Tuesday, June 14, 2011

Zulauf/Faber and Financial Armageddon Redux/Debt Burden of the American Household/

As usual, Felix Zulauf caused the OG to have anxiety attack. His interview in the Barron's Mid-Year Roundtable raised the same negative bullet points that have kept the OG hooked up to an IV of chill pills for weeks now.

According to Felix, all of the economic indicators are "rolling over", and economic growth could "slow to crawl" well into next year. The stock market has not priced in that scenario and is vulnerable to a 20% correction from the May high.  The OG agrees generally with Zulauf on those points but never has Zulauf's certainty. (see e.g. Introduction to Stocks & Politics: Jobs: June 6, 2011 Post).

The world is possibly headed for a bigger crisis than the one experienced in 2008. Zulauf puts the timing of the next financial meltdown as anywhere from soon to the middle of the decade "at the latest". 

Zulauf states his predictions about the future as facts.  His scenario may occur, with a 30% to 40% likelihood, giving some leeway on the timing. Possibly, if Greece is allowed to default, with ripple effects similar to what happened after Lehman's failure, the timing of the financial crisis envisioned by Zulauf could accelerate to this year, particularly if combined with a near in time "technical" default by the U.S. or the failure of the U.S. government to meaningfully address its extremely serious financial problems. None of those events, however, can be predicted now with anything resembling certainty including the contagion effect of a Greek government default on Spain and Italy, the next dominos. If in fact the European sovereign debt crisis spins out of control, possibly occurring as early as this summer, then the likelihood of Zulauf's scenario of a financial meltdown would be closer to 80%.  It is possible that the political tide in Germany will turn against subsidizing the weaker EU countries.

I heard several gurus say yesterday that a Greek default would not cause investors to back away from Spanish and Italian government debt.  There is simply no way to have their certainty.  Credit default swaps on government debt issued by Portugal, Ireland, and Greece hit record high prices yesterday.  Bloomberg  S & P cut Greece's credit rating 3 notches, further into junk territory, calling a "restructuring" of the debt as "increasingly likely".  NYT   Reuters

The OG believes that the patchwork and crazy glue may hold, given enough time without another meltdown in the world's financial system. One alternate scenario to the one advanced by Zulauf is for the world to muddle through the current problems, with patchwork and glue, until everyone calms down, growth in emerging markets pulls the excessively leveraged developed countries out of their financial holes along with less insane fiscal policies by most of those countries, and the European sovereign government debt problems are successfully managed without causing another worldwide financial meltdown similar to what was happening in the summer of 2008.  

Financial Armageddon was postponed by the actions undertaken by governments and central banks after Lehman's failure, but the underlying structural problems are still omnipresent with no certain or reliable path to resolution.   The world is in uncharted territory, and Zulauf's scenario is certainly a realistic possibility.  

Marc Faber agrees in his interview at Barron's that the global economy has started to decelerate.  The recovery since 2008 was supported by extraordinary fiscal and monetary stimulus worldwide that is winding down.  He also points out that U.S. stocks are down 50% to 80% since the highs in 2007 when measured in Swiss Francs, Australian Dollars, gold or silver.  Another obvious point made by Faber is that wages for works in the lower and middle classes are not keeping up with inflation.  Doug Kass calls that "Screwflation" in his Barron's column.

{The strength of the Swiss Franc suggests that all is not right with the world.  The CHD has been making substantial gains in value against both the EURO and the USD. CHFUSD=X Basic Chart CHFEUR The Swiss Central bank tried to stop the rise against the EURO for several months.}

The OG would disagree with Faber's suggestion that the household sector in the U.S. is deleveraging to any meaningful degree.  The FED recently reported that household debt as a percent of disposable income fell to 119% in 2011's first quarter.  Sure, that is down from the ridiculously over-extended 133% in 2007, but is nowhere near the historic average of around 60% prevailing before 1985.

Paul Krugman recently reproduced a longer term chart of this ratio published by the St. Louis Fed,  NYT

In the heading to that chart, CMDEBT stands for consumer debt and DPI is shorthand for disposable personal income.  

