Let me give you the Cliffs Notes version of how I think the next decade will play out, more or less, kinda sorta.
We already see the major developed economies beginning to slow and likely enter a global recession before the end of the year. That will drag the US into a recession soon after, unless the Federal Reserve quickly loosens policy enough to prolong the current growth cycle.
Other central banks will respond with lower rates and ever-larger rounds of quantitative easing. Let’s look again at a chart (courtesy of my friend Jim Bianco) that I showed three weeks ago, showing roughly $20 trillion of cumulative central bank balance sheets as of today. If I had told you back in 2006 this would happen by 2019 you would have first questioned my sanity, and then said “no way.” And even if it did happen, you would expect the economic world would be coming to an end. Well, it happened and the world is still here.
Before 2008, no one expected zero rates in the US, negative rates for $11 trillion worth of government bonds globally, negative rates out of the ECB and the Swiss National Bank, etc. Things like TARP, QE, and ZIRP were nowhere on the radar just months before they happened. Numerous times, markets closed on Friday only to open in a whole new world on Monday.
In the next crisis, central banks and governments, in an effort to be seen to be doing something, will again resort to heretofore unprecedented balance sheet expansions. And it will have less effect than they want. Those reserves will simply pile up on the balance sheets of commercial banks which will put them right back into reserves at their respective central banks.
Crescat was one of the best performing hedge fund of 2018 and although this year has started on a negative note , they clearly lay down their views and strategies for this tough market .
They write……The year-to-date rally in global risk assets after the Fed flip appears to us to be a last gasp of speculative mania for the current economic cycle.
In our view, three flawed narratives are driving late-cycle euphoria in financial markets today:
“Central banks can always prevent a downturn in financial markets and the business cycle”;
“US stocks valuations remain attractive”; and
“Chinese stimulus and a US-China trade deal will reignite growth in the second half of 2019.”
We believe that the first two storylines are simply wrong. We show why herein. Regarding the third, in our view, China is much more likely to tank the world economy over the next several quarters than rescue it given the historic credit imbalances there.
Central Banks Do Not Have Your Back
There has been a huge misconception that global central bank liquidity is what is driving stock prices up today. Our work shows that both global M2 money supply and central bank assets have been contracting on a year-over-year basis so far in 2019. That tells us liquidity has not been the driver of the market-top retest rally; hope has been.
But even when global QE returns, it is likely to be no saving grace. As shown above, starting in September 2006 led by China, global central banks increased their balance sheets by $3.9 trillion or more than 50% through March of 2009. This unprecedented level of money printing did not prevent the Global Financial Crisis. Rather it preceded and accompanied it.
Even the Fed’s QE1 which started in 2008 did not stop stocks from plunging; it only coincided with it as shown below.
The same goes for the Fed’s past changes in interest rate regimes from hiking to easing which are much more often bearish than bullish for stocks. As we show in the chart below, there were twelve times since 1954 (the history of the Fed Funds) that the US central bank paused its interest rate hiking cycle and then reversed it. Only three of those reversals ended in soft landings (1966, 1984, and 1995). In contrast, nine were associated with stock market downturns that led to recessions. We believe the three soft landings were possible because they occurred early in the business cycle, an average of only three years into the expansion. The Fed’s December 2018 hike followed by a pause, on the other hand, occurred a record 9 1/2 years into the economic expansion, beating the pause at the peak of the tech bubble by one quarter! Of the nine pauses associated with market downturns and recessions, the economic contraction began an average of just five months from the date of the last rate hike. That would be next month if this is the average delay! But we likely won’t know officially when the next recession begins, as typical, until months after it has started when prior-reported economic data gets revised downward.
It is also important to note that the stock market peak associated with the nine recessions occurred an average of two months before the last Fed rate hike. The September 2018 market peak, therefore which we are re-testing though still shy of, could still be relevant; it was three months before the Fed’s last hike. Even if the market pushes marginally higher here, it will still be very likely that we are near a top based on Crescat’s work.
It is also important to note that none of the historical corrections and bear markets that surrounded late-cycle Fed rate reversals bottomed until after the economy entered the recession. It seems highly prudent therefore to wait until the next inevitable recession which could be right around the corner before buying stocks today.
