MARKET OBSERVATIONS

CREDIT WHERE CREDIT IS DUE

MARKET OBSERVATIONS - 4/11

Credit Where Credit Is Due...There's a lot of credit to be handed out for the "saving of the market" last week.  Credit fast thinking Clinton for calling off the biotech patent dogs.  Credit judge Penfield Jackson in the Microsoft case for deftly realizing that "fast tracking" the remedy portion of the trial would calm the frayed nerves of investors far and wide.  Credit those states-attorneys-general for realizing they would be putting their own political careers in danger if they decided to litigiously pounce on the wounded Microsoft beast.  Credit Abby for discovering a profound newly discovered love for a handful of index leading "new idea" tech stocks (Cisco, Oracle, et. al.).  Credit Merrill and Goldman for bravely stepping up to the plate when the NAZ futures were lock limit down last Tuesday and executing futures buy orders that essentially opened them 100 points above cash market levels (and held them there).  When the chips are down (literally), it's just nice to know that so many really care and will clearly go out of their way to lend a helping hand.  We're sure there may be a few others, such as mutual fund behemoths like Janus, that contributed to the cause.  It's just that folks like this prefer to remain anonymous donors in most charitable instances of this nature.  There you have it, collectively the new era "salvation army".  We're just wondering if they're preparing for a second round.

Since the "all is well" bells were temporarily chiming by last week's end, we believe credit was just not duly reigned on Consumer Credit.  After all, hasn't consumer credit stuck by those in need of liquidity through thick and thin for years now?  Of course it has.  That's OK.  We're here to right the wrong and fully bestow accolades and positive perspectives on the wonderful American birthright of Consumer Credit.  Investors were most likely mesmerized by the oratory prowess of Larry Kudlow cleverly explaining the tenets of new era economics on CNBC last Friday morning to have noticed the consumer credit numbers that were reported.  In fact, we're clearly focused on consumer credit as, perhaps, the best performing major index this year.  For the month of February, consumer credit increased at a 10.25% annualized rate.  This followed a staggering, upwardly revised 15.75% growth number for January.  Just so you know, the January number was a one month record in the annals of consumer credit growth tracking in this country.  Consumer credit grew at an rate of 7.1% in 1999, 5.4% in 1998 and 4.4% in 1997.  Imagine, just like the overall economy and the NASDAQ index, consumer credit growth has accelerated as we have moved into the new millennium.  Smashing, baby.

Same As It Ever Was...As in prior overall credit driven financial manias, consumer credit is surely an important prop in driving asset prices.  Additionally, the credit-manic masses having simply turned a blind eye to the Fed's feeble interest rate foibles is further definitive characterization of the bubble all around us.  Over the past few weeks, we have discussed GSE credit creation, margin debt, growth in M3, etc.  Growth in consumer credit simply joins the Liquidity Big Boys club in terms of its overall contribution to asset price inflation.  Consumer credit is also part of the true "it's different this time" characterization of the new era.  Think about it.  Consumer credit is really only a phenomenon of the last four decades or so.  It simply wasn't there in 1929.  In 1973, it was still in its infancy.  The baby boomers had not yet come of age, and neither had their consumer credit demands.  We often hear that margin debt is just not that big a deal today relative to its GDP equivalent levels in 1929.  Our answer is that today we have forms of personal debt that had not yet been "created" or exploited to their fullest extent in '29.  Consumer debt, mortgage debt, equity lines, collateralized loans against stock holdings, auto lending, etc.  We suggest that when looking at personal leverage, it should be done in the aggregate.

Our last bone of contention is that consumer credit is basically financing the savings gap the US is now experiencing.  Given the length of time we have run a negative savings rate in this country, clearly consumer credit is financing living standards while savings have been diverted to investments (common stocks).  After all, don't the current new age economics argue that this should be so?  (Consumer credit at low-to-mid teens rates and perceptions of stock returns certainly higher than that.)

Digging Deeper...Time for the graphs and the charts.  Simplistically, let's first look at overall consumer credit growth over the last five years:

Simple enough.  As you would expect.  Progressively higher as the market has gone higher and the savings rate has declined.  In absolute numbers, you are looking at a graph that encompasses an increase of $319 billion in consumer credit outstanding.

