Debt, Debt and More Debt

Debt, Debt and More Debt


While U.S. Consumer credit increased less than expected in January, we are concerned with what we are seeing in consumer loans and debt in general across the world.

Auto Loans

With our Cash-Strapped Consumer investing theme, the average amount financed and the duration of new auto loans continues to rise – same car, bigger loan and for longer means a more highly leveraged car owner.

Credit Cards

We also see warnings sign with credit card debt as our Cash-Strapped Consumers struggle to make ends meet. At small banks, the share of outstanding card balances written off as a loss after consumers failed to pay hit 7.2% in the fourth quarter of 2017, up from 4.5% a year ago, according to Federal Reserve data. While overall card losses across all banks remain below the historical average of the last 30 years, they’ve been slowly climbing in the last two years. We believe these smaller banks are canaries in the coal mine as the average charge-off rate at those smaller banks is near an eight-year high, while the 3.5% loss rate at large banks remains well below the 10.6% seen in 2010.

If an effort to compete with the large and increasingly larger banks, some smaller banks have taken to lowering lending standards, which means their credit cards are held by those that are first to feel economic angst. The subprime borrower is always the first to get hit when the economy weakens. For years, wage growth has been slower than the growth in expenditures, forcing many families to take on credit card debt just to pay for necessities. The rising charge-off rates indicate that these folks are in a perilous economic condition if wage growth doesn’t accelerate sufficiently and soon.

Student debt

Education debt swelled to nearly $1.38 trillion at the end of 2017, with 11% of borrowers 90 days or more delinquent, according to the New York Fed. The U.S. federal government now owns over 30% of total consumer debt in the U.S., thanks to its utter dominance of the enormous student loan industry. Prior to the financial crisis, that number was less than 5%. Think about what that means concerning the reduced firepower of the federal government in the case of another financial crisis.

This area of lending reminds us of the dynamics in the housing market that led to the subprime mortgage disaster. The problem in subprime was that too many players had no real skin in the game. Thanks to various legislative acts, the banks issuing mortgages were incentivized to immediately turn around and sell them to Fannie Mae or Freddie Mac – particularly the subprime loans. This meant the issuing bank had no real interest in the quality of the loan.

With student loans, the student or prospective student has little ability to estimate the relative earnings advantage potential for any particular education. The seller of the education, the college or university, is financially indifferent as to whether the student will ever be able to pay off the loans and with the way student loans work, has no incentive to tie the cost of tuition to the improvement in future earnings it provides through its curriculum. This creates an entirely new generation of Cash-Strapped Consumers that start off their young lives already saddled with brutal debt levels, which often postpones the traditional cycle of car and home purchases as well as starting a family.

Emerging Market Debt

It isn’t just domestic debt that has us concerned. Another area of concern that we are watching has been in emerging market debt which has helped generate the Rise of the Middle Class investing theme in these economies. The 26 largest emerging markets monitored by the Institute of International Finance have seen their sovereign debt load rise from 148% at the end of 2008 to 211% of GDP at the end of the third quarter of 2017. Couple that with the pricing perversions driven by investors’ search for yield that have the 10-year Kenyan bond trading at 7.5% and the Dominican Republic 30-year at 6.5% while the 10-year and 30-year U.S. Treasury bonds trade at 2.87% and 3.15% respectively. Really? Not a whole lot of risk premium priced in there.

Then there is the incredible size of China’s financial system. As of the end of last year, assets in Chinese commercial banks were approximately $40 trillion, which is around 51% of global GDP. The highest the U.S. every reached was 32% of global GDP in 1985 and Japan at 27% in 1994. For additional perspective, at the end of last year, in the United States, that number was $17.4 trillion versus U.S. GDP of $19.4 trillion while China’s GDP is around $13.1 trillion. This is wholly unprecedented in the history of global finance.

Let’s not forget that over the weekend China removed term limits for Xi Jinping, allowing him to possibly rule for life. History tells us that a nation, controlled by a single leader, who is no longer bound by any sort of accountability thanks to his/her ability to rule for life, rarely experiences increasing individual freedoms, increased open trade and responsible debt management – yet another geopolitical concern to add to the pile.

The bottom line is the world has been awash in a whole heck of a lot of liquidity thanks to the concerted efforts of the world’s major central bankers. The intention was to suppress interest rates, thus induce borrowing. Well, it worked. The secondary effect, which was also intentional, was to inflate assets prices so as to induce the so-called wealth effect.

Done! Thanks to stock prices rising at a much faster rate than the economy, household wealth as a percentage of disposable income has reached a new record high.