Another good macro timing signal for the peak of the stock market and business cycle is when the credit markets start pricing in Fed rate-cuts late in the expansion. That has never been a bullish sign. As shown in the chart below, every prior time the 2-year yield started to fall after re-testing a multi-decade resistance line going back to 1980, a major bear market and recession followed. Will this time be any different?
Precious Metals
The recent drop in nominal rates is also causing a drop in real yields. Below we show a multi-year breakout of the 5-year TIPS, inverted, which reflects the real interest rate. Real rates have followed gold prices remarkably closely for years. If this pattern holds, even if inflation expectations remain muted, the decline in nominal rates should be positive for gold, especially at today’s historically low valuation relative to the global fiat monetary base.
It’s stunning to us how historically depressed the valuation for gold’s high-beta, safe-haven cousin, silver, is this late in the cycle. One interesting way to see this is by comparing silver’s performance relative to a broad US stock index. Below, we show Russell 3000-to-silver ratio near record levels. It formed what appears to be a double top after retesting tech-bubble-peak levels last year.
Global Yield Curve Inversion
As we noted before, today we have an unprecedented amount of economies with 30-year yields lower than LIBOR overnight rates. Spain just joined the pack recently and we now have fourteen economies showing this negative spread. For us, it reiterates Crescat’s global yield curve inversion thesis, which is negative for global stocks and positive for future inflows into US dollars, and US Treasuries by extension as haven assets in a global financial crisis. The fact is, US yields across the entire curve today are attractively high compared to many global developed market alternatives.
When financial crises have unfolded in the past, US rates have tended to converge with global rates. Therefore, we expect many of these yield spreads to narrow significantly as the global economic cycle turns down.
US Treasury vs. German Bund Spread
US vs. German 5-year yield spread just broke down from a multi-year support line! Previous breakdowns timed the market top in 2000 & 2007. It’s another critical macro timing indicator.
The US-German 5-year yield spread breakdown is possibly leading a big move that is likely to happen on 10-year spread. In our global macro hedge fund, we are long US 10-year Treasuries and short 10-year German Bunds to play the likely breakdown and narrowing of that spread as shown in the chart below. The legendary former bond king, Bill Gross, was too early in this trade. It got away from him, but it was still a good idea. The trade is now lining up with so many of our other macro timing indicators that we believe the spread is finally getting ready to converge. A classic head-and-shoulders pattern meanwhile appears to have formed over the last year, a bearish technical set up.
US Yield Curve Inversions
Below is our comprehensive way of measuring inversions in the US yield curve. This model calculates all possible 44 spreads across US rates, and the percentage is now close to 50%, just as high as it was at the peak of the tech and housing bubbles. Historically, these elevated levels of inversions tend to be great times to own precious metals and sell US stocks.
US Equity Valuations Near Record Highs
The recent surge in stocks has pushed valuations back near all-time highs. Below, we show that the total US market cap-to-GDP ratio reached its highest ever last September at almost 150% prior to the 4th quarter market meltdown. This measure is close to re-testing its highs again today! The first panel of the chart below illustrates how the total US equity market capitalization tends to fluctuate above and below GDP across economic cycles. A multiple of one time GDP tends to be the median valuation over time. But valuations rarely stop at the median during bull and bear market cycles. They have become more stretched than ever relative to GDP in the current business cycle. In the second panel, we can clearly see that valuations in this cycle went even higher than in the tech bubble.
Total market cap to GDP is just one example of US stock market valuations at historic extremes. Crescat’s models show that record valuations were hit on September 2018 across most valuation measures. We are just shy of re-testing them today:
Crescat Macro Model
Crescat’s macro model combines sixteen factors across key fundamental, economic, and technical indicators to time the stock market and business cycle. After the year-to-date rally, the model is just two percentage points from record overvalued and record late-cycle levels! The yellow line below shows a back test of our model score going back to 1987. The model did extremely well at timing the tops and bottoms of the last two US stock market and business cycles. This time, the S&P 500 briefly entered overvalued/late-cycle levels in September of 2015 and was followed by a meltdown in China and emerging markets that Crescat capitalized on in 2015. A pause in 2016 in Fed interest rate hikes gave emerging and developed markets a new lease to extend the global business cycle. As hikes resumed in 2017, the market and our macro model score only surged to new highs. In September 2018, we reached what we believe were and still are truly mania levels.