The next chart may not look so staggering, as we have witnessed growth rates near those experienced today, albeit on a much smaller absolute dollar base of total dollar consumer credit outstanding.  (January 2000 did annualize at an all time record near 16%.):

Into the Deep End of the Pool?...Although we have not touched on it yet, growth in consumer credit is most certainly being aided and abetted by securitization of consumer credit receivables.  First the simple chart:

Now for the raw numbers:

Pools of Securitized Assets as % of Total Revolving Consumer Credit

This table dramatically screams that asset securitization is allowing outstanding consumer credit to mushroom.  As you know, originators of this debt lay off these receivables in the secondary markets and are free to originate anew.  What a beautiful perpetual cycle?  Right?  Either that, or simply a massive house of cards awaiting a mild breeze.  Take your pick.  Once again, the secondary markets are the key to the game.  Want to know the other essential key?  DERIVATIVES.  Most certainly, large holders of / investors in these securitized pools need a theoretical risk offset.   Here's yet another reason why derivatives use is exploding in the US.

Pools of Securitized Assets as % of Total Non-Revolving Consumer Credit

Securitization is quietly creeping higher as an overall factor in non-revolving debt, but clearly nothing like what is happening in revolving consumer credit figures.  Remember, this revolving consumer credit situation that obviously effects GDP growth is what people like Kudlow and Greenspan refer to as prosperity.  New Era Kudlow-nomics.

What's On The Other Side?...Well it just so happens that the "other side" is already here, just nobody wants to address the situation quite yet.  Just have a look and tell us we're wrong:

The dark side of excessive consumer credit is already upon us.  Record bankruptcies are being recorded during Clinton's "best economy in generations".  What seems more ironic is that if there was no title on this chart above of personal bankruptcies, we would swear we were looking at a chart of the NASDAQ.  This chart only records activity up until about two years ago.  Trust us, the line moves higher. 

Conversely, in this best of all possible economic nirvana environments, business bankruptcy filings have been trending down since the recession in 1991:   

 
Source: American Bankruptcy Institute

At the moment, business bankruptcy filings are at two decade lows.  We're in a unique period where equity capital is flowing freely on the street and business borrowings are booming.  With a strong debt financed consumer economy, corporate cash flows (pre interest expenses) are running strong.  Don't worry.  At some point, the dot.com filings will skew the business bankruptcy curve upward quite strongly.     

Although the chart above portrays the picture nicely, here are the numbers on personal and business bankruptcy filings:

There you have it.  Record amounts of personal consumer credit outstanding coexist hand-in-hand with record personal bankruptcies.  (One would think that risk premiums on securitized credit card receivables and other securitized pools of consumer credit related receivables would simply be sky high.  In fact, in the last few weeks, they have been sky high.)  It's somewhat like watching interest rates go higher and the stock market ascend concurrently.  So much of what happens in today's marketplace defies the logic of historical relationships.  This truly is some kind of new era...at least for now.

In terms of the stock market, consumer credit lurks on the nasty left side of the personal balance sheet.  It's the coiled snake ready to strike the unsuspecting, trusting and uninitiated among the investment populace.  It's clearly a catalyst for perceptual change at some point in the market cycle.  This time around, it's effect may be quite vicious in terms of perceptual influence regarding stocks, consumer spending and the economy as a whole.

The Tuition Payment...To say that the market and market sectors have been volatile over the last few weeks is nothing short of an understatement.  Many novice internet, biotech and tech investors are beginning to make "tuition payments" to the almighty Market Gods.  Last week marked the first public outflows from tech mutual funds in recent memory (or distant memory for that matter).  Where does all of this lead us ahead?  (Answer: Wherever it wants to.)  Tim's perspective is as follows:

 Whether we test the Tuesday intra day lows or not remains to be seen.  The question we would ask is "what perceptions will propel the market back into a parabolic up move"?  Clearly the illusions of continuous Internet and Biotech riches are beginning to be questioned.  Jesse Livermore opined, "It is not so much greed made blind by eagerness as it is hope bandaged by the unwillingness to do any thinking." (that ultimately trips up novice investors).  We have to believe that stock market tuition will not be extracted without a few lessons learned.  Or better yet, let's hope the lessons are learned.  

You live, you learn.
You love, you learn.
You cry, you learn.
You lose, you learn.
You bleed, you learn.
You scream, you learn.

- Jagged Little Pill  (Alanis Morrissette)

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