For some time we have maintained that the economy, following the severe 2008 credit crisis, would grow at an exceeding slow and uneven pace, and this is the way it is playing out. This is unlike the garden-variety post-war inventory recessions that were mostly short and shallow, and followed by robust rebounds that quickly exceeded prior peaks. The crisis was caused by an extraordinary debt boom that will take many years to work off and create severe headwinds to economic growth.
Household debt as a percentage of GDP averaged 55% over the past 60 years, but soared to 99% by 2008. It has now declined to 87% and still has a long way to go before returning to anything near normal. Federal government debt has climbed from 56% of GDP in 2000 to 97% as of September 30th, and is undoubtedly higher now. In our view the overall debt is the single most important factor to take into account in analyzing the future growth of the economy. The reduction in household debt since the 2008 peak has been the key factor in dampening economic growth to date. In fact, household debt has now been down for 13 connsecutive quarters after never being down for even one quarter in the entire post-war period!
The effect of deleveraging is not a vague academic theory, but is clearly reflected in the real numbers. GDP in the fourth quarter was only 0.8% higher than it was at the peak four years earlier. In the last four quarters GDP growth was only 1.6%. While fourth quarter GDP growth was an annualized 3.0%, two-thirds of the amount was accounted for by inventories. These probably have to be pared down in the first quarter. By almost any measure the current recovery has been far weaker than any other post-war expansion.
Although a number of recent indicators have shown improvement, there are major headwinds to economic growth. Consumer spending remains weak as a result of sluggish wage growth, declining wealth, a moribund housing market and restricted access to credit. Savings rates have probably dropped as low as they are going to get, and any further strength in spending will have to come from a lot more jobs and higher wages. Employment today is no higher than it was ten years ago despite large increases in population. Consumer confidence, although improved, is still at recessionary levels. According to January numbers, released today, real personal income was up 0.1%, real disposable income down 0.1% and consumption flat.
Housing remains a weak spot. New home purchases are down 33% from the 2005 peak while home prices continue to fall. Almost a quarter of homes with mortgages are underwater. Although published home inventory figures have improved, they do not include 5 million homes either in delinquency or foreclosure or 3 million more that are vacant, but not on the market.
In sum, we believe that the numerous headwinds to economic growth are creating substantial downside risks to the economy and corporate earnings that are not being discounted by an increasingly euphoric stock market that seems on the verge of running out of gas. At current levels the downside risks are far greater than the potential upside rewards.