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1) Unprecedented plunge in household wealth
Households ran for the safety of guaranteed deposits amid the worst financial crisis since the 1930s. However, the mere $200 billion they stowed away in that haven fell far short of protecting them from the massive $5 trillion in losses they incurred on equities and real estate. Real estate net worth fell by $670B in 4Q for a $4.6 trillion total decline since the sector rolled over in 2006. Equity losses totaled $8.5 trillion for the year, and $3.9 trillion of that was incurred in just the fourth quarter alone. The slide in the equity market inflicted considerable damage to pension funds and mutual fund shares, which collectively lost $2.2 trillion in 4Q. The aggregate loss in household wealth is now an eye-popping $12.9tn (and now roughly up to $20 trillion in 1Q): This constitutes a 20% decline in household wealth since the peak was put in back in mid-2007. Wealth destruction of this magnitude is unprecedented in the post-WWII era. The 2001 tech-wreck saw a 9.6% decline in net worth while the 1975 equity asset deflation yielded close to a 4% decline in wealth. So far in the first quarter of 2009, we’ve already seen a 20% decline in the value of the S&P 500. History suggests a strong correlation between falling wealth and rising savings and this 18% year-over-year plunge in net worth is highly deflationary.
2) Meanwhile, consumer deleveraging continues
The household debt-to-income ratio dropped to 134% in 4Q from 136% in 3Q. What this confirms is that a 20-year secular expansion has now come to an end. At its peak, this ratio was as high as 139% and nearly a 40ppt increase from 2001 levels. US consumers levered up so much that they tacked on more debt in the last seven years than in the prior 40 years combined. With equity and real estate values plunging, households are being forced to rely less on rising asset prices and more on their paychecks to fund living expenses. In other words, frugality has come back into fashion and we would expect this ratio to continue coming down – adding to deflation pressures.
3) Most sources of borrowing are drying up
The Federal government is expanding its balance sheet at its second fastest rate in recorded history – debt has exploded by 24% year-on-year as of the fourth quarter of 2008. But the Federal government does not operate in a vacuum – other sources of borrowing are drying up rapidly. From nearly 7% growth a year ago, the annual trend in household credit has vanished. Corporate borrowing growth has gone from 13.5% a year ago to a YoY trend of 4.7% currently. State/local governments have sliced debt growth to 2.2% in 4Q from 9.3% a year ago. All in, domestic credit growth, even with the Federal government surge, slowed to an 8-year low of 5.8% YoY in 4Q, down from 6.3% in 3Q and 8.6% a year ago. All the surge in Washington has done is slow the overall descent – it has certainly not prevented overall credit growth from subsiding. Panacea, not an antidote.
4) Retail catches a tailwind
The Fed’s Beige Book actually hinted that consumer spending was no longer falling off a cliff in the past couple of months and that anecdotal view was backed up by the data that came out for February. Not only was January revised up to +1.8% (from +1.0%), but the gains held in February as the headline came in at - 0.1% versus expectations of -0.5% (and ex-autos were +0.7% on top of a 1.6% spurt in January). It seems strange to be seeing such a pickup in view of the fact that we lost 651,000 jobs in February and 655,000 in January, not to mention the collapse in consumer confidence to all-time lows. Be that as it may, the data are the data and many economists now are going to be headed back to the drawing board and revising their first quarter GDP numbers to be somewhat less negative than they were before (we had been at -6.5% SAAR for 1Q). Here are some possible explanations:
1. Income tax refunds have been huge so far this year – up 40% YoY in Jan- Feb (a record $105 bln in Feb).
2. There has been a refinancing boomlet that has left money in people’s pockets – up 17% YoY in Jan-Feb.
3. The seasonal factor for February was also very aggressive (0.878 – i.e. looking for a 12% slide in the raw data) – in fact, it was the most aggressive SF in 12 years. The RAW data actually showed that retail sales slid 3.9% in February, which was the weakest sequential change on record (and half the time, in any given February, sales manage to rise before the seasonal adjustment is applied). We estimate that retail sales would have DECLINED 1.5% if a more normal seasonal factor had been deployed – so tread very
carefully in interpreting this data.
