Comstock Partners, Inc.February 02, 2012
Deleveraging For Years Ahead
"A 30-50 year virtuous cycle of credit expansion which has produced outsize paranormal returns for financial assets----bonds, stocks, real estate and commodities alike----is now deleveraging because of excessive risk and the price of money at the zero-bound. We are witnessing the death of abundance and the borning of austerity, for what may be a long, long time."
This quote from Bill Gross's February comment for Pimco neatly summarizes in one sentence the main theme we have been emphasizing in our own comments for many years. Periods followed by credit crises are almost always followed by many years of below average growth, anemic expansions and frequent recessions. The most recent example is the experience of Japan since 1989. It is now happening in the U.S. and much of the world, and will not end anytime soon.
In the U.S., total domestic debt is now 341% of GDP, compared to about 150% in 1980. Gross federal government debt is about 100% of GDP, up from 32% in 1980. Household debt is 87% of GDP, compared to 49% in 1980. The period of abundance ended with the severe credit crisis of 2008 that was followed by the worst recession since the Great Depression.
Similarly, the recovery has been the weakest since the 1930s. Real GDP, over the last four quarters, has grown at the meager rate of 1.6%. Although the recently reported fourth quarter GDP growth of 2.8% was the best of 2011, the underlying data was extremely weak. The growth was driven largely by inventory accumulation, while final sales were up only 0.8%. Consumer spending increased by only 1.5%. Furthermore, nominal GDP growth (before deducting inflation) was only 3.2%, down from 4.4% in the prior quarter as the implicit price deflator was only 0.4%, against 2.6% in the third quarter. Had the same deflator been applied to the fourth quarter, growth would have been only 0.6%.
Looking ahead, consumer spending is likely to remain weak as households seek to deleverage and increase their savings. December real retail sales were down 0.1% as consumers raised their savings rate from 3.5% to 4%. The savings rate generally averaged between 8% and 9% from the 1950s to the 1980s. Declining household wealth, mostly a result of dropping home prices, is another factor inhibiting spending. While initial unemployment claims have dropped, new hiring is still in the doldrums, and wages increases are minimal. Since capital spending growth generally follows consumer spending by a quarter or two, this segment is likely to remain tepid as well. In addition, 2011 capital spending was boosted by a 100% tax credit that expired by year-end, thereby pushing some potential 2012 spending into the prior year.
Inventory accumulation will probably decline after the fourth quarter rise. Exports should be under pressure as a result of weakness in Europe and declining global growth. Fiscal stimulus will be less this year than last, while government spending is dropping at federal, state and local levels. Furthermore, last week's FOMC meeting and Bernanke's testimony today indicate to us that the Fed is essentially out of ammunition, while government is likely to remain dysfunctional in a hotly contested election year. Given all of these factors it is difficult to see where economic growth will come from.
Although the strong point of the economy until now has been corporate earnings, even this area is showing some early signs of faltering. Only 59% of corporations so far have beat fourth quarter earnings expectations, the lowest since the third quarter of 2008, while only 43% exceeded revenue forecasts, the lowest since the first quarter of 2008. The combined results for those who have reported and the estimates for those yet to report show an increase of 11.5% over a year earlier. The increase, however, would be only 1% without AIG and Apple. Furthermore, the number of companies reducing guidance exceeded those raising guidance by about 3%. In view of our outlook, we think that earnings disappointments will mount throughout the year.