Consumer credit metrics are worsening, with rising bankruptcies and credit-card losses.
Reiterating our bearish view on retailers, REITs and the U.S. dollar.
The following article was originally published in “What I Learned This Week” on May 4, 2017. To learn more about 13D’s investment research, please visit our website.
Total bankruptcy filings by consumers and businesses jumped 40% between February and March, and rose 4% year-over-year to 81,590, according to data from the American Bankruptcy Institute (ABI) cited by author and financial blogger, Wolf Richter. Commercial bankruptcy filings were up 8% year-over-year to 3,658, while consumer bankruptcy filings were up 4% to 77,932. Although bankruptcy filings normally spike higher as the annual mid-April tax deadline approaches, the following charts show that the annual March spikes are now in an up-trend, after several years of moving lower. (As we went to press, the ABI released new data showing a 4% year-over-year decline in bankruptcy filings in April, but with a slight increase in the per capita filing rate from the first quarter.)
Last Friday’s disappointing GDP report, underscored by the weakest sequential quarterly personal consumption growth in over seven years, came as no surprise. Durable goods spending fell 2.5% sequentially (SAAR), with motor vehicles accounting for a 45 basis-point drag on overall quarterly GDP growth in Q1, underscoring the deceleration of fundamentals in the auto industry. (In WILTW March 30, 2017, we warned that the automotive sector was losing momentum rapidly.) Making matters worse, The Wall Street Journal reported last week that unit sales of consumer packaged goods in the U.S. fell 2.5% in the first quarter, according to Nielsen data, with the major brand names encountering severe headwinds.
In WILTW April 6, 2017, we warned about the margin squeeze negatively- impacting the consumer packaged goods sector, and the mounting evidence suggests that the problem is not temporary. IHS Markit director of consumer economics, Chris Christopher, outlined the following challenges: “There are some behavioral changes: A lot more is going online, people are not getting married, they’re living in smaller spaces, and they aren’t having as many children. That’s not going to turn around very fast.”
The poor consumer spending in Q1 could be a harbinger of more economic weakness, not only because the consumer is almost 70% of the U.S. economy, but because average real personal consumption expenditures grew at a faster rate than real GDP over the last three years, 2.9% to 2.2%. The dynamics underlying the gains in consumer spending in recent years do not inspire confidence, because they have been driven mainly by new debt rather than real income growth. The following charts bear this out quite clearly.
Total consumer credit is growing faster than personal consumption expenditures, as shown by the upward trajectory of the blue line in the following chart. A false sense of security has prevailed over the last few years because the consumer debt service ratio (denoted by the red line) collapsed from 6% to 5% after the onset of the last recession, as bad debts were written off and interest rates collapsed. Unfortunately, this process had perverse effects, because it enabled cash-strapped consumers to take on more debt for a given level of income, because the interest costs were lower.
It is therefore understandable that the ratio of consumer credit-to-personal consumption expenditures has gone straight up since 2010 (denoted by the blue line) but, unlike the debt service ratio, now stands well above the levels that prevailed before the subprime mortgage crisis unfolded. At 28.9% during last year’s fourth quarter, the ratio is above the 26.8% that existed in early 2009 and even further above the 24% that existed before the year 2000, both recession years.
Making matters worse, consumer revolving credit is growing faster than real per capita disposable income — and the gap has widened over the last three years. We have suspected for some time that many consumers have been paying their everyday expenses with credit cards and other forms of revolving debt. The following chart shows that since February 2015, the growth rate of consumer revolving credit has nearly doubled from 3.4% to 6.2%, while the growth rate of real-per-capita-disposable income has been cut almost in half, from 3.2% to 1.7%. Is it any wonder why so many Americans are unprepared for a financial emergency?
This begs the following question: how fast can personal consumption grow if new debt growth slows or bears a higher interest burden or credit losses escalate? The answer to this question may be revealed over the course of this year, if the Fed follows through with two more rate hikes. The chart on the left shows that consumer spending growth has not followed the path implied by consumer confidence, and the chart on the right shows that credit-card charge-off rates have been moving higher at the major banks over the last two quarters. These trends do not inspire confidence. One could reasonably suspect that the first quarter’s poor consumption growth could be a result of consumers being tapped-out on their credit cards.
These trends underscore the rationale to maintain underweight or short positions in stocks with exposure to consumer discretionary spending, such as SPDR S&P Retail ETF (XRT, $43.04), CBL & Associates (CBL, $9.26) and the Vanguard REIT Index ETF (VNQ, $82.03). In addition, the more that consumer spending weakens, the greater the probability that the Fed might be inclined to delay further rate hikes, which would undermine support for the U.S. dollar index (DXY, 99.32).
This article was originally published in “What I Learned This Week” on May 4, 2017. To subscribe to our weekly newsletter, visit 13D.com or find us on Twitter @WhatILearnedTW.