We strongly believe US stocks are overdue for a bear market and the time of reckoning is near. The bear market started to unfold in the fourth quarter of last year in our view. But now we are close to retesting the September highs. Based on Crescat’s macro model score, and a myriad of other indicators, there is a strong probability that this rally will fail and that the bear market will resume.
It’s interesting to us how surging US stocks are in complete disconnect with the deteriorating fundamental outlook. Earnings estimates for 2019 in fact have been plunging all year while diverging significantly from sharply rising equity prices. This is not a positive set-up for stocks as we start the Q1 earnings season.
Sentiment Indicators
The recent stock market rally has remarkably similar fingerprints to the January 2018 and September 2018 speculative tops as shown by the two charts below courtesy of Jason Goepfert at sentimenTrader.com.
Jason’s smart versus dumb money indicators incorporate OEX put/call and open interest ratios, commercial hedger positions in equity index futures, and the current relationship between stocks and bonds. The smart-money indicator is currently near its lows while the dumb money one is near its highs. A similar wide spread between these two indicators preceded the market’s two steep selloffs last year.
SentimenTrader also tracks 60+ market indicators and tallies the percentage of them showing extreme optimism versus extreme pessimism. As shown in the chart below, 44% of these indicators are registering extreme optimism levels in equity markets today. Conversely, only 2% of these indicators are showing significant levels of pessimism. Similar to the smart vs. dumb money spread, such divergences performed extremely well at identifying the last two interim market tops.
Record bullishness sentiment rarely ends well for longs. Neither does extreme divergences between speculative longs and professional hedgers who are short.
Certainly, indicators like these in hindsight could have helped us see how temporarily oversold the markets were in late December to better manage the recent counter attack from the bulls. While we have stayed grounded primarily in our macro and fundamental research, and that will not change, sentiment indicators can help on the margin. We hope they will help others to can see why timing for many of our tactically bearish macro views could be ripe.
The chart below shows a third sentiment indicator we found that looks incredibly frothy today, VIX speculation at an extreme. Speculative futures traders are more net short stock market volatility than they were at the September market peak.
China More Likely to Tank than Rescue the Global Economy
We think those looking for China growth resurgence or trade deal to materially extend the stock market and business cycle are sorely mistaken. We have written extensively about China’s 400% growth in banking assets since 2008, likely creating the largest credit bubble and overvalued currency in modern financial history. Based on this unsustainable rate of credit expansion, China was responsible for over 60% of global GDP growth since the global financial crisis. The country’s massive investment in non-productive infrastructure assets was financed on credit and created high GDP growth but failed to add to the wealth or debt-servicing capacity of the country. As a result, China appears to us to be a financial crisis waiting to unfold.
State-directed misallocation of capital has compromised the savings of Chinese citizens. In other words, there is an enormous non-performing loan problem that we believe renders China’s banks insolvent. The country’s citizens, the banks’ creditors, are the ones holding the bag. When the Chinese economy inevitably implodes under its bad debt, the government will be forced to print money to recapitalize its banks and bail out its citizens to avoid social unrest. This massive money printing will almost certainly lead to a currency crisis.
The Trump administration’s hardball on trade is just one of many catalysts for the bursting of the China credit bubble. Whether there is a trade agreement or an ongoing trade war, either one would lead to a continued decline in China’s current account balance which should exert downward pressure on its currency. We think China’s increasing fiscal deficit due to the recent stimulus will also exert new downward pressure on the currency.
While the US administration may continue to hype an impending trade deal as hope for financial markets, we believe trade talks have dragged on for too long already to not have wreaked havoc on global supply chains and economic growth for the rest of the year. As the light continues to get shined on China, it should become clear that nothing beyond a token trade deal is likely to ever be reached. It is much more likely that the ongoing trade negotiations will only continue to serve to awaken the US government and its citizen voters to the egregious extent of China’s malfeasance.
