January 5, 2018
“This time it’s different.” That quote is from Sir John Templeton, a legendary investor who is considered the father of the modern mutual fund industry. For most of the month of December, I’ve been hearing ads from mortgage brokers who are promoting the idea of refinancing your house in order to take care of holiday bills. It reminded of the early 2000’s when then Fed Chairman, Alan Greenspan, was urging Americans to use their house as “an ATM” by taking on home equity loans as a means of drawing out cash against home equity for consumption spending. Adding more debt against your house to pay off big credit card balances merely shifts household debt from one creditor to another. What’s worse, it frees up room under the credit card accounts to enable the consumer to take on even more debt.
In reference to the mortgage and housing market collapse in 2008, Ben Bernanke wrote, “Clearly, many of us at the Fed, including me, underestimated the extent of the housing bubble and the risks it posed.” It’s hard to know if that statement is genuine or not, given that many of us saw the housing bubble that was developing as early as 2004.
The Federal Government’s low-to-no down payment programs via Fannie Mae, Freddie Mac, the FHA, VHA and USDA, combined with the hyper-promotion of cash-out refinancings (bigger 1st mortgages and/or second-lien mortgages) tell me that, once again, most people in this country believe – or rather, hope – that the outcome will be different this time.
The graphic just below is an interesting way to show the affect that Central Bank monetary inflation has on asset valuation vs income.
Asset valuation should be theoretically derived from the income levels connected to the assets. Either the asset requires a certain level of income level to purchase and maintain the asset or the asset itself generates income/cash flow.
You’ll note the pattern that developed starting with the tech bubble era. Prior to the Clinton administration the Fed subtly intervened in the financial system by been printing money in excess of marginal wealth creation (GDP growth) once Nixon closed the gold window. But, in conjunction with the Greenspan Fed, the Government’s willingness to print money as an official policy tool took on a whole new dimension during the Clinton administration. Note: I’m not making a political judgment per se about the Clinton presidency, because the Fed’s ability to print money to prop up the stock market was established with Reagan’s Executive Order after the 1987 stock crash. You’ll note that the household net worth to income ratio began to rise at a sharp rate starting in mid-1994, which was when the Clinton-Rubin strong dollar policy was implemented. It’s also around the time that Greenspan began regularly printing money to address the series of financial problems that arose in the 1990’s.
The current ratio of household net worth to income is 6.75 – the highest household net worth to income ratio in history. It peaked around 6.5x in 2007 and 6.1x in early 2000. You’ll note that from 1986 to 1995 the ratio averaged just around 5.1x.
A graphic that is correlated to the household net worth/income ratio is the household net worth to GDP. The pic to the right shows household net worth (assets minus debt) vs. a plot of the U.S. nominal GDP.
As you can see, when the growth in household net worth deviates considerably from the growth in nominal GDP, bad things happen to asset values. Note: household assets consist primarily of a house and retirement funds. Currently the level of household net worth – that is, the value of homes and stock portfolios – relative to GDP is at its highest point in history. This will not end with happiness.
I wanted to present the two previous graphics and my accompanying analysis, in conjunction with the theme that “it is not different this time.” The extreme degree of household asset inflation relative to incremental GDP wealth output is yet another data-point indicating the high probability that a nasty stock market accident will occur sooner or later. To compound the severity of the problem, household asset inflation has been achieved primarily through massive credit creation. The amount of debt per home sold in this country currently is at a record level.
During this past week, the bullish sentiment of investors continued to soar. A record level of investor bullishness never ends well for the stock market. Speaking of which, there has been an interesting development in the Conference Board’s Consumer Confidence metrics. The headline-reported index showed an unexpected declined from 129.5 to 122.1 vs 128 expected. This is a big percentage drop and a big drop vs Wall Street’s crystal ball. However, while the “present situation” index hit its highest level since April 2001, the “expectations” – or “hope” – metric plunged from 113.3 to 99.1. It seems the current euphoria connected to the stock and housing markets is not expected to last.
The chart above shows the spread in consumer confidence between “present conditions” and “future conditions” (present conditions minus future conditions). A rising line indicates that future outlook (“hope”) is diverging negatively from present conditions. I’ve marked with red lines the peaks in this divergence which also happen to correlate with stock market tops (1979, 1987/1989, 2000).