More on Household Deleveraging
(December 23, 2010)
Dear Subscribers and Readers,
There would be no “full-blown” commentary this weekend due to the Christmas Holidays. Instead, we will follow our yearly tradition of authoring the first of a two-part 2011 outlook on the global stock market, commodities, etc. In the meantime, I wish all our subscribers a great Christmas/Holiday and New Year's! I understand that 2010 was, shall we say, a “transition” year for most of us. Here's wishing a much smoother and enjoyable 2011!
The deleveraging in households rages on… While we don't know whether it's voluntary or forced (probably a bit of both), the fact of the matter is that U.S. households are saving more, spending less, and paying out less interest payments as a percentage of their disposable income. One area where U.S. household borrowing is evidently slow is U.S. bank lending. Following is a monthly chart showing the state of U.S. bank lending—i.e. the year-over-year change in loans and leases by held by U.S. commercial banks for the period January 1949 to December 2010 (updated to December 8, 2010):
While bank lending (in absolute terms) has steadied in the last 12 to 15 months, subscribers should note that the plunge in banking lending in 2009 is unprecedented. One would need to go back to the Great Depression to see similar stats (when one-third of all U.S. banks failed). Note that the dramatic decline in bank lending came after the disintegration of the “shadow banking system.” If the Federal Reserve and the U.S. Treasury had not provided support under its various liquidity facilities and its quantitative easing policies, there is no doubt that the U.S. and much of the developed world would have been in a second Great Depression. Note that while bank-lending growth has risen back to the zero line, we are not out of the woods yet. In other words, the U.S. banking system remains a little bit dysfunctional. In fact, the absolute amount of bank loans and leases outstanding (seasonally adjusted) has actually declined by $62 billion (to $6.77 trillion) from the end of August to December 8, 2010. The Christmas Holiday is usually a slow time for bank lending—so we would not get a better picture of the state of U.S. bank lending until the end of January, at the earliest.
The trend of deleveraging U.S. households could also be seen in the declining proportion of U.S. disposable income that is dedicated to debt payments. As mentioned before, I expect US households' balance sheets to continue its deleveraging process (as consumers adept to a more frugal lifestyle; as banks and credit card companies restrict lending; and finally has GDP growth normalizes early next year). I personally do not buy PIMCO's “New Normal” view of a ten-year deleveraging process, although U.S. economic growth could surprise on the low side as we seek to reduce the fiscal deficit. But the inevitability of Schumpeterian growth (as well as old-fashioned population growth) will no doubt allow U.S. economic growth to normalize again. The combination of this Schumpeterian growth and relatively clean U.S. household balance sheets will drive the next secular bull market in U.S. stocks. I expect the next secular bull market to begin sometime in the 2012 to 2015 timeframe. While the ongoing deleveraging wasn't clear in the 3Q 2010 Flow of Funds data, there is obvious evidence that U.S. households are saving and paying down their debts. This is clear in the most recent trends in US households' financial obligation ratios (ratios of debt payments to disposable incomes), as illustrated in the following chart:
The financial obligation ratio for all U.S. Households' is now at its lowest level since 1Q 1995! Note that one reason would be that many households simply stopped paying their debts. Regardless, it is difficult to reconcile these (flow) numbers with the (stock) numbers we showed in our 3Q 2010 Flow of Funds commentary (in that commentary, we note that the amount of U.S. household liabilities may be overstated). My guess is that the deleveraging in the broader US economy should continue—but at the same time, we have definitely finished the most painful adjustments. Going forward, I expect U.S. households to deleverage through a combination of higher disposable incomes (the unemployment rate has likely peaked), higher savings, and as lenders work through its backlogs of foreclosures and loan defaults (although I expect U.S. housing prices to remain in the doldrums for years to come). Furthermore, as U.S. households continue to pay down their debts and become more productive through technological innovation, “workforce re-education” and starting new businesses, we should experience an improvement in the long-term health of the U.S. economy and society.
Henry To, CFA, CAIA