The Debt Beneath

Authored by Sven Henrich via NorthmanTrader.com,

Debt is irrelevant and matters not. It’s different this time. That’s the message from politicians, markets and participants. Tax cuts pay for themselves (they do not), leverage doesn’t matter (it does) and the increased costs of servicing the debt as a result of rising rates will be offset by imaginary real wage growth to come (they won’t).

But the calmest market waters in history continue to keep these illusions alive as asset prices keep levitating from record to record.

Debt does matter and it was ironically left to Janet Yellen to voice any remnant concerns about the sustainability of debt to GDP: “It’s the type of thing that should keep people awake at night” she said.With good reason:

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After all the debt burden has never been higher and rates, following years of enabling the largest debt expansion in human history, are starting to rise in the US. In the larger historic context rates are still low, but let’s be clear, they are rising:

And with rising rates come questions of the sustainability of servicing incredibly high debt loads.

The worldwide equity rally since the early 2016 lows has resulted in a massive increase in the market capitalization of global asset prices which have increased by over $25 trillion in value since then. As discussed in my 2017 Market Lessons US market capitalization is now north of 143% of US GDP.

Low rates and free money in form of global QE and now US tax cuts make it all possible and consequence free. But is it?

Let’s take a look at the leveraging game over the past 2 years since this is when the most recent rally began. And note in many cases we don’t have full 2017 data yet so I’m using the running 2 year data where I can pull it. The trend is the same: Up, up and away.

Federal debt has increased by $2.1 trillion. Different management, same result and tax cuts will leave a revenue source gap in the long term budget and will add further to the debt:

Corporate debt has increased by over $568B during the same timeframe:

Household debt has increased by $364B:

Revolving debt, you know the one subject to higher rates, is now exceeding $1 trillion, up over $100B in less than 2 years:

Student loans continue to expand unabated, up by another $166B:

And consumer loans on credit cards at commercial banks are up by another $100B since the February 2016 lows alone:

We don’t have full year end data yet, but there are indications on how the trend concluded:

“Shoppers in the U.S. racked up an average of $1,054 of debt this Christmas season — an increase of 5% over last year – 44% of shoppers racked up more than $1,000 in holiday debt, and 5% accumulated more than $5,000 in debt.”

So you see a solid portion of the GDP growth you are seeing is debt spending related. It’s not as organic as it may seem. US government deficit spending filters its way into GDP as much as consumer debt spending.

How will consumers deal with all these increases in debt? It’s a good question as real disposable income is up only $382 per capita over the same time period:

And personal interest payment obligations keep rising while the personal savings rate keeps dropping:

One more nugget: Margin debt in stock market accounts has increased by a whopping $146B since the February 2016 lows and now stands at over $580B. Graphically this looks like this:

The Fed say they are committed to reducing their balance sheet and will continue to raise rates.

Wall Street is projecting for the 10 year rate to move into the 3% range:

They’ve tried this forecast a few times before, but it has never materialized. Perhaps this time it will and, if it does, here are a couple of key questions looking at a 30 year chart:

What will the breaking of a 30 year downward trend in the 10 year do to equity prices that appear to have been entirely dependent on said downward trend?

And how will consumers sustain their debt driven spending habits as the burdens of ever higher interest payments are not a theoretical construct but a reality already knocking on the door?

The waters are calm, but they mask the real danger of the debt beneath and that is: The math doesn’t work.