China’s cyber hacking, intellectual property theft, and forced technology transfer are likely to be impossible roadblocks to arriving at any meaningful and enforceable trade deal. The U.S. Trade Representative reports make it clear that China has failed to live up to its commitments to open its markets to fair trade ever since it was permitted to join the WTO in 2001. China’s state-directed economic policies are simply incompatible with an international trade system based on open, market-oriented policies and rooted in the principles of nondiscrimination, market access, reciprocity, fairness and transparency.
With election season upon us in the US, the nature of our country’s engagement with China should once again become a major campaign issue. Taking a strong stance against China’s trade and human rights transgressions would likely have broad, bi-partisan voter support. Democracy, liberty, and justice are the foundation that has made the US a true world economic superpower. Contrast that with China’s authoritarianism, suppression, and corruption. Sure, there may be some corruption in democratic, advanced economies too. But we believe it pales compared to China.
In our view, the trade talks are closer to morphing into a new cold war than to being resolved by a substantial trade pact. Meanwhile, much like downfall of other totalitarian communist economies, we believe both internal and foreign capital is likely to continue fleeing the country, exerting downward pressure on its currency, economy, and banks. We continue to have a negative view on both the Chinese yuan and Hong Kong dollar that we are expressing in our global macro fund through put options on these currencies. We also are short richly-valued, US-listed “China-hustle” stocks in both hedge funds.
Crescat Remains Steadfast in our Views and Positioning
Today, with historic US equity valuations, record credit bubbles globally, and longest US economic expansion cycle ever likely to soon come to an end based on our models, we remain steadfast in our net short US and global equities position in our hedge funds. We are also short subprime credit in our global macro fund. We remain long precious metals and precious metals mining stocks across all our strategies.
There is indeed a US business cycle as well as a global economic cycle. We believe both are ripe for a downturn. We intend to capitalize on it like we did in the fourth quarter of last year which should be only the beginning. Like last year, we are having what we think is only a temporary pullback as the US stock market retests its all-time highs. Like last year, we believe global financial markets are poised for a major downturn. Staying grounded in our models, themes, and positioning was key to our strong year in 2018. Such grounding we believe will be key to generating strong performance again in the coming months and quarters.
We will continue to follow our model signals and risk controls, but we aim to stay net short global equities and subprime credit until the next global economic downturn has been widely acknowledged and stock values are once again cheap before we get significantly net long again.
As macro managers with a strong value bias, we remain confident that the underlying intrinsic value of Crescat’s portfolios at any time are worth substantially more than the market is quoting them (longs worth more and shorts worth less) or we would not be in those positions. This grounding gives us the fortitude to withstand a moderate amount of market volatility and persevere for long-term high absolute and risk-adjusted returns compared to our benchmarks as we have been able to deliver historically and expect to in the future. We think the financial markets are presenting an incredible setup for Crescat’s strategies today
Brett writes…In the end, central banks can keep pumping liquidity and suppress interest rates to make markets appear risk free, but the harsh reality will set in sooner than later. It’s not a question of if, it’s a question of when will this market collapse. On top of this you have an ever going issue of pensions, endowments, and the general public loaded up on stocks more so than ever due to yield chasing which is a by product of the low and negative interest rates we’ve seen the past decade. Combine that with the largest generation of American’s in the process of retiring or nearing retirement, baby boomers, and you have your recipe for disaster. Price discovery is broken and this will cause for a violent selloff once things begin to tumble. The fundamentals are much worse now in April 2019 than they were in the beginning of October 2018. The IMF continues to cut global growth forecasts and with geopolitical risk rising, we are likely to see market shocks. France is a perfect example, where production has slowed down heavily due to over five months of “yellow vest” protests. We will soon see how the last decade really wasn’t a recovery and when shit hits the proverbial fan it will be more apparent than ever, especially when 69% of Americans have less than $1,000 in total savings
Amazon today remains a small player in global retail. We represent a low single-digit percentage of the retail market, and there are much larger retailers in every country where we operate. And that’s largely because nearly 90% of retail remains offline, in brick and mortar stores. For many years, we considered how we might serve customers in physical stores, but felt we needed first to invent something that would really delight customers in that environment. With Amazon Go, we had a clear vision. Get rid of the worst thing about physical retail: checkout lines. No one likes to wait in line. Instead, we imagined a store where you could walk in, pick up what you wanted, and leave.