The Federal Reserve is now attempting to increase interest rates and take away that liquidity and asset-price-inflating punchbowl without any major disruptions.  The European Central Bank may join in here soon too as all are concerning that this post-financial crisis party may shift into inflation-mode, which no one wants. This too is wholly unprecedented in human history. While the mainstream financial media is all about the Goldilocks outcome, we remain skeptical and wary of highly leverage assets or those whose risks are significantly underpriced.

Aging America Faces A Changing Economy

Aging America Faces A Changing Economy

This morning an article in Investor’s Business Daily focused on one of our investing themes, the Aging of the Population and its impact on economic growth and certain sectors of the economy. Combining the headwind of a growing portion of the population moving into the sunset years with massive levels of student debt, the housing sector looks to have some serious headwinds in the coming years.

The recent level of mortgage purchase applications has recently hit a six-year low as we head towards the 98th month of this expansion. While the University of Michigan’s Consumer Sentiment survey reported today that the headline index rose to 97.6 versus expectations for 94 with sentiment amongst those of 55-years of age reaching the highest level since November of 2000, Homebuying Plans are at a 6-year low.

The graying of the U.S. population will have far-reaching consequences well beyond rising demand for earlier restaurant reservations!

Yet what some have called “secular stagnation” or “the new normal” is largely about America — along with much of the rich world — turning gray. Aging has cut 1.25 percentage points from both trend GDP growth and the neutral real interest rate in the U.S. since 1980, with most of that coming since the early 2000s, according to Federal Reserve researchers.

To put it into perspective,

In 20 years, the whole country will look like Florida — only older. Now 20% of Floridians are 65 and older vs. 15% for the country as a whole. Two decades from now, 21% of Americans will be seniors, according to Social Security Administration projections.

This has implications for the spending plans of politicians in that,

A decade ago, 3.3 workers paid into Social Security for every beneficiary. By 2037, that will fall to 2.1 workers. The situation is already far worse for local governments like Chicago, which has 47,000 retirees drawing pensions and only 34,000 current government workers (excluding Chicago Public Schools).

Those heading into retirement may find their nest egg isn’t quite what they’d been told to expect.

Despite an eight-year bull market, unfunded state and local pension liabilities have ballooned to an estimated $4 trillion.  Moody’s figures that the total value of benefits promised to current and future U.S. retirees but not paid for tops $23 trillion — bigger than gross domestic product. That includes unfunded promises for federal employees ($3.5 trillion), Social Security ($13.4 trillion) and Medicare’s Hospital Insurance program ($3.2 trillion).

The who, what, where and how much of spending in the coming decades in the country will look very different from in decades past.

Source: 50 States Of Gray: Aging America Faces Retirement Benefit Battles, Even-Slower Economic Growth | Stock News & Stock Market Analysis – IBD

July Retail Sales Contradict Retailers

July Retail Sales Contradict Retailers

Tuesday’s Retail Sales report from the Census Bureau for July surprised to the upside, with stronger than expected motor vehicles and parts sales which were in sharp contrast with the weak sales reported by the auto manufacturers themselves. The report also showed an increase in sporting good sales, which is also in contrast to what we’ve seen from companies in the sector. The headline retail sales number is “seasonally adjusted,” which means it is the result of a bunch of adjustments based on models. The actual raw data for July saw a 0.8 percent decline, which is the steepest falloff for the month of July since 2012.

At Tematica Research, we are loath to rely on any one data point to reach a conclusion, particularly when the data is the result of adjustments based on assumptions that cannot be precisely accurate by definition. However, if we can find sufficient confirming data points, we become more confident. For example, the Johnson Redbook survey reported a 1.2 percent sales decline in July – so no help confirming the Census numbers from there.

We don’t give this month’s Retail Sales report much weight because not only could we not find anything to confirm it, companies in the sectors that it reports saw solid gains have reported the opposite.

The July Retail Sales Report has Sporting Goods rising 0.3 percent yet Dick’s Sporting Goods (DKS) Q2 earnings, also released yesterday, showed same-store sales growth was just 0.1 percent year-over-year versus management’s expectations for 2 to 3 percent. The 9.6 percent year-over-year increase in sales was driven by digital sales, which rose 19 percent from 2016. CEO Ed Stack cited a challenging retail environment during the quarter, with hunting, athletic, and athleisure apparel all under pressure. The big slam came from the lowered guidance to $2.80 to $3.00 for the year in contrast to consensus estimates for $3.62. Shares of DKS fell 23 percent on the day and analysts adjusted expectations to the lower end of guidance.

Foot Locker (FL) shares dropped 4.4 percent in response to the news from DKS. We’ll be watching their results closely on Friday morning. Hibbett Sports (HIBB) saw its shares drop 16.5 percent as the entire sector got a pounding thanks to DKS results. Three weeks ago the company announced that same store sales for the second quarter may be down as much as 10 percent – not exactly consistent with the July Retail Sales Report.

