“Shoot for the moon, even if you miss you’ll land among the stars.”
People say all kinds of dumb things.
I’m not excluding myself from that company but there’s probably a small country of people who will believe pretty much any pithy meme as long as it rhymes or contains alliteration or brandishes some glossy philosophical veneer.
How about that cutesy gem from above: Shoot for the moon, even if you miss you’ll land among the stars.
No you won’t.
The moon is 238,900 miles from earth. The nearest star is 4.3 light years away. That’s 25,000,000,000,000 miles away.
If you miss the moon you’ll waft adrift aimlessly in a sea of black, for eternity … or until you get impaled or decapitated by some rogue space debris.
Back to the Global Macro Grind…
One on again-off again notion that gets floated to us through the macro-scape is that credit trends are of diminishing importance in the present cycle given the broader deleveraging.
That, of course, is nonsense.
Keith touched on this in the Early Look yesterday, but I want to drill down on it further.
… and, fair warning, I’m gonna go for full contextualization cramjob this morning, so caffeine it if ya got it….
As we and others highlight recurrently, modern developed market Macroeconomies are inextricably financialized.
And as we remain on the wrong end of a multi-decade demographic and interest rate (i.e. leverage) cycle and have ~17X more obligations to pay dollars than there are actual dollars, credit remains as relevant as ever in its role as marginal driver of spending growth and catalytic engine for the cycle, in both directions.
So, as rational, objective observers, I think we can all agree to agree that credit matters, a lot.
Now, let me tell you why it probably doesn’t. At least over the nearer-term on the consumer side.
First, let’s get some simple durational context out of the way. For expositional convenience, we’ll divide the future into the short-term and longer-term.
- Short-term: Incomes are improving, growth is improving, and debt service ratio’s remain relatively low. Credit demand and credit availability are both pro-cyclical and that ‘improvement cocktail’ should allow consumers to continue to accelerate credit growth if they are so inclined.
- Longer-term: Collectively, Households, Corporates and Sovereigns are as levered as ever. The household sector certainly hasn’t delevered enough to start another ‘credit cycle’ and, critically, initial interest rate conditions and demographic trends are antithetical to those prevailing at the start of the 30Y cycle that began in 1981.
Now let’s re-remember what happened in the 5 quarter period from 1Q15 to 2Q16:
- GDP: GDP slowed progressively from 3.3% to 1.3% YoY.
- Employment Growth: Employment growth peaked in February 2015 and slowed progressively until January of this year.
- Income Growth: Aggregate Income Growth slowed alongside employment growth as the increase in wage growth was not enough to offset decelerating growth in aggregate hours.
- Consumption Growth: Consumption mirrored the trends above with household spending growth slowing.
- Profit recession: we had a multi-quarter profit recession
- Industrial Recession: we had an industrial recession with a host of ‘this-time-was-different’ dynamics as things like Industrial Production and Capital Goods saw their longest non-recession streaks of negative growth ever.
What happened to Credit:
- On a short lag to the dynamics above, the credit box began to constrict as banks began tightening credit first for C&I and CRE loans then for consumer auto and credit card loans.
Given the prevailing growth and profit conditions over that period, is it overly surprising that banks responded with tighter lending?
Which brings us to our point …. as your rhetorical “No” also implies the answer to that questions converse.
That is, would you be surprised to see some measure of pro-cyclical reacceleration in credit/credit conditions alongside accelerating growth, accelerating income and improving profits?
- GDP: GDP has accelerated from +1.3% to +1.9% over the last two quarters and we think that remains 2nd derivative positive over the nearer-term.
- Income Growth: The combination of underlying improvement and favorable comps suggest we see an (continued) acceleration in employment growth through May, at least. Alongside flat to higher wage growth, that translates into an acceleration in aggregate income growth and improved consumption capacity. The implications are twofold: 1.That backdrop supporting household spending growth will improve nearer-term and 2. Rising income growth would fill the gap left by any modest credit deceleration should it occur.
- Profits: 4Q marked the fastest pace of earnings growth since 2014 and base effects and #ReflationsPeak should drive continued acceleration in reported 1Q17 earnings.
