I have been saying all year that we will really get a bead on certain aspects of the economy when we get to the holiday season. Ladies and gentlemen, here we are fully past Halloween and into the shopping season. Can you believe it? Stores have had their seasonal Thanksgiving and Christmas gear out since before trick or treating began in anticipation of Black Friday, etc.
And while I expect holiday sales to be robust, for reasons I will explain in a moment, I have some concerns about what is to come after. Will the American consumer go on a drunken spending binge as one last hurrah before what everyone expects to be a protracted recession? Or will financial sense reign supreme and cause consumers to tighten their wallets heading into the busiest time of year?
Consumer Debt Explodes
We follow economic data every week and discuss the prescient points with you every week on our Market Wrap video series. And one of this week’s key data points heading to the holidays is consumer spending. The good news is that it is up. The bad news is that a lot of it is being put on credit cards.
Per the Fed, household debt has increased the most in 15 years, leading the Fed researchers to comment that the increase “towers over the last eighteen years of data”. That certainly doesn’t sound like what we want to hear. After all, a healthy consumer equals a healthy economy.
Total consumer debt jumped by $351 billion in the last period, led by mortgage and credit card debt. With rising interest rates, it makes sense that debt balances would jump a bit to accommodate for higher borrowing costs. What will be interesting to watch is how far housing prices have to fall to offset the increase in interest costs, and whether that adjustment will moderate the downturn in housing that has already begun.
The above pic is from my recent research video on home prices, and as you can see they have surged mightily since 2000. The problem is, so has inflation. And that means real home prices are not as robust as one may think, leading to a false sense of security in household net worth.
Recent surges in real estate prices have been driven not only by demand from healthy population growth, but also by a surge in materials, labor, and marketing costs. Meaning, real estate is not as lucrative for the average homeowner as one would believe. Here is the same data, inflation-adjusted.
While home prices have increased, the value of real estate hasn’t returned quite what many homeowners think. What will be harder to digest is the flattening of real estate during a recession. As economic problems reduce consumers’ discretionary income at the same time costs and interest rates are rising, I expect housing to continue to come under more pressure.
Credit Cards Are a Problem
Higher credit card balances now mean less discretionary income later. Higher credit card spending is no doubt due to the holidays and all the expectations our commercial economy has thrust on the average household. Buy a turkey, travel to an exotic location, buy Christmas gifts for your loved ones, and spend spend spend!
While consumers spent a $trillion in the last year on mortgages, close behind are credit card balances which have increased by $930 billion. In fact, credit usage has jumped 15% from this same time last year. So, it’s not just the holiday season that is contributing – we know that prices are just getting more expensive across the board. That is why I believe the consumer will spend more this holiday season, while receiving a lot less than they are used to.
In that mix are also student loan balances at $1.57 trillion and auto loan balances at $1.52 trillion. That is multiple trillions of debts upon a consumer that does not have the ability to weather higher prices, and interest rates, or to save for retirement. That’s not a good recipe for the near future, in terms of economic growth and GDP.
What Comes Next
The economy is ripe for a deleveraging event, which will no doubt occur during the next recession which I don’t think is far off. If I am being honest about my trust in government numbers, I would say we are already in a recession. But semantics isn’t going to matter in 6 months anyway when it is obvious the economy needs to cool down and take a nap for a while.
The tech sector is already deleveraging, with Amazon now saying it will cut 10,000 jobs. I expect more of this in the tech space which has suffered a large correction so far in 2022. The economy is telling companies to slow down and that is exactly what they are doing.
So far we are in the normal business cycle cooling-off period, but I do expect to have a bigger deleveraging event, which is rooted in lax lending and consumer debt policies that have existed for over two decades. Meaning, a bigger economic plunge is due. It will be one needed to clean out badly misallocated capital and restore stricter lending requirements on the banks while forcing consumers to clean up their personal balance sheets.
And this deleveraging stage will likely last several years at the least. I will document why I think that is the case in future articles, where we will have the space to explore it in sufficient length and detail.
Coin of the Week
After a week off, the coin of the week series is back! For this week, I really like the Perth Lunar series. I LOVE the Australian Gold Lunar Tiger coin. I wasn’t born during the year of the Tiger, but really wish I was. Tigers are such majestic and strong animals who prowl the countryside as kings of their domains.