The July Retail Sales Report also saw solid growth in Auto Sales and Parts. We’d point out that Advance Auto Parts (AAP) reported a revenue gain of just 0.3 percent on flat comparable-store sales with a 17 percent drop in adjusted EPS and is projecting sales growth between 1 and 3 percent for the full-year. Last month O’Reilly Automotive (ORLY) warned that it would be reporting weaker-than-expected sales as well, projecting comparable store sales increases of 1 to 2 percent for the full-year.

We also found it rather odd that those areas that show the greatest strength also saw material pricing pressures – rising demand but less pricing power? Sporting goods saw sales rise 0.3 percent but prices fall 0.2 percent. Autos experienced a 1.2 percent gain in sales while prices dropped 0.4 percent. Building materials saw sales rise 1.2 percent yet prices fell 0.3 percent.

Finally, if we take a look at the consumer, the group that is responsible for all those sales, finances aren’t moving in a terribly robust direction. Without much in terms of wage gains, spending has been funded by the only other source, debt. Two years ago the savings rate was 6.3 percent, last year 5.1 percent and today has fallen to just 3.8 percent. Debt levels have again reached record levels, with auto and student loans making up a bigger piece of that credit pie. US Consumer Revolving debt reached an all-time high in June with auto loan delinquencies nearing recessionary levels. Student debt also reached an all-time high in June, with rising delinquencies as well. This makes future retail sales growth even more challenging if wages don’t rise appreciably to make up for the slowing in credit growth rates.

Just how much is the consumer struggling? Consumer staples tell the story. Johnson and Johnson (JNJ) reported a 0.8 percent drop in sales. Kimberly-Clark (KMB) reduced revenue guidance from slightly better than flat to down 1 to 2 percent, with the CEO stating that the near-term environment has become more challenging.” Toilet paper and diaper sales have become challenging! Procter & Gamble (PG) cut prices with CEO Jon Noeller reporting that growth in the U.S. markets has slowed from over 2 percent in 2016 to barely flat by the second quarter. Colgate-Palmolive (CL) saw a 4 percent drop in revenue from oral, personal and home care products.

About 20 percent of those in their last 20s and early 30s are living at home with mom and dad, a level that is virtually unprecedented in modern America. Household formation for 25 to 34-year olds has been flat over the past 3 years. Over the past 12 months, we’ve seen no growth in U.S. households.

The Bottom Line is with too many contradicting data points, we aren’t putting much weight on the July Retail Sales report. Overall, the 3-month moving average is still much weaker than historical norms.

Housing Recovery?

Housing Recovery?

We are in a housing recovery, yay!   Not so fast there Mr. Headline.  Before we get too giddy about the happy run up in home prices, we need to assess some important fundamentals. House prices across the spectrum are heavily dependent on first-time home buyers. The first-timer buys a home from an existing homeowner who is then able to purchase a more expensive home, which allows that homeowner to buy an even more expensive home and so on. Over the past 30 years, first-time home buyers represented 40% of existing home sales. According to the National Association of Realtors, in June of 2013, first-time buyers represented only 29% which was a drop from 32% a year earlier. Why this deviation from historical norms? First-timers are typically younger than existing homeowners. In today’s market, younger workers have a higher unemployment rate than the overall workforce and are also saddled with much larger student loans than in the past. Their required payments on these loans reduce how much of a mortgage they can afford, their ability to save up for a down payment and lower their credit score.


  • In August, sales of new single-family homes dropped to their lowest level since last October, according to the department of Housing and Urban Development.
  • The Mortgage Banker Association reported that their mortgage application index just fell 13.5% from the week ended September 6th, reaching a five-year low.
  • Median household income, which greatly affects home affordability thus prices, was $52,098 in June 2013. That’s still down significantly from the start of the recession in December 2007 when it was $55,480. (Both figures adjusted for inflation)
  • Now for one heck of a head scratcher! Interest rates on jumbo mortgages, which are too big for government backing, have historically been at higher rates than conforming loans, which are back by Fannie Mae, Freddie Mac or other government agencies. At the end of August the relationship flipped, putting the interest rate on larger mortgages that lack government backing lower! This is the first time in history that this has happened, further highlighting the dramatic impact of the recent sharp rise in interest rates.


Bottom Line: Until youth unemployment and the mind-boggling rise in tuition fees are addressed, home prices will continue to face limiting headwinds. In addition, there have only been 16 periods in the past 50 years when interest rates rose more than 20% in 200 days. The recent rise in rates has been dramatic on a percentage basis. Be wary of the impact on housing.