- Credit Growth: The source of recent concern is the latest January data which showed Total Consumer Credit growth slowing to +2.8% MoM SAAR, representing the slowest pace of growth since AUG ’11. This, however, only represents a -19bps acceleration to +6.29% on a year-over-year basis and a continued Trend acceleration off the most recent 3Q16 trough. Similarly, revolving credit growth – which, arguably, is the better barometer of the state of domestic consumerism – has only decelerated for one month off the cycle peak.
Admittedly, there are some emergent cracks in the credit sphere:
- Subprime: subprime consumer loans are showing some early deterioration and rising rates will serve as increasing pressure. However, labor really needs to break down for problems here to propagate and modest deterioration doesn’t negate the positive sweep of improving growth and profits. I’ll touch more deeply on this topic in the next Early Look.
- Corporate Investment: capex has been underwhelming for a decade now and policy uncertainty may further disincentivize investment. Any near-term decline, however, probably represents deferred activity as capex plans have risen conspicuously, inventory investment remains solid and inventory-to-sales ratios remain in retreat.
Personally, I think the more recent concerns over credit represents a kind of angst transference.
In short, price momentum has slowed and investors are more acutely surveying the threat to the prevailing reflation narrative.
We’ve covered all of reflation’s factors before but macro markets are dynamic and globally interdependent, so let’s put it all back together in an integrated narrative package:
- Base Narrative: Out of the election optimism prevailed and the market reflexively re-priced growth and inflation expectations => cross-asset correlations went positive as Dollar Up, Rates Up, Stocks up predominated with reflation and policy levered exposures getting bid.
- Domestic Amplifier: the growth and inflation data domestically had already shown a fledgling, positive inflection. Continued acceleration across both factors confirmed and amplified the base narrative.
- OUS Amplifier: European political risk further supported the base narrative associated price action. Summarily, the factor flow looked like this:
- The odds of Le Pen winning the French election became the proxy for Eurozone risk => As Le Pen’s odds rose the Euro fell, German bonds got bid, US-German spreads widened, and the dollar rose.
In mid-February the dynamics above began to stall. In the context of those same factors:
The expedited repricing of the growth outlook drove crowded positioning in reflation exposures => the market began to price in Reflation’s Peak as we traversed trough energy comps in 1Q => Le Pen’s odds rolled over, the Euro got a relative bid, German yields moved up, US-German spreads tightened => Euro strength, improving yield differentials, and a “dovish hike” put some short-term pressure on the USD and US Treasuries ….
…. => Oil weakness and rising concern around the prospects for health reform (and its impact on the tax reform/fiscal stimulus timeline) add further angst around the base narrative.
And here we are.
And here’s where we stand:
- Reflation’s Peak: #ReflationsPeak was one of our 1Q17 Macro Themes. That momo in inflation expectations began to ebb and commodity related reflation exposures came under pressure as the market more thoroughly considered and priced in that reality wasn’t particularly surprising. It’s also why we haven’t not buying “Commodities” and/or their related equity exposures on down days.
- Growth: What was conspicuously absent from the “stalled” list above was the growth data, both domestically and globally. The preponderance of domestic macro data is 2nd derivative positive (and remember, that’s independent of any policy related impacts) and our outlook is for improving growth over 2017. Our Trend outlook is the source pool for most of our invested allocation and our highest conviction allocations. We get the push-pull of international developments (think EU dynamics above) and the decremented conviction around the reflation narrative but we continue to think the slope of growth and inflation will remain the predominate driver of Trend returns.
To close, we’ll get the Durable and Capital Goods Orders data for February this morning. Consensus is looking for +1.3% and +0.5% sequential growth, respectively.
By the math, we could actually get negative sequential growth and still realize an acceleration on a year-over-year basis. How’s that for margin of #GrowthAccelerating safety.
Our immediate-term Global Macro Risk Ranges are now:
UST 10yr Yield 2.38-2.65%
SPX 2
VIX 10.51-13.23
EUR/USD 1.05-1.08
YEN 110.58-115.31
Oil (WTI) 47.03-49.55
Gold 1190-1259
Copper 2.59-2.69
Have a great weekend,
Christian B. Drake
