Late last year I highlighted a variety of charts that painted a picture of "impressive economic strength." In this post I revisit one that has displayed some impressive follow-through: Commercial & Industrial Loans, a good measure of bank lending to small and medium-sized businesses. The top chart shows the past 5 years' worth of data, while the bottom chart zooms in on the past several months (both are seasonally adjusted by the Fed). The message is very clear: bank lending to businesses has bottomed, and is now rising at a fairly impressive rate. This marks a very important change in financial conditions in recent months: after two years of a sharp decline, bank lending is up at a 13.6% annualized rate since Nov. 24th.
Unfortunately, we can't know whether the recent strength in new lending reflects an easing of bank credit standards or a new-found desire on the part of businesses to borrow (or stop deleveraging), or both, but it's likely a combination of the two. In either case, however, it reflects increased confidence on the part of banks and small businesses, and that is something that has been sorely lacking in this recovery.
The rise in new lending may also reflect an emerging decline in the demand for money (borrowing money is equivalent to being "short" money, or wanting less of it), and that could mean the Fed's QE2 program is gaining traction. The Fed's massive expansion of bank reserves has not yet resulted in any meaningful expansion of the money supply, as I noted yesterday, since banks have been content to let their extra reserves sit idle at the Fed, but this may now be changing, if C&I loans are any guide.
Nothing is out of control yet, of course, but if there has indeed been a real decline in the economy's demand for money, then this, coupled with increased business confidence, would point to a meaningful increase in nominal GDP growth in coming months. That nominal increase would likely be comprised of a pickup in inflation as well as a pickup in the pace of real growth.
It appears to me we are in the early stages of a new credit cycle. If Scott's analysis in this post is correct then investments made in well managed bank and insurance companies will be huge winners over the next few years.
ReplyDeleteThere is a lot of good research available. If you agree, do some homework and if you invest, be patient. The financials have been the top performing sector for the last several weeks so a rest/pullback should not be a surprise. It has no bearing on the longer term investment case. I'm sure Scott will continue to post on this subject since the economy's health is related closely to bank lending.
This is not for everyone. Many disagree with the basic premis, which is fine. Also, remember equities are RISK assets and thus are volatile.
"Nothing is out of control yet, of course, but if there has indeed been a real decline in the economy's demand for money, then this, coupled with increased business confidence, would point to a meaningful increase in nominal GDP growth in coming months. That nominal increase would likely be comprised of a pickup in inflation as well as a pickup in the pace of real growth."
ReplyDeleteA certain English teacher I know would say, "That nominal increase would likely comprise a pickup in inflation, as well as a pickup in the pace of real growth."
Comprise does not equal compose.
I would say the pickup will comprise a large amount of real growth, and a tad of inflation--and that inflation will be good for us.
BTW, I am involved in architecture and furnishings industries, and follow real estate closely in SoCal area. Pick-ups all around, matching closely Grannis' bottom chart. Something seemed to click about two months ago.
Dow up nearly 100 today. Rising equity prices, and slowing rising property values, should help Americans feel good again. I sense we have years of bull markets ahead of us.
Nothing in America is overvalued right now (well, maybe Lichtenstein and Warhol prints).
As John points out, equities are risky. But sometimes it is riskier to sit on the sidelines.
John,
ReplyDeleteJohn Hussman had the following commentary on banks today. He references dividends and bonuses but obviously the argument extends to reported earnings.
"As for the U.S. financial system - particularly major banks - I am continually perplexed by the juxtaposition of tens of millions of underwater mortgages and millions of delinquent and unforeclosed homes, coupled with a set of FASB accounting rules (revised at the height of the recent crisis) that allows these debts to be carried at face value upon the discretion of the banks that report the data. I'll say one thing - it should take less than two seconds of thought to recognize that allowing dividends, bonuses, and other withdrawals of capital - without the requirement that banks mark their assets to market - is quite literally how Ponzi schemes function. We've laid a lovely turf lawn over a toxic waste dump, and are all too willing to assume that the underlying issues have been solved. The FASB and the Fed have turned the U.S. banking system into the Love Canal."
http://hussman.net/wmc/wmc110124.htm
On the one hand, it’s been enlightening reading Hussmans recent self examination with respect to completely missing the gains since the market lows. It’s quite sophisticated crawfishing. So obviously his crystal ball is far from perfect. On the other hand – he’s got a point. The banks are so dependent on fed policy ( monetary policy, regulatory, and bailouts ) it seems very challenging to view them based on fundamentals like most other equities. Of course, nothings easy these days is it.
