This is a quick hit but I think something to watch. You saw the blurb from Reuters in today’s links on how US consumer debt surged higher for the first time since the financial crisis. My thesis has been that consumers only retrench when forced to because of their ‘uncreditworthiness’. I like to say that deleveraging in balance sheet recessions happens largely during recessions. And I think of ‘uncreditworthiness’ as consumers either actively declining credit in order to pare down debt or being declined by banks as uncreditworthy.
There are certainly supply constraints when the business cycle is at its nadir. However, at this point in the business cycle, i.e. in the third year after recession has supposedly ended and after FDIC-insured US banks have started earning tens of billions each quarter, supply side issues are not as relevant. Banks have long since started to loosen the purse strings and are only inhibited by the demand for credit amongst creditworthy borrowers. Supply side constraints are not more severe than during any other business cycle now. The defining character of this cycle is a lack of creditworthy borrowers with increased credit demand. Now, that term creditworthy is key because the definition is flexible as the business cycle waxes and wanes. But, the bottom line is that this far into a business cycle, credit growth will increase as demand for credit amongst borrowers deemed creditworthy does.
Demand for credit is always robust for uncreditworthy borrowers. Don’t people who are underwater want credit? Don’t the unemployed want credit? So it is a given that it is demand by creditworthy borrowers that counts since there is always an almost infinite demand for credit if it is given without regard to creditworthiness as we have just seen during the bubble. And that creditworthiness is limited both by the creditors and those receiving credit themselves. But when you talk about balance sheet recessions as secular events, the supply side is less relevant. The supply side is a cyclical phenomenon. And that’s an important point to make because what we are seeing now are incipient signs of typical cyclical credit driven dynamics.
Things don’t move in a straight line on the way up and not on the way down. When it comes to the balance sheet recession and deleveraging, policy makers have abundant ways to forestall the inevitable reduction in debt ratios. Americans increased the savings rate during the downturn. However, the savings rate is not increasing. The average personal savings rate in the U.S. peaked in mid 2009 just as the recession ended. The data since do not suggest savings will continue upward until another economic downturn hits. Deleveraging may continue in small measure, but I continue to believe that this balance sheet recession will see the bulk of deleveraging as a result of economic downturns.
So don’t be surprised by consumer releveraging. It is the norm. However, do note that the US economy is growing at a fairly anaemic rate given the 6.9% increase in consumer spending in Q4 2011. That tells you the debt is not translating into increased productivity and that we should expect earnings growth to start to decline as a result. 2012 will be the year of margin compression and so I predict that stocks will start to react by the second half of the year if not before.