U.S. stocks slipped again on Monday, beginning the week much like we did last Tuesday (last Monday being a holiday) as the major indices gained ground at the open before sliding late in the session.

Industrial and financial shares led the broad market lower, again.  Industrials are feeling the pressure that weaker Chinese growth and European government debt issues will have on the global economy. Financials took it on the chin after Goldman Sachs was subpoenaed by the Financial Crisis Inquiry Commission for failing to comply with information requests in a “timely manner.”

The S&P 500 index that tracks utility shares was the only major industry group to gain ground.  Health-care and telecoms performed well on a relative basis, but did decline slightly.

Stocks closed at session lows for the second-straight session as the latest report on consumer credit, which we touch on below, reminded of household balance sheet problems.  Overall consumer credit has declined 6.6% since December 2008 and is down 4.6% at an annual rate since GDP turned positive again in the third quarter of 2009.  It is unusual for consumer debt to decline, much less during the initial stages of expansion, but then household debt levels are more elevated than at any time in the postwar era. 

Market Activity for June 7, 2010

Consumer Credit

The Federal Reserve reported that consumer credit rose a seasonally-adjusted $1.0 billion to $2.44 trillion in April (0.5% at an annual rate) after a huge downward revision for March (down $5.4 billion after initially reported as a $2.0 billion increase). 

Revolving credit was slashed by $8.5 billion to $838.0 billion (12% at an annual rate), marking the 19^th straight month of increase.  It’s impossible to tell how much of the credit-card balance deduction was due to consumers paying down this debt and how much was due to continued high default rates (which have come off of recent peaks, but remain elevated). 

Non-revolving credit pushed the overall figure higher as this segment, largely car loans but also tuition, jumped $9.4 billion to $1.6 trillion in April, (7.1% at an annual rate).  Terms of credit for auto loans remained virtually unchanged from March, with the exception of the average rate.  Loan maturity held at 62.8 months, the LTV at 88% and the amount financed at $27,797.  The average interest rate fell to 4.13% from 4.28% in the month prior.  

We need consumer credit to continue to decline for a while, particularly if job and income growth falls short of absorbing this debt.  I suspect we’ll see the non-revolving loan figures trend lower as auto sales pullback over the next few months.  Revolving credit will continue its descent into 2011.

How Quickly Sentiment Can Change

No, I’m not referring to the stock market with that heading, although the direction of stock prices will definitely have an effect on consumption, but rather to economic growth prospects.  The gaggle of economists who were predicting the vaunted V-shaped recovery, in their apparent belief that the economy would find the juice to expand in a normal manner, are having second thoughts.  This shift in sentiment matches all of those stock trading bulls who seemed so sure a couple of months back that any pullback in the market couldn’t possibly eclipse 5%, much less 10% and counting. 

But more economists are beginning to realize/admit, whatever one wants to call it, that this time is different.  A debt crisis led recession is infrequent and by definition different from the normal contraction. 

There are a number of reasons why the economic trouble just kind of drags on. 

One, the political response always goes too far, which causes private-sector anxiety (think hiring) and actually delays the time it takes for markets to find price equilibrium (think the housing market).   As the government desperately attempts to boost economic activity, debt rolls onto the public sector as what had already been an extend and pretend  attitude toward entitlement programs, which fancy enough will be taken to a whole new level with health-care “reform,” becomes a clear and present problem. 

Two, bad bank assets along with a tighter regulatory regime causes credit to continue contracting. 

Three, it takes time for households to get their debt levels to manageable ratios, which means personal consumption must eventually trend lower.

Lastly, state and local economies put additional drag on economic prospects as their revenues decline and must cut workers and pension benefits, even as they delay this reality for as long as possible. 

As a result, there can be two-three stages to credit-led contractions, they just don’t fizzle out such as the typical recession that’s caused by bloated inventory levels. During this typical downturn, firms can get right to the inventory slashing and within 6-9 months are back in production mode.  In the aftermath of a credit crisis things don’t progress so smoothly.  

The economic growth we’re seeing right now is largely the result of government spending and historically loose monetary policy.  But the economy is not yet ready to stand on its own and since we’ll find there is a limit to what the government can spend, and ultra low short-term rates actually hampers the extension of loans to credit-worthy small business (why put more capital at risk when all banks need to do is borrow near zero and invest in Treasury securities), reality must set in again. 

This is not to say that the economy is irreparably damaged, although government policy can cause things to deteriorate for longer than is necessary, but it just takes more time than is usual for things to wash out.  Those who believed things were not different this time are beginning to have second thoughts. 

Have a great day!

Brent Vondera, Senior Analyst

Phone: 636-449-4900