Getting there was hard. Technically hard. It required the efforts of hundreds of smart, dedicated computer scientists and engineers around the world. We had to design and build our own proprietary cameras and shelves and invent new computer vision algorithms, including the ability to stitch together imagery from hundreds of cooperating cameras. And we had to do it in a way where the technology worked so well that it simply receded into the background, invisible. The reward has been the response from customers, who’ve described the experience of shopping at Amazon Go as “magical.” We now have 10 stores in Chicago, San Francisco, and Seattle, and are excited about the future.
Failure needs to scale too
As a company grows, everything needs to scale, including the size of your failed experiments. If the size of your failures isn’t growing, you’re not going to be inventing at a size that can actually move the needle. Amazon will be experimenting at the right scale for a company of our size if we occasionally have multibillion-dollar failures. Of course, we won’t undertake such experiments cavalierly. We will work hard to make them good bets, but not all good bets will ultimately pay out. This kind of large-scale risk taking is part of the service we as a large company can provide to our customers and to society. The good news for shareowners is that a single big winning bet can more than cover the cost of many losers.
Development of the Fire phone and Echo was started around the same time. While the Fire phone was a failure, we were able to take our learnings (as well as the developers) and accelerate our efforts building Echo and Alexa. The vision for Echo and Alexa was inspired by the Star Trek computer. The idea also had origins in two other arenas where we’d been building and wandering for years: machine learning and the cloud. From Amazon’s early days, machine learning was an essential part of our product recommendations, and AWS gave us a front row seat to the capabilities of the cloud. After many years of development, Echo debuted in 2014, powered by Alexa, who lives in the AWS cloud.
No customer was asking for Echo. This was definitely us wandering. Market research doesn’t help. If you had gone to a customer in 2013 and said “Would you like a black, always-on cylinder in your kitchen about the size of a Pringles can that you can talk to and ask questions, that also turns on your lights and plays music?” I guarantee you they’d have looked at you strangely and said “No, thank you.”
Since that first-generation Echo, customers have purchased more than 100 million Alexa-enabled devices. Last year, we improved Alexa’s ability to understand requests and answer questions by more than 20%, while adding billions of facts to make Alexa more knowledgeable than ever. Developers doubled the number of Alexa skills to over 80,000, and customers spoke to Alexa tens of billions more times in 2018 compared to 2017. The number of devices with Alexa built-in more than doubled in 2018. There are now more than 150 different products available with Alexa built-in, from headphones and PCs to cars and smart home devices. Much more to come!
SRSROCCO writes in their blog…”So, after the Middle East spent hundreds of billions on capital expenditures to increase its oil production by nearly 8 mbd, its citizens consumed more than half of that amount. Thus, the increase in Middle East net oil exports since 2000 was only 3.7 mbd.“
Now, if we look over a more extended period, the results are even worse. According to the data in BP’s 2018 Statistical Review, Middle East oil consumption surged to 9.3 mbd in 2017 from 1.3 mbd in 1975:
The tale from some of the most cyclical and predictive economic indicators are telling investors two very different things at the moment. Copper, the metal with a PhD in economics is giving us the all-clear sign while lumber, which is perhaps only regarded as having a master’s or bachelor’s in economics, is saying, “be careful.”
Both indicators can’t be right, so which is actually the most useful in telegraphing economic activity? From my perspective, it’s lumber, despite its rather lesser educational attainment. The reasoning is simple. Lumber has a leading relationship with leading indicators of economic activity while copper has a coincident relationship with leading indicators of growth. Yes, you read that right: lumber prices are a leading indicator of a leading indicator, and the data bears it out.
Philip Grant writes for Almost Daily Grant observer….
