Wednesday, June 25, 2014

The end of deleveraging: update

In a post three months ago, "The end of deleveraging," I noted signs that households' risk pendulum had stopped swinging in the direction of risk-aversion, and that the public was beginning to embrace risk rather than shun it. That had important implications for monetary policy, since the underlying rationale for QE, which in essence amounts to the "transmogrification" of bonds into T-bill substitutes, was to satisfy the world's seemingly unlimited demand for safe, short-term assets. If risk-aversion is on the decline and risk-taking is on the rise, there is no need for the Fed to continue QE. I think this explains why the Fed has been able to taper QE without there being any adverse effects on the economy or the markets. We don't need QE any longer, and the Fed is acting appropriately. 

The Fed has recently released pertinent data from the first quarter of this year which reinforces this view. What follows are some updated charts and commentary.

As the chart above shows, households' financial obligations (i.e., debt payments as a % of disposable income) reached a high in 2008, but have since declined significantly. Importantly, financial burdens are essentially unchanged in the past year. This means households have rebuilt their balance sheets and restructured their finances to the point where they no longer need to tighten their financial belts. Financial burdens today are as low as they have been at any time in the past three decades, and they are unlikely to decline meaningfully going forward. This is a very healthy development and it justifies the Fed's ongoing tapering of QE.

As the chart above shows, households' overall leverage (liabilities as a % of total assets) has declined significantly—by almost 30%—since hitting an all-time high in early 2009. Leverage is now back to levels that prevailed through much of the 1990s. All of the excessive speculation that helped fuel the housing boom in the 2000s has been reversed. This is also a very healthy development that is ongoing: household liabilities are no longer declining, but the value of households' financial and real estate assets are rising. This is healthy deleveraging, not risk-averse deleveraging.

As the chart above shows, as of Q1/14 the delinquency rates on consumer loans had fallen to its lowest level in decades. Consumers haven't been so careful with their finances for a very long time.

Gold prices, shown in the first of two charts above, have been relatively unchanged for the past year, even as tensions in the Mideast have risen. As the second chart shows, real yields on 5-yr TIPS have also been relatively unchanged for the past year. Both of these developments reflect a decline in risk aversion.

Capital goods orders—a proxy for business investment—were relatively flat for most of the past year, but in recent months (the most recent data, released today, cover May) have begun to rise. This is a good sign that corporations are shedding some of their risk aversion and are beginning to be more optimistic about the future.

PE ratios have been rising for several years, and are now above their long-term average, a good sign that risk-taking is beginning to come back into fashion. This is likely to continue, given all the other signs of the risk-pendulum swinging in a favorable direction, which means that there is still plenty of room on the upside for the stock market.

I should note that all of these changes are moving at a somewhat glacial pace—nothing dramatic is happening on the margin. It's all part of a slow but relatively steady improvement in the economy that is likely to persist until Congress adopts more growth-friendly policies. 


William said...

James Paulson: Initial Unemployment Claims Take on a New Interpretation!?!

William McKibbin said...
This comment has been removed by the author.
D Brown said...

As I recall, as of a year or so ago, much of the "debt reduction" was actually bank writeoffs of uncollectible debt. Since these loans should never had been made in the first place it is doubtful if lower interest rates, QE etc are going to be able to recreate them. It is true that increased asset prices do improve the denominator of debt to assets. However, like bad debt writeoffs, this primarily effects a segment of the population. In other words the lower income people do not yet have access to lending (and probably shouldn't in a mathematical sense) but the asset rich have improved access but less nead. The latter is especially true if you consider the other pending demands on their money (i.e. tax increases, student debt etc.

theyenguy said...

The bond vigilantes, have tenaciously yielded the Bow of Economic Sovereignty, that is the Interest Rate on the US Ten Year Note, ^TNX, calling it higher from 2.49%, to its close at 2.53%.

Floating Rate Note, FLOT, traded lower, suggesting that there be no more risk free money. And Junk Bonds, JNK, traded lower, confirming that Pursuit of Yield Investing is history. Demand for risk assets, that came via money manager capitalism, is being relegated to the dustbin of history.

With the see saw destruction of fiat wealth underway, that is with World Stocks, ACWX, Nation Investment, EFA, and Global Financial Institutions, IXG, underway, and Credit Investments, AGG, moving to a double top high, global economic deflation will get seriously underway as investors derisk out of Debt Trade Investments, and deleverage out of Currency Carry Trade Investments.

The bond vigilantes will have a hay day, together with the currency traders, in effecting coup d etats world wide, resulting in steepening the 10 30 US Sovereign Debt Yield Curve, $TNX:$TYX, and in driving the Benchmark Interest Rate, ^TNX, ever higher, sparking a dramatic rise in inflation, and in birthing the new normal government of regional fascism, replacing all current forms of government such as Crony Capitalism, European Socialism, Greek Socialism, Chinese Communism, where the investor is replaced by the debt serf.

Benson te writes Stocks Continues On With Record Run. Record stocks in the face of contracting economy, so what’s the connection? Who says stocks are about the economy? Aside from retail investors driving record stocks, and the just off the record in margin debt, a bigger factor has been corporate buybacks.

Sigmund Holmes notes According to Reuters, 1st quarter share weighted earnings amounted to $258.8 billion. So companies in the S&P 500 spent 93% of their earnings on buybacks and dividends. It’s been all the rage in this cycle to look at “shareholder yield” which is a combination of buybacks and dividends, something I find too clever by half considering the past track record of management led buybacks. But if you think that is a useful metric, you have to ask yourself, is a 93% payout ratio sustainable? I guess we do have the answer to one question though. We know why capital spending has been so punk.
The rising price of Gold, GLD, reflects risk avoidance, and communicates a investment demand for safe assets has commenced. Wealth can only be preserved by dollar cost averaging into the physical possession of gold bullion.