And, the current reduction in debt is not coming from changes in spending habits.  Instead, the decline is largely due to the epidemic of defaults on mortgage obligations. The Fed showed that debt fell at a 2% annual rate in the first quarter, due to a decline in mortgage debt, while other forms of consumer debt increased by 2.4%.  

This is another chart, borrowed from the St. Louis Fed, that puts U.S. household debt in perspective: 

I noted a few other article over the weekend about worse debt levels in Australia and Korea:   Fitch on Australian  Borrowers South Korea Household Debt- Bloomberg

A sizable segment of the U.S. population has no mortgage debt.   Based on a 2009 survey made by the Census Bureau, 24.206 million homes are owned free and clear of any debt, about 1/3rd of the totalcensus.gov/pdf. I would suspect that a large number of those households have no debt of any kind.  I would call them the saver class, mostly older folks.

The high numbers represented in the preceding charts originate from a large segment of the population, possibly around two-thirds of households, and consequently suggest to me substantially more stress on that segment than indicated in these charts which already show an unsustainable trajectory.  With these debt levels, how can the debt class increase their discretionary spending to support a sustainable U.S. recovery, the OG asked?  The debtor class remains excessively burdened with debt, though many are shedding mortgage debt, in many cases voluntarily through strategic defaults.  The saver class, while in a position to increase spending, may choose to cut back on discretionary spending due to declines in interest income associated with their savings, as they bear the brunt of the Fed's Jihad.  

In short, the OG believes that consumers in most developed countries, particularly in the U.S., still need to substantially deleverage their balance sheets by spending a lot less and saving more for at least two more years. The governments, at all levels, in developed countries, particularly the U.S. and many European countries, will be reducing spending, and there will be no significant "stimulus" spending by the U.S. government.  With Japan likely to remain anemic, and emerging nations trying to place a break on inflationary pressures in their own economies, this does not sound like ripe conditions for more stock market gains. The OG wants to know where will demand for goods and services originate to sustain an economic recovery where there is such widespread retrenchment in demand? And the yields in the investment grade bond market are not consistent with the growth currently estimated by economists in the second half of 2011 and 2012.

LB is becoming increasingly concerned that the OG is not only becoming cogent, but has even started to perform some research, no doubt in an effort to convince HK to delay the implementation of the LB's plans.

I had a number of securities go ex dividend or ex interest yesterday, including the CEFs BCF (quarterly), JQC (quarterly), JSN (quarterly), JLA (quarterly), JTD (quarterly), PSY (monthly), BTZ (monthly), ERC (monthly), BHK (monthly), NBB (monthly) and ERH (monthly); exchange traded bonds GFW (quarterly) and STLPRA (quarterly-a TP); and common stocks ARCC, VLY, CBU, RNST, HPQ and KO. Most of those distributions will be taken in cash which is always the case with exchange traded bonds.  I recently quit reinvesting KO dividends due to the price.   Of the CEFs, I am reinvesting the dividends for JQC, 1/2 of the 400 shares of BTZ, and BHK, mostly due to the discounts to their respective net asset values.    My largest bond CEF position is GDO, which goes ex dividend for its monthly distribution on the June 15th.

My most basic strategy is to generate a constant stream of cash flow from dividends and interest and then to buy more income generating securities with those funds.  While I am constantly receiving cash flow throughout the month, the primary payment periods are the 1st, 15th and the last business day in the month, and I will generally receive more in March, June, September and December then the other months.   MarketWatch

I did not buy or sell anything yesterday.  Stocks & Politics: LB is In a Slow Mo Trading Mode While Preserving Recently Raised Cash Stash 

1 comment:

  1. The weekly ECRI has rarely failed to be accurate, it's down for several weeks now, recession never ended. Gov stimulus supply-side clowns give business a 100% depreciation on a machine they can't afford, but for it replacing a worker. Then they produce more, as in today's inventories up 14%. NO DEMAND. Time for more layoffs and buying back stock with record junk bond issuance, to fake earnings.