The Federal Reserve has consistently forecast GDP growth in excess of 3.0% since the end of the 2007-2009 Recession, which was otherwise considered normal for recoveries after World War II. Yet, we are just completing eight years of slow growth, averaging less than 2%. The “Great Recession” was a global credit crisis, the result of years of excess financial leverage that began in the 1980s. In the U.S. spending grew faster than after-tax incomes. Global financial institutions increased the size of their balance sheets, and money poured into developing economies.
The unwinding of excess debts incurred during this borrowing binge takes time. Gary Schilling, an economist who has written extensively on the deleveraging process (see his 2010 book The Age of Deleveraging: Investment Strategies for a decade of slow growth and deflation) now thinks that the average of 10 years to return to historical norms for debt ratios after a credit crisis should be extended another 6 to 8 years. Why? As a ratio to disposable, after-tax income, household debt on mortgages, credit cards, student loans, auto loans, etc. went from the 65% level of the 1960s and 1970s to 130% in 2007. It has since receded to 104% (Federal Reserve data), still 60% above the long-term historical norm.
Recent market volatility seems to be sensing the formally rosy forecasts of the Federal Reserve are not going to materialize any time soon. The International Monetary Fund has reduced estimates for global growth, and Wall Street analysts are reducing estimates for corporate earnings. We are seeing increased speculation about a global recession, including in the U.S.
Beyond the usual flow of economic statistics and the ups and downs in global equities, we are looking to the credit markets for clues. Bloomberg reports that there are increasing signs of stress. Credit rating downgrades represent the bulk of credit rating actions: corporate borrowings are at a 12 year high; and, they estimate that one third of global companies are failing to generate high enough returns on investments to cover their cost of funding. Consequently, credit spreads have been widening. High yield spreads have increased largely – but not entirely – due to concerns over the impact of declining oil prices on smaller, highly indebted energy producers. According to Bank of America Merrill Lynch indices, even the interest rates of highly rated corporate debt have increased over equivalent U.S. Treasuries to 1.84% from 1.18% last March
None of this means that we are facing an imminent crisis. It does mean that much of the corporate debt that has been accumulated in response to the Federal Reserve’s extended zero rate policy and used for financial engineering purposes (Mergers & Acquisitions, stock buy backs, dividends) is unsustainable. It also means that it will take a number of additional years before corporate debt levels in addition to household debt levels return to historical norms, and that we can expect, at a minimum, slow economic growth for the foreseeable future
- The views expressed are provided for information only and are not to be used or considered as an offer or solicitation to buy or sell securities or investment products. 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.
- The economic forecast set forth in this presentation may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.
- Investing in real estate/REITs involves special risks and may not be suitable for all investors.
- Because of its narrow focus, specialty sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.
- Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise.
- Data provided by LPL Financial.
- All investing involves risk including loss of principal.