4. There is some ‘noise’ around the data because in the three months to December, sales plummeted at a 26% annual rate. So we could also just be seeing a bit of a bounce from extremely depressed levels.
Areas that look better are clothing (which we highlighted in our Beige Book piece last week), electronics, pharma and e-tailing. All have posted back-to-back gains. Building materials, food and autos have been quite soft by way of comparison.
5) Total pool of unemployed surges
What gets lost in all the commotion in the trading pits over the headline payroll number is what happened to the total pool of unemployed. It soared 851,000 in February to a record 12.5 million, up 5 million or a huge 68% from a year ago. It’s a good thing we have an elaborate social safety net that includes unemployment insurance or else we would be talking more about the 1930s. The headline unemployment rate jumped to 8.1%, the highest since December 1983, from 7.6% in January, 7.2% in December, 6.8% in November, 6.6% in October and 6.2% in September. At that rate, we could be breaking above the post-WWII high of 10.8% established back at the depths of the 1982 recession, by September of this year. Keep in mind that there is a significant correlation between the unemployment rate and consumer delinquency rates in the banking system. This is not merely a comment on what the jobless rate data imply for consumer discretionary and homebuilding stocks, but for financials as well. And, just as the financials led the peak in the S&P 500 by six months in 2007, we would expect to see a recovery in this vital sector first before expecting to see a bottom in the overall market.
The number of full-time jobs sagged 940,000 in February after more than 1 million lost in both December and January – 3.5 million full-time jobs lost in just three months and 6.7 million since the recession began in late 2007. In a normal recession, we tend to see around 2.5 million full-time employment losses and currently we are nearly triple that and counting. These are jobs with benefits and because of their permanency, they have a tremendous impact on the household budget.
6) Why Treasuries look so attractive
After last Friday’s employment report let’s not kid ourselves any longer that we do not have a major deflationary backdrop on our hands. In this environment, income is king. Now, if it weren’t for the fact that default rates are soaring and the move into high-grade corporates has become a mainstream view, we would be big fans of the credit market. That is a crowded trade. Treasuries are generally underowned and unloved. We do see that the equity culture is not dying as much as we would have thought, but insofar as the stock market can generate cash flows, the ability to do so with consistency is in question. Wells Fargo became the latest to cut its dividend – by 85% to a nickel per share in a move that will save the bank roughly $5 billion per year. So far this year, the amount of dividends that has been cut has totaled $40.78 billion (financials now represent 11% of total dividend payouts, down from the 2006 peak of 30%). In less than three months, the dividend cuts have already exceeded the $40.6 bln in all of 2008. According to S&P, dividends are on track to decline 23% this year, the most since 1938. According to the folks at S&P, the sharp curtailment of dividends (but the yield is 3.1%!! Hey – ever heard of a ‘value trap’?) is the equivalent of a 26% pay cut to the average retiree.
7) Is gold at a critical juncture?
We are amazed at how many people believe gold is in some sort of bubble. Is it an over-owned investment? Not in our view. Is it talked about incessantly like oil was last year or tech in the late 1990s? No. Has the bull market been premised on leverage? No. Some bubble. In any event, gold is still in an uptrend, and that does not mean that it will never correct hard. It will, and it has already – this latest corrective phase is the 15th of this 8-year-old bull market. The key is to time your purchases as closely as possible to these tests of the 50-day moving averages – which is the process the gold price is now in technically. And the history of this bull market has shown that after gold touches the 50-day m.a. in these corrective phases, it has gone on to rally by an average of 12% in the coming year (median too). When an article shows up like this on page 20 (20!) of Wednesday’s FT, it suggests to us that this is not a bubble just yet (“UBS Bullish On Gold Price Nearing $2,500”). Call us when it hits the front page.
8) Small business sentiment at a new 28-year low:
• The NFIB index sagged to 82.6 in February from 84.1 in January, the lowest print since April 1980 (and the second lowest ever). The difference, of course, is that in April 1980 the funds rate was 18% as opposed to 0% today (at least the Fed back then still had bullets in its chamber).
