Hedgeye Guest Contributor | Thornton: My Scary Chart

Editor's NoteBelow is a Hedgeye Guest Contributor research note written by Dr. Daniel Thornton. During his 33-year career at the St. Louis Fed, Thornton served as vice president and economic advisor. He currently runs D.L. Thornton Economics, an economic research consultancy. 

 

A brief note on our contributor policy. While this column does not necessarily reflect the opinion of Hedgeye, suffice to say, more often than not we concur with our contributors. In the piece below, Thornton writes "I believe that some unforeseeable event will prick the bubble, perhaps this year. The result will be recession which will, unfortunately, be accompanied by more misguided monetary and fiscal policies."

 

Hedgeye Guest Contributor | Thornton: My Scary Chart - Bubble bear cartoon 09.26.2014  1

 

I published the graph below in a recent essay titled, Why the Fed’s Zero Interest Rate Policy Failed, but the graph deserves special attention because of what it seems to imply for the economy going forward. The graph shows household net worth (wealth) as a percent of personal disposable income. Household net worth as a percent of disposable income increased dramatically in the mid-1990s. Its collapse precipitated the 2000 recession. It increased even more dramatically during the subsequent expansion only to collapse again, precipitating the 2007 – 2009 recession.

 

Hedgeye Guest Contributor | Thornton: My Scary Chart - thornton1

 

Once again, household net worth has increased dramatically. Since the end of 2012 it has increasing by nearly 100 percentage points to 640% of disposable income. This is scary; not just because it is an incredibly large rise in wealth in a short period of time, but because it happened twice before with very bad consequences.

 

The first rise in household wealth ended because of the bursting of what is known as the Dot.com bubble. It is called the Dot.com bubble because the NASDAQ composite index rose dramatically in the mid-to-late 1990s only to fall even more dramatically beginning in 2000Q1. The graph below shows that the rise and fall of household net worth was accompanied by the rise and fall of the NASDAQ.

 

Hedgeye Guest Contributor | Thornton: My Scary Chart - thornton2

 

The NASDAQ and household net worth reached their respective peaks at exactly the same time, 2000Q1, after which they both fell precipitously. Household net worth recovered quickly during the expansion, but the NASDAQ didn’t. Indeed, the NASDAQ didn’t reach its 2000Q1 level again until 2014Q3. In contrast, household wealth as a percent of disposable income rose quickly, increasing by 125 percentage points from 2002Q3 to 2006Q4 before declining even more precipitously.

 

The large increase in household wealth was largely driven by an equally large and, as it turned out, unsustainable rise in house prices, as shown in the graph below. Not surprisingly, house prices and household net worth both peaked in 2006Q4.

 

Hedgeye Guest Contributor | Thornton: My Scary Chart - thornton3

 

By 2015Q1, household wealth had surpassed its 2006Q4 peak. This time the rise in wealth was fueled by both equity and house prices. The relevant question is: Is the 100 percentage point rise in household net worth sustainable, or will house and equity prices fall dramatically again?

 

The latter answer seems most likely. One reason is behavior of household net worth has been unusual since the mid-1990s. The graph below shows the level of household net worth over the period 1952Q1 to 2015Q4. The graph also shows a quadratic trend line estimated over the period 1952Q1 to 1994Q4 and extrapolated to 2015Q4.

 

 Hedgeye Guest Contributor | Thornton: My Scary Chart - thornton4

 

During the entire period from 1952Q1 to 1994Q4, household net worth tracks the trend line very closely. Since 1995Q1, however, household net worth has been consistently above the trend line and the gap has been getting progressively larger. Such behavior would be a concern in any circumstance, but it is particularly troubling because we know that the previous two boom cycles were followed by busts. The recent rise in household net worth has not been accompanied by a correspondingly large increase in output or the price level. Hence, it too does not appear to be supported by economic fundamentals—it appears to be unsustainable.

 

The Fed’s monetary policy has contributed to this problem. First, by keeping the federal funds rate below its own estimates of the normal or natural rate for much of this time and way below the normal rate for nearly a decade. The second, by unnecessarily purchasing a massive amount of government and mortgage-back securities, which Fed Chair Yellen and her colleagues are reluctant to sell. I don’t see the Fed doing anything different anytime soon.

 

I predict that the current level of household net worth is not sustainable. I believe that some unforeseeable event will prick the bubble, perhaps this year. The result will be recession which will, unfortunately, be accompanied by more misguided monetary and fiscal policies. I call this monetary and fiscal policy insanity: Keep doing the same thing and expect a different result! I would love to be wrong, but I doubt I will be.


Another French Revolution?

"Don't be complacent," writes Hedgeye Managing Director Neil Howe. "Tectonic shifts are underway in France. Is there the prospect of the new Sixth Republic? C'est vraiment possible."

read more

Cartoon of the Day: The Trend is Your Friend

"All of the key trending macro data suggests the U.S. economy is accelerating," Hedgeye CEO Keith McCullough says.

read more

A Sneak Peek At Hedgeye's 2017 GDP Estimates

Here's an inside look at our GDP estimates versus Wall Street consensus.

read more

Cartoon of the Day: Green Thumb

So far, 64 of 498 companies in the S&P 500 have reported aggregate sales and earnings growth of 6.1% and 16.8% respectively.

read more

Europe's Battles Against Apple, Google, Innovation & Jobs

"“I am very concerned the E.U. maintains a battle against the American giants while doing everything possible to sustain so-called national champions," writes economist Daniel Lacalle. "Attacking innovation doesn’t create jobs.”

read more

An Open Letter to Pandora Management...

"Please stop leaking information to the press," writes Hedgeye Internet & Media analyst Hesham Shaaban. "You are getting in your own way, and blowing up your shareholders in the process."

read more

A 'Toxic Cocktail' Brewing for A Best Idea Short

The first quarter earnings pre-announcement today is not the end of the story for Mednax (MD). Rising labor costs and slowing volume is a toxic cocktail...

read more

Energy Stocks: Time to Buy? Here's What You Need to Know

If you're heavily-invested in Energy stocks it's been a heck of a year. Energy is the worst-performing sector in the S&P 500 year-to-date and value investors are now hunting for bargains in the oil patch. Before you buy, here's what you need to know.

read more

McCullough: ‘My 1-Minute Summary of My Institutional Meetings in NYC Yesterday’

What are even some of the smartest investors in the world missing right now?

read more

Cartoon of the Day: Political Portfolio Positioning

Leave your politics out of your portfolio.

read more

Jim Rickards Answers the Hedgeye 21

Bestselling author Jim Rickards says if he could be any animal he’d be a T-Rex. He also loves bonds and hates equities. Check out all of his answers to the Hedgeye 21.

read more

Amazon's New 'Big Idea': Ignore It At Your Own Peril

"We all see another ‘big idea’ out of Amazon (or the press making one up) just about every day," writes Retail Sector Head Brian McGough. "But whatever you do, DON’T ignore this one!"

read more