Some eye-catching credit data out of the People’s Bank of China today: Total credit grew by a record RMB 2.8 trillion ($420 billion) in March, far above the RMB 1.85 trillion consensus estimate. During the first quarter, total new financing ballooned to RMB 8.2 trillion, up 40% from a year ago and equivalent to 9% of China’s reported 2018 GDP. Extrapolated to a full year, the credit expansion is just behind the 40% jump in total financing as a percentage of GDP seen in the massive stimulus year of 2009. That liquidity surge coincides with a “recovery extending across both sectors and geographies, with every major sector and each one of our regions showing better revenue results than Q4,” according to the China Beige Book. Beyond opening the credit spigots, Beijing is trying to stoke economic growth in other ways. Last week, Xinhua’s Economic Information Daily reported that policymakers are crafting tax cuts and other fiscal policies to help spur consumption. In addition, the National Development and Reform Commission announced Monday that small and midsize cities (populations of between one and five million) will relax hukou, or household registrations, in a bid to boost real estate markets. Regulators have also targeted the stock market. Bloomberg reports that nearly 700 firms bought back stock between December and January after authorities relaxed rules around the practice, up from 609 corporate buybacks in 2018 through early November. Mark Huang, analyst at Bright Smart Securities, explained to Bloomberg that: “China is looking to developed markets like the U.S., where buybacks are a key approach to sustaining a long-term bull market.” Those exertions are bearing fruit, if asset prices are any guide. Thus, China’s Shanghai Composite Index has ripped higher by 28% year-to-date, while contracted project sales from an index of nine property developers jumped 20% in March, according to data from Bloomberg. That follows a 9.4% year-over-year advance in February property investment according to the National Bureau of Statistics, the hottest reading since 2014. But the stimulus barrage has yet to translate into much acceleration in the money supply (M2 grew at 8.6% year-over-year, up from 8.3% average growth in 2018 but far below the 16% average since March 1996), nor improve the balance sheets of China’s debt-soaked corporations. S&P Global Ratings cut its assessment of 13 companies in the first quarter, the highest level of downgrades since 2016, with analyst Cindy Huang noting that “despite a slew of easing measures from the policy makers, small private firms still lack sufficient liquidity.” Peer Fitch Ratings has issued 30 corporate downgrades year-to-date, compared to just five upgrades. That follows a jump in yuan-denominated debt defaults to RMB 119.6 billion last year according to Singapore-based DBS Bank, four times 2017’s level. With RMB 2 trillion of bad debt sitting on Chinese bank balance sheets according to research from UBS Group A.G., things are likely to get worse before they get better. A survey of 202 bankers conducted by China Orient Asset Management Co. finds that 83% of respondents believe that bad loans will increase in 2020.
Why that disconnect between free flowing liquidity and rising corporate distress? Zhu Min, head of Tsinghua University’s National Institute of Financial Research and former deputy governor of the PBoC, told Caixin that while a decade of easy money has goosed financial markets, stimulus has not helped larger banks adequately lend to smaller companies which need liquidity and can often offer little collateral. Zhu asks: “How can financial institutions lend money to small-to-micro companies if all of their money has been invested in the stock market?”
Jim Grant writes in Grant Daily…“U.S. hedge funds from time to time have appeared in this country over the last 10 years, with the same hypothesis of shorting Canadian banks, and it hasn’t worked out very well for them,” Brian Porter, CEO of the Bank of Nova Scotia, said yesterday. “There are always going to be those that take an opposing view, and we’ll prove them wrong over the long term.”
Gabriel Dechaine, banking analyst at the National Bank of Canada,
likewise came to his industry’s defense in a note today: “A trend that is
making us believe that sector sentiment is becoming too bearish is the
re-emergence of a vocal ‘short Canada’ investment crowd.” Dechaine writes that
a Stanley Cup victory for the woebegone Toronto Maple Leafs (last title, 1967)
is more likely than a jump in loan losses.
One well-known investor is publicly taking the challenge: Steve
Eisman, portfolio manager at Neuberger Berman and a protagonist in Michael
Lewis’ The Big Short. “Canada has not had a credit cycle in a few decades and I
don’t think there’s a Canadian bank CEO that knows what a credit cycle really
looks like,” Eisman, who is short various Canadian banks and mortgage lenders,
fired back in an interview yesterday with BNN Bloomberg television. “I
just think psychologically they’re extremely ill prepared.”
While Canadian bank advocates and their skeptics exchange words,
the formerly-white hot housing market is now in deep freeze. March sales in
Vancouver collapsed by 31.4% year-over-year according to the local real estate
board, the worst showing since 1986 and down 46% from the 10-year average for
March. Prices also lurched lower, with the benchmark detached home price
falling 10.5% year-over-year to C$1.44 million ($1.08 million). Things are more
stable in Toronto, where March sales and benchmark prices were little changed
from a year earlier, but those figures remain 40% and 14% below their
respective levels from March 2017.