• The net share of companies reporting that credit was tough to secure stayed at +13, the highest in three decades. Just prior to the Fed’s move to cut the funds rate to 0%, this metric was running at +11, and before the TALF was announced, it was +12, so clearly monetary policy, whether in a traditional or nontraditional sense, is pushing on a string.
• Up until the summer of 2008, when oil was surging toward $150/bbl, the top concern by small businesses was inflation. Now it is the sales backdrop – one in three cite this as their top worry.
• Corporate pricing as per the NFIB plunged in February to a record low -24 from -15 in January and -6 in December. Now as for ‘plans to raise prices’, a more forward looking indicator, this too fell to +1 in February from +2 in January and +22 a year ago – again, an all-time low.
• Not only that, but the index measuring wages collapsed to a record-low of 7 in February from 9 in January and 23 a year ago. Note that the last time the unemployment rate was over 8%, this metric was running north of 20, which goes to show that in today’s much more competitive and less regulated labor market, an 8%+ jobless rate actually represents much more dramatic excess capacity than was the case two or three decades ago. Company plans to raise wages stayed at an all-time low of +3 as well.
9) Nothing is quite like the Fed cutting the rates to zero
We think Bernanke et al better soon stop talking about quantitative easing and embark on the program to buy coupons: The financial markets are becoming unglued and monetary policy appears to be, in a word, impotent. Since the funds rate was taken to near-0% on December 16th, the yield on the 10-year note has surged 50 basis points. Mortgage rates have come down an insignificant 40 basis points. New car loans rates have jumped 25 basis points. Rates on homeequity lines of credit haven’t budged. Three-month Libor is back above 1.3% and has risen 8 bps in the past week. And the Dow has lost 2,400 points – since the Fed went to ZERO. We think it’s time for some dramatic action out of the Fed – not just to bring credit spreads in, which has been met with some but not a whole lot of success, but to take the whole yield curve lower and further ease debtservice strains for the overall economy (investors yanked a net $911 million out of high-yield funds last week, the most since early October; the junk bond market is down 3.3% so far this month; the US CDX is index is back trading at a 250 bp premium over Treasuries, the widest spread for the year).
10) Foreclosures on the rise
Foreclosure data out of the USA showed a 6% MoM rise and +30% on a YoY basis in February, so the growth rate is slowing but the base level is still uncomfortably high and still rising. The banks are saddled with 700,000 properties on their balance sheets as well (the ‘shadow inventory’), according to RealtyTrac. And, according to the Mortgage Bankers Association, a record 11.2% mortgage borrowers are at least one payment past due or in the foreclosure process. Since the housing rescue plan only goes so far as to cut debt-servicing burdens for certain homeowners to 31%, but does not address the negative net equity position many still face, it is an open question as to how successful this initiative is going to be – we recall all too well that Hope Now and FHA Secure were supposed to be the saviors ages ago. California, Arizona and Nevada are the main culprits – in fact, 1 in every 70 Nevada homes received foreclosure filings last month (and the total number is up 156% over the past year). California foreclosures were up 5% MoM (and +134% YoY) – and this is with the lowest mortgage rates on record, all the bank efforts for loan modifications and all the moratoria on foreclosure activity. So yes, it is impressive that home sales in the Golden State have doubled from a year ago, but from what we can see, we estimate up to 60% of that activity is foreclosure based. Sphere: Related Content
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7 comments:
The Fed still seems very overconfident.
Tyler, fantastic blog- really informative for us simple equity guys. But I was hoping you could help me with a macro question:
I keep reading how overleveraged the US consumer is and in certain large demographics that is true; but in aggregate (q3'08) American consumers were not severely over-levered. Mortgage debt was $10.5T and Credit debt was $3.5T versus $71T in assets ($21.5 RE, $45 Financial, $7.5 Deposits). From this I conclude that the asset bubble was not caused by consumer leverage but by other leverage or simply irrational valuations.
