obligations. And then suddenly debt matters.
For further details on the implications of rising debt and rising rates please see the Macro Corner.
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.