Randy,
ReplyDeleteThank you for your polite comments.
I have long been a respectful reader of Mr. Hussman's observations. While I usually do not agree with him, he is always thought provoking and makes his case well. Thank you for pointing out he has missed most of this rally. His style is his own and from what I can tell he will outperform in bear markets and underperform in bull markets. In my opinion we are in a bull market.
You are so right about it not being easy. I well remember the bull market of the ninties...every time I bought a risk asset I thought I was grossly overpaying. Bull markets characteristicly do not give you comfortatable entry points.
There are many many nonbelivers in the coming prosperous times for the financial industry. It tells me we are still early. Near the top everyone will be talking about their winning stocks and how they have split and split again.
Scott has an excellent post below on the steepness of the yield curve. This is a highly beneficial development for the banking industry and suggests growing incentives to increase lending. I believe increased lending and dividends are both catalysts to higher share prices. In my opinion both will be obvious by the end of the second quarter. There are many who see it coming...the financial sector has been the market's top performing sector since the end of November.
Having spent my career in the financial services industry I naturally follow it's prospects. I believe the coming credit cycle will be a prosperos one for investors who get in reasonably early and see it through. But as you say...the market will never make it easy.
Benj,
ReplyDeleteI am glad to hear your industry is doing better. It appears the Fed has succeeded in stabilizing the real estate markets in most areas. If, as Scott suggests in his post above, bank lending continues to improve, things will continue to get better. In his 2011 forcast he thinks GDP growth will likely exceed 4%. Lets hope he is correct.
John-
ReplyDeleteI always enjoy your commentary.
On one point I disagree with you, at the present time.
"Bull markets characteristicly do not give you comfortable entry points."
You are generally right, but I think now is a comfortable time, and we are in a bull market!
Nothing seems particularly overvalued to me right now (except perhaps gold). The equity multiples are normal, property values are subdued.
Oh sure, Dow at 7,000 was a better bet. Hindsight is 20/20. But earnings are almost assured to rise sharply in years ahead, now with recovery getting traction.
Best of luck to you in 2011--and 4 percent on GDP growth is easy. I hope Bernanke is targeting five percent.
seems were jumping up and down over a little bump off a bottom with fed induced hopium..
ReplyDeletebut it seems little new credit is being generated...credit score destruction decimated middle class...
http://www.federalreserve.gov/releases/h8/current/
fed induced inflation is a 25 year old home buyers worst nightmare, paying more for a propped up asset, ignoring rule of law and waiving fasb while allowing rampant fraud to keep bankers afloat is exactly what Jefferson warned about years ago..
The improvement in C&I loans is
ReplyDeletewelcome but we need to see positive
year over year improvement,,,,
As with many of your assertions the question remains, "...compared to what...?"
ReplyDeleteSure, when you look at just that one slice of the lending market it all looks great. C&I loans are not even 20% of the entire lending market.
ReplyDeleteWhen you look at the ENTIRE lending market it's still stagnant and most certainly NOT recovering.
http://research.stlouisfed.org/fred2/series/TOTLL
why not show the hourly graph for real drama. also, why not semi log?
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ReplyDelete"Throughout modern history, and in nearly every economic system, whether we are talking about China, the US, France, Brazil or any other country, there has really only been one meaningful way to resolve banking crises. Whenever non-performing loans or contingent liabilities surge to the point where the solvency of the banking system is threatened, the regulators ensure that wealth is transferred in sufficient amounts from the household sector to borrowers or banks to replenish bank capital and bring them back to solvency. The household sector, in other words, always pays to clean up the banks."
ReplyDelete