I know there is a lot more debt in the financial system that may have to be unwound but I was wondering if you can shed some light on this aspect of credit. The way I see it, if I lend you $100 @3% and you lend to B at 4% and the he lends to S at 5% then there is now $300 in both assets and liabilities but really no increase in money (except a transfer from Sargon down to Me via interest payments). With our personal incomes (GDPs) constant the Debt to GDP ratio looks daunting but, if S defaults, $300 in assets AND debt are wiped out. I guess the problem is that all of those assets from me to you to B etc. have been used as collateral for more leverage via financial institutions. Thx.
Several issues:
1. The short covering was inevitable. This is hardly a "rally" of long term proportions. Fact is, when C is $1.50 - why go short? Better to take a shot long and squeeze the shorts for a quick gain.
2. Deleveraging, while "bad" now, is a long term "good". The pain doesn't have to be all bad. There are benefits to the pain for those who did things right (I'm pleased I'm lucky to be one of these). I have to believe that the faster our debt ratio drops, the sooner we get out of this mess. I don't have to believe it - I know it.
3. Deflation MAY be in the cards, but in a deflationary environment, any kind of inflationary activity can offset the deflation. We haven't see massive deflation yet because steps have been taken to "reflate". This could, just as easily, become hyperinflationary. but if handled judiciously can be stagflationary (think the 1970's).
There's a lot more to go here...but I remain an eternal optimist. Not because of Obama - far from it, he's likely to turn us into a Socialist nation at a faster rate than FDR, destroying wealth and property in the process. But I do believe in the optimistic and forward thinking psychology of the US people as a whole. We are innovative, industrious, and we are above all survivors.
BTW, "irrational valuations" are the result of too much debt. We bid up prices in the expectation of more spending, but that spending has to be fueled by debt....
So debt IS the problem.
You can leverage out only so far, then the real equity is gone. We reached that point some time ago and the equity that kept building was based on easy credit and the assumption of more lending.
That is why the Obama claim that getting the banks to lend is ridiculous. They are lending - they are making the very best loans they can make. Any other lending would be suspect and thus only expand the bubble. That kind of lending is not value add, it's potential value destruct.
you ask a very good question, and the response is usually a matter of opinion. i plan on providing my perspective soon, but in a nutshell the core of the problem has to do with "real" assets, or the type that actually generate cash flows. The bulk of the 70T in assets is amortizing, non cash-generating assets. The pool of actual markable assets, that one can use to create wealth and cash with is really small percentage of this amount. as you point out, this pool is the one that was extremely leveraged: for every dollar of cash generated asset holders used leverage to magnify their returns. now that cash generation is falling off a cliff there is a disconnect in the capitalization ratio which is what is main reason for the unknowns in the market. MTM is really a byproduct of this problem as all it does is tries to put a fair value on how much asset X that generates cash flow Y is really worth assuming it is leveraged by Z. this is a multivariable equation that is not easily solved if at all... and yes, securitizations such as CLOs, CDSs, CMOs and other gimmicks merely layered debt upon debt, ergo the credit bubble. the real question is at that level is this equation in balance. but this is really the question that everyone is trying to resolve.
The MTM controversy seems to revolve around the relluctance of banks to acknowledge a non-temporary, fundamental decline in the Z variable (leverage). On Tuesday Buffet said that the "toxic assets" are actually the best assets on the bank blance sheets because they are priced assuming a non-leveraged buyer. The implication is that this is the wrong price becuase when things return to normal a levered buyer will return. But why should we assume that yield surpressing leverage should return? Shouldn't all debt be priced at yields that reflect the underlying interest rate and default risk of the issuing firm and shouldn't that rate bring a suitable return without leverage?
I wonder if another factor to "Retail catches a tailwind" might be that folks are buying goods now, rather than waiting given the prospect that 1) we'll all be much more under the squeeze in the future financially and 2) there's the very real possibility that prices are going to get really high in the years to come. Add to that you have some portion of Americans who are currently stocking up on spam, guns'n'ammo -- not sure how significant that is at a national retail level...
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