As the housing market sputters, the highly-leveraged Canadian
consumer displays increasing signs of distress. According to the Bank for
International Settlements, Canada’s household debt stands at 100.2% of GDP as
of the end of September, by far the highest ratio among G7 economies (the U.K.
is next at 86.5%), while the debt service ratio, or the percentage of
disposable income allocated to principal and interest payments, rose to 14.9% in
the fourth quarter per Statistics Canada, just shy of the 2007 peak.
That debt burden is starting to weigh on consumers. Auto loan
delinquencies rose to 0.97% at year-end according to Equifax, Inc., the highest
since 2009. At the same time, 36% of new auto loans in the fourth quarter were
leases, the largest such share since 2007. Bill Johnston, vice president
of data and analytics at Equifax Canada Co., noted that “we’re starting to see
consumer behavior shift to keep the payments as low as possible.”
On the credit card front, delinquencies of at least 90 days remained
at a relatively low 0.79% as of February, down from 0.88% in the same month
last year according to data from Bloomberg. But, as noted by the Royal Bank
of Canada, consumers cut their average monthly payment to just 38% of
outstanding balances in February, down from 50% in October and the lowest such
ratio since 2015. RBC credit analyst Vivek Selot commented:
That deterioration in payment rates may be attributed to some
stress on the consumer. Considering that fragile household balance sheets could
be a precipitating factor for the credit cycle to turn, any signs of consumer
credit quality deterioration seem worthy of attention.
Indeed, the Office of the Superintendent of Bankruptcy reports
that consumer insolvencies rose 5.4% year-over-year in February, bringing the
rolling three-month average to its highest level since 2011.
The slowing housing market and increased consumer stress has taken
a toll on one of the banks’ primary profit centers. According to the Bank of
Canada, residential mortgage growth registered at 3.2% year-over-year in
February, the lowest reading since 2001 and barely half of the 6% monthly
average logged since the housing boom gathered steam in 2009. Back in
March, Edward Jones & Co. investment strategist Craig Fehr noted to
Bloomberg that mortgages frequently represent “the largest and most profitable
and steady of the businesses that these banks operate.” Fehr concluded: “The
bread and butter of profitability for Canadian banks – is going to have a
little less butter on the bread.” Meanwhile, expectations remain high, with a
2019 analyst consensus of 15.7% return on equity for the S&P/TSX Bank
Index, up from 14.2% last year and a five year average of 15%.
For those unfazed by CEO taunts and eager to investigate the bearish
case for Canada’s lenders, an analysis in the Feb. 9, 2018 edition of Grant’s
Interest Rate Observer identifies one bank that stands out from the
rest.
The amount of bonds in the lowest investment-grade category (BBB, red in the chart below) has ballooned by 262%, from $820 billion to $3.0 trillion.
But the amount of higher- and highest-rated bonds (categories A, AA, and AAA, green and blue in the chart below) has increased “only” 147% – though that’s a huge increase too – from $842 billion to $2.1 trillion.
The US savings rate is
rising and China’s foreign exchange reserves are not. For some these will seem
to be irrelevant facts in a world where the focus is on the seemingly more
urgent issue of growth. For this analyst the rise in the US savings rate and the
only moderate growth in China’s foreign reserves are much more important. Their
importance resides in the fact that they point to the growing impotency of
monetary policy at a time of weak growth.
Investors have, like Pavlov’s dogs, begun salivating as they see the global growth slowdown as the ringing of the bell that signals monetary rewards for asset owners. This bell has been wrung many times since 2009 and the monetary meat that followed has provided a sumptuous feast – at least for those who own assets. Such meat has been in ample supply now for over a decade. But now it is being delivered when the condition of China’s external accounts is dictating tighter, not easier monetary policy to the world’s second largest economy, and when the citizens of the US have decided to save more. These are profound changes which will mean, given that the world’s debt-to-GDP ratio has risen steadily in the past decade, that the next time the central bankers act, it may be merely the ringing of the bell and disappointment that follows.
