“Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.” -Charles Mackay
I recently came to learn of the story of Ignaz Semmelweis, a mid-19th century Hungarian obstetrician who, while working in a Vienna hospital, observed a more than two times delta in the maternal mortality rates between two maternity clinics, one staffed by doctors and the other midwives. This deathly disparity was well known outside of the hospital, such that pregnant women would often get on their knees and beg not to be admitted to the first clinic.
Semmelweis suspected a connection between the then strange “childbed fever” and the morning autopsies conducted by him and his colleagues before delivering babies in the afternoon - absent washing their hands in between.
With germ theory having not yet been established, Semmelweis followed his suspicions and introduced simple handwashing with chlorinated lime solutions. The results were astounding—puerperal fever cases plummeted.
Semmelweis’ triumph went uncelebrated and was instead met by rejection and ridicule from the medical community. In 1865, four years after publishing his findings, Semmelweis suffered a nervous breakdown and was committed to an asylum by his colleagues where he died 14 days later from an infected wound.
Ironically, that same year marked a significant breakthrough: Joseph Lister successfully demonstrated the principle of antiseptic surgery in Glasgow, applying sterile techniques in a hospital. This marked the inception of the germ theory of disease, affirming Semmelweis’s findings.
In our line of work, there is a common saying: the market can stay irrational longer than one can stay solvent. Lately, it appears we should revise the ending of that saying to include "or sane.”
Having priced in nearly double the number of rate cuts given by the Fed’s forward guidance for 2024 (-140 bps vs. -75 bps), the market has declared the inflation problem solved and the glidepath to a goldilocks economy all but certain. Stuck in yesteryear’s paradigm of inflation, rates, and earnings multiple revaluation, risk assets have melted up in a crazed frenzy.
In the days of "transitory inflation," we faced a similar madness. If one were working at the Fed during this period and reported observations that contradicted the prevailing narrative, they may have very well gotten the asylum treatment. Unlike Dr. Semmelweis, however, we lived to feel the catharsis from our macro call to the contrary.
As we ride what my colleague Daryl Jones referred to as “the crazy train” in his Early Look yesterday, the importance of a data-driven, multi-asset, multi-duration investing and risk management process has never been greater.
Back to the Global Macro Grind…
Speaking of inflation, what is often lost in the discussion is the nature of inflation and its impact.
Inflation is a regressive tax, impacting households regardless of income, yet doing so with varying degrees of relative magnitude. That is, the left-tail or more vulnerable segments of households are disproportionately affected by this hidden tax, the effect of which is gradual and cumulative. As such, disinflation from record-high price levels offers little relief.
The inflation effect has manifested in the rocketing credit card delinquency rates of Capital One and Discover, two of the big card lenders with outsized exposure to lower-income and less creditworthy borrowers. From the latest numbers this week, it is readily apparent that we have overshot normalization and there doesn’t seem to be abatement in sight, notwithstanding the supportive labor backdrop.
Contending with the cumulative effect of 26 consecutive months of real earnings decay, households turned to credit lines in bridging the income gap. Unsurprisingly, revolving credit has reached an all-time high of 1.3 trillion. While some argue that revolving consumer credit as a share of disposable income is below pre-pandemic levels, the rate-of-change in these balances is what matters: credit card debt is currently growing at +9.3% y/y, far exceeding the 20-year average of 3.3%.
The cost of credit also matters; the average credit card APR of 22.77% is +34% or +6 pts above its pre-pandemic level. Accordingly, personal interest payments as a percentage of disposable income have risen to 2.8%, +70 bps above the pre-pandemic level and in-line with the levels in the leadup to the GFC. While it's true that personal income from interest-earning assets may serve as an offset for some, it is certainly not the case for most, particularly the left-tail of households.
Another significant factor contributing to the observed credit deterioration is the “catch-up” or “credit boomerang” effect. Historically, periods of credit underperformance are often succeeded by periods of outperformance and vice versa. The aftermath of the GFC exemplifies this phenomenon, with net charge-offs and bad credit being pulled forward and washed out by a severe economic downturn and leading to credit outperformance in its wake. We are currently experiencing the inverse of that reality: the pandemic acted as the mother of all bailouts for the most vulnerable of borrowers. Paradoxically, the worse off you were, the better off you became. Now, with pandemic-induced excesses having been eroded, this ever-present, most vulnerable segment of households is returning to economic reality.
There are people who say the worst of credit is behind us and, based on how some of the card lenders have performed recently, one may think that; however, the data, and the sanity it lends us, does not seem to be turning that way.
Immediate-term Risk Range™ Signal with @Hedgeye TREND signal in brackets
UST 30yr Yield 4.00-4.45% (bearish)
UST 10yr Yield 3.90-4.32% (bearish)
UST 2yr Yield 4.31-4.73% (bearish)
High Yield (HYG) 74.91-77.18 (neutral)
SPX 4 (bullish)
NASDAQ 14,207-14,850 (bullish)
RUT 1 (bearish)
Tech (XLK) 183-193 (bullish)
Energy (XLE) 79.92-85.28 (bearish)
Utilities (XLU) 62.61-66.46 (bullish)
Shanghai Comp 2 (bearish)
Nikkei 32,319-33,418 (bearish)
BSE Sensex (India) 68,108-71,105 (bullish)
DAX 16,302-16,951 (bullish)
VIX 11.89-15.10 (bearish)
USD 101.42-103.69 (bearish)
Oil (WTI) 67.40-74.61 (bearish)
Nat Gas 2.21-2.72 (bearish)
Gold 1 (bullish)
Copper 3.71-3.93 (bearish)
Silver 22.30-25.35 (bullish)
Uranium (URA) 28.24-29.92 (bullish)
Have a great day.
Drago Malesevic
Macro & Financials Analyst
