Goldman's Hatzius: US's Household Debt Slowdown

And we Jan Hatzius from Goldman Sachs analyzes the american Flow of Funds report.
Nothing really new, but the re-acceleration of household deleveraging.

He cites this fact as one of the reasons why we're seeing a slow down in the US that goes beyond Japanese-supply-chain-disruption.

Goldman Sachs Research
US Daily: Deleveraging Continues in Early 2011 Print Friendly

Published 05:40 PM Tue Jun 14 2011
Jan Hatzius

The Fed's flow of funds report for the first quarter shows continued deleveraging in the US economy. The broadest measure of debt owed by the nonfinancial sectors -- which includes the borrowings of private households, nonfinancial businesses, and all levels of government -- grew just 2.3% (annualized) in the first quarter. As shown in the first chart below, this was the third-slowest pace on record; only the second half of 2009 was lower.

One key reason for this weakness was the continued paydown of household debt. In the first quarter, nominal household liabilities declined by 2.0% (annualized), the twelfth consecutive quarter of debt paydown, as shown in the second chart below. This has taken the ratio of household debt to disposable income down to 114%, from a peak of 130% in 2007.

The implications of the ongoing deleveraging process for the economy are double-edged. On the one hand, it partly explains the weakness of US economic activity in 2011 so far. The US private sector is still running a financial surplus of 6.3% of GDP, which means that the level of spending remains unusually far below the level of income. At a time when real income growth has been restrained by the sharp increase in energy prices, this has depressed the growth pace of spending.

On the other hand, the deleveraging suggests that households have continued to repair their balance sheets and are thereby increasing their ability to spend in the future. The Federal Reserve Board publishes quarterly data for the household debt service burden, defined as interest payments plus scheduled principal repayments as a share of disposable income. Although figures for the first quarter will not be available until later this week, the fourth quarter of 2010 showed a drop in the debt service burden to 11.8%, the lowest since 1998 and down from a peak of 14% in 2007.

The decline in the debt service burden is translating into an improvement in household credit quality. According to the New York Fed, newly delinquent loans to households in the first quarter fell to $250 billion or 2.2% of total household debt outstanding, down from a peak of $405 billion or 3.3% of total household debt outstanding in the fourth quarter of 2008. In turn, improved credit quality is translating into a greater willingness of banks to make loans to consumers. The Fed's quarterly Senior Loan Officers' survey showed that the net share of banks indicating greater willingness to make consumer installment loans rose to 28.8% in the second quarter, the highest reading since 1994.

Over time, these improvements should feed into a pickup in household spending growth. Eventually, households will find that they have cut their debt stock sufficiently. At that point, spending should increase relative to household income. In turn, this should feed into stronger aggregate demand for good and services, as well as positive multiplier effects in the labor market that again feed back into stronger income growth. The recent data suggest that this is a slow process, but we continue to believe that it will ultimately result in a stronger US economy.

Jan Hatzius

*Disclaimer: charts and data are presented as I receive/see them. Sources are usually not checked for validation and my own calculations are of 'back of the envelope'-type. I am aware that some math that I do myself might be wrong and/or misleading to some extent. In financial markets the rate of change of economic data is often more important than the actual level and the perception of 'what is priced in' is more important than 'what is actually going to happen'. This is actually the way people pick entry and exit points. So... yes, sometimes you might say 'This guy is an idiot, this is way wrong!' with a high conviction, being right. Not to worry. Markets are made of expectations and the clash of conviction between its participants. Portfolio managers know that being an idiot is sometimes profitable and being smart is often a bad choice. It is all reality, sometimes good, sometimes bad. By the way: corrections to my analysis and intelligent debate is welcome. theintriguedtrader AT gmail do com

Regarding Japan... more comments.

I got a few questions about the presentation on Japan... and I'd like to present