Consumer
Credit Conundrum
Worries
about a "hard landing" in China have been in the headlines for
months. Last week's (July 9 – 16) batch of Chinese economic data for June 2012
may help to ease those concerns, at least for now. Consistent with our
long-held forecast, China's gross domestic product (GDP) report for the second
quarter of 2012 points to a soft landing, not a hard landing for the Chinese
economy. On an inflation-adjusted basis, China's economy grew 7.6% between Q2
2011 and Q2 2012. The reading represented a deceleration from the 8.1%
year-over-year reading in Q1 2012, and it was also slightly below published
expectations.
However,
the report was inside the range of forecasts (+7.3% to +9.3%) and was far above
the "whisper number" that had been circulating in the market. The
question now for markets is: does the Q2 GDP report in China represent the low
point for the year, and will policy stimulus lead to a re-acceleration of
growth over the second half of 2012?
China Transitioning to Consumer-Oriented Economy
China's
economy, as measured by real GDP, grew by more than 10% per year between 2002
and 2008, before slowing to a “hard landing" growth rate of just over 6%
in late 2008. A sizable portion of the 10%+ growth seen between 2002 and 2008
was export oriented, and the U.S. economy pulled in nearly $2 trillion of
China's exported goods during that time period. Those goods, from televisions
to tablecloths, helped to fill the nearly 10 million new single family homes
built in the United States in that period. China is now slowly transitioning to
a more consumer-oriented versus an export-oriented economy, and Chinese
authorities have made it clear that the transition is likely to occur against a
backdrop of much slower economic growth, likely in the 7.5 – 8.0 % range. As
China begins the transition to slower, more consumer-oriented growth, the U.S.
economy continues to struggle with the high levels of personal debt left over
from that earlier era (2002 – 2008).
U.S. Consumers Continuing to Struggle With Debt
Since
the onset of the Great Recession, many market observers have generally taken a
pessimistic view on how quickly U.S. consumers could repair the damage to their
personal balance sheets incurred during the 2002 – 2008 period (and really
since the mid-1990s). The good news on this front is that the process of
“deleveraging,” although by no means complete, has occurred much more quickly
than the most pessimistic forecasts. Although it has taken the consumer a lot
less time to deleverage than was thought even a few years ago, consumer balance
sheets are probably not back to “normal.” Absolute levels of personal debt
remain high, and thanks to sub-par personal income growth, debt-to-income
levels remain high as well, although down from recent peaks. One bright spot in
the process has been the sharp reduction in the cost of servicing the debt.
Fed Actions Have Helped Ease Some of Consumers’ Debt Burden
Actions
by the Federal Reserve (Fed) — lowering the Federal funds rates, two rounds of
bond purchases(QE1 and QE2), and Operation Twist — along with slow domestic
economic growth, low inflation, and a series of global growth worries have
sharply reduced consumer interest rates. Lower rates, in turn, have made it
easier for consumers to service the personal debt (pay credit cards, student
loans, mortgages, etc.) that has not already been eliminated (either
voluntarily or involuntarily). Mortgage rates, which were close to 7% as
recently as the middle of 2008, are now well below 4.0%, and could be headed
lower if the Fed decides to pursue a third round of quantitative easing (QE3)
and target the mortgage market. Economy-wide, the drop in mortgage rates, along
with a drop in mortgage debt outstanding, translated into $150 billion in lower
mortgage payments in 2011 versus 2008. To put that dollar amount in
perspective, $150 billion dollars is what Americans spent on furniture,
lighting fixtures, carpets, floor coverings, and window coverings in the past
12 months.
Rates
on auto and truck and personal loans have seen similar declines. In 2007, the
average rate on a five-year loan for a new car or truck was around 8.0%. Today,
the rate is well under 5.0%. The rate on a two-year personal bank loan in 2007
was close to 14%. Today, rates on unsecured personal loans are under 11%.
Interest rates on credit cards have moved down as well. On balance, personal
interest payments on non-mortgage debt have been cut in half since late 2008,
while mortgage interest payments have been cut by 25%. While some of that
reduction in interest represents “involuntary” reduction in principle (on
mortgages, credit cards, personal loans,etc.), the drop in rates has certainly
eased the cost of servicing debt, and sped up the process of consumer balance
sheet repair.
The
cost of servicing the debt is captured in the figure on the financial
obligations ratio, or FOR. The FOR is an estimate of the ratio of financial
obligations payments to disposable personal income. The FOR includes automobile
lease payments, rental payments on tenant-occupied property, homeowners'
insurance, and property tax payments. From a peak of near 19% in late
2008/early 2009, the FOR has fallen to 16%, the lowest in 12 years, and very
close to the all-time low of 15%, hit in the early 1980s.
The
drop in the FOR reflects the big drop in consumer interest rates (discussed
above), along with the modest drop in overall debt levels which has come about
both voluntarily (consumers consciously paying down consumer, housing, and
credit card debt) and involuntarily (bankruptcy, foreclosure, etc.). The nearby
figure on overall debt levels relative to personal income paints a slightly
more dire picture, showing that while debt-to-income levels have moved lower
since 2008, and are at the lowest level in more than 10 years, they remain well
above their long-term average.
What’s Next?
The
truth about consumers’ financial health lies somewhere between still-elevated
debt levels, the debt-to-income ratio,and the FOR. As the economy continues to
recover, consumers will continue to spend a little, save a little,and pay down
debt, as they have been doing for four years now. As this process continues to
unfold, the implications for the broader economy include a slower-than-normal
pace of spending, and increased caution in taking on new debt. However, it does
appear that most of the hard work, at least on the consumer front, may be
behind us. With personal debt levels moving (slowly) in right direction and
corporate debt levels well contained (a topic for a future Weekly Economy
Commentary), markets and policymakers are now likely to turn their attention to
government debt levels (mainly federal but state and local as well) over the
remainder of 2012 and into 2013.
Prepared
By:
John
Canally, CFA
Economist
LPL Financial
______________________________________
IMPORTANT DISCLOSURES
The opinions voiced in this material are for general information only and are
not intended to provide specific advice or recommendations for any individual.
To determine which investment(s) may be appropriate for you, consult your
financial advisor prior to investing. All performance reference is historical
and is no guarantee of future results. All indices are unmanaged and cannot be
invested into directly.
The economic
forecasts set forth in the presentation may not develop as predicted and there
can be no guarantee that strategies promoted will be successful.
Chinese Purchasing
Managers Index: The PMI includes a package of indices to measure manufacturing
sector performance. A reading above 50 percent indicates economic expansion,
while that below 50 percent indicates contraction.
Leading indicator: An
economic indicator that changes before the economy has changed. Examples of
leading indicators include production workweek, building permits, unemployment
insurance claims, money supply, inventory changes, and stock prices. The Fed
watches many of these indicators as it decides what to do about interest rates.
The Consumer Price
Index (CPI) is a measure of the average change over time in the prices paid by
urban consumers for a market basket of consumer goods and services.
International
investing involves special risks, such as currency fluctuation and political
instability, and may not be suitable for all investors.
Quantitative Easing
is a government monetary policy occasionally used to increase the money supply
by buying government securities or other securities from the market.
Quantitative easing increases the money supply by flooding financial
institutions with capital in an effort to promote increased lending and
liquidity.
Empire State
Manufacturing Survey is a monthly survey of manufacturers in New York State
conducted by the Federal Reserve Bank of New York. The Federal Open Market
Committee action known as Operation Twist began in 1961. The intent was to
flatten the yield curve in order to promote capital inflows and strengthen the
dollar. The Fed utilized open market operations to shorten the maturity of
public debt in the open market. The action has subsequently been reexamined in
isolation and found to have been more effective than originally thought. As a
result of this reappraisal, similar action has been suggested as an alternative
to quantitative easing by central banks.
The Federal Open
Market Committee (FOMC), a committee within the Federal Reserve System, is
charged under the United States law with overseeing the nation’s open market
operations (i.e., the Fed’s buying and selling of United States Treasure
securities).
This research
material has been prepared by LPL Financial.
To the extent you are
receiving investment advice from a separately registered independent investment
advisor, please note that LPL Financial is not an affiliate of and makes no
representation with respect to such entity.
Not FDIC/NCUA Insured
| Not Bank/Credit Union Guaranteed | May Lose Value | Not Guaranteed by any
Government Agency | Not a Bank/Credit Union Deposit
Member FINRA/SIPC
Tracking #1-084092
(Exp. 07/13)
