Friday, August 28, 2015

Credit conscious consumers

If anything good came out of the Great Recession, it was the lesson—for consumers, at least—that debt can be a very unpleasant thing to have when the going gets rough. Consumers have taken that message to heart, by managing their credit card debt more carefully.

As the chart above shows, credit card debt outstanding fell from a high of $866 billion in 2008 to $703 billion as of last June. Relative to disposable income, credit card debt fell by fully one third over the same period.

Reduced credit card debt, combined with rising incomes, has dramatically reduced the percentage of credit loans that banks have had to write off.

Consumer loan delinquency rates are at their lowest level over 25 years, and falling.

All of the above is consistent with the Fed's calculation of household leverage:

Bottom line: consumers and households have trimmed their exposure to debt and are managing their debt much more cautiously and conservatively. This is, arguably, one of the under-appreciated facts that contribute to a positive outlook for the future.

GDP stronger than expected

It's ironic that the stock market suffered a huge "correction" only days before the second revision to Q2 GDP growth came in surprisingly strong. Sometimes the market gets carried away by emotions, and sometimes the economic statistics get revised significantly after the fact, so it pays to keep an eye on the fundamentals as revealed by key market-based prices (e.g., real yields on TIPS, swap spreads, the dollar, gold).

I've long argued that real yields on 5-yr TIPS were a good indicator of the market's expectation for the trend of real economic growth. As the chart above shows, the two tend to track each other over time. Real yields on 5-yr TIPS have moved quite a bit higher over the past two years, and now we discover that the economy strengthened over that same period. The annualized rate of economic growth over the past two years was 2.7%, a good deal better than the 2.2% annualized growth since the recovery started in mid-2009. .

Despite the pickup in growth, however, the economy is still a lot smaller than it could/should have been. As the chart above shows, the shortfall in growth relative to long-term trends is about $2.8 trillion. Per year. We're talking about a lot of income that's being left on the table, and a lot of people unemployed or underemployed, most likely because of higher tax and regulatory burdens.

Yesterday's GDP revisions also gave us the first look at corporate profits after tax for the second quarter. They reached a new nominal high of $1.82 trillion. As the chart above shows, that puts corporate profits very close to an all-time high relative to GDP. From a long-term historical perspective, corporate profits have been exceptionally strong throughout the current business cycle expansion.

The chart above shows the PE ratio of the S&P 500 using the after-tax corporate profits (with adjustments for inventory valuation and capital consumption allowances and normalized in order to facilitate comparisons to reported PE ratios) as the "E" instead of trailing GAAP earnings. By this measure, the stock market at the end of June was trading very close to its long-term average valuation.

What does all this say? The economy is doing OK, and has even managed to improve somewhat in recent years, despite all the moaning and groaning. Corporate profits have been absolutely fabulous, and certainly supportive of higher equity prices. Stocks aren't in a bubble, and monetary policy hasn't stimulated the economy or caused equity prices to artificially inflate.

So why is the market so worried? Why is the Fed so worried about the economy that they have to keep interest rates at zero? Sure, things could be a lot better, but we're not talking about a fragile economy that needs an extraordinary dose of TLC (aka low interest rates) to survive. If we want things to improve, we need to look to fiscal policy, not the Fed.

Wednesday, August 26, 2015

Chart updates II

Only two charts from yesterday merit updating today, one the result of a bounce in stock prices and a drop in fear, the other the result of a further decline in 2-yr swap spreads.

When stock prices move inversely to fear (as proxied in the above chart by the ratio of the Vix index to the 10-yr Treasury yield), it's a good bet that emotions are the primary driver. More and more this looks to be the case with the recent volatility in global equity markets.

Swap spreads typically lead or track credit spreads, but not recently. 2-yr swap spreads in the U.S. are now a mere 14 bps, while high-yield spreads remain somewhat elevated. Equity and corporate bond markets are nervous about a deceleration in China's growth and a possible slowdown in the U.S. economy. But swap spreads are about as low as they get, which is a good sign that markets enjoy a healthy degree of liquidity and a virtual absence of systemic risk. This further suggests that elevated fears may be groundless—since they are as yet unaccompanied by any deterioration in the financial and economic fundamentals.

The next two charts are updated versions of ones I have featured periodically. Both show that the commercial real estate and construction markets are quite strong. As such, they lend support to the notion that the economic fundamentals have not deteriorated, and the market's fears are arguably misplaced.

According to the folks at Co-Star, commercial real estate prices are booming. Prices have been rising at a 12-14% rate for several years now. This is one of the strongest economic indicators I've seen.

New business on the books of the nation's architectural firms is increasing, according to a survey by the AIA. This points to increased commercial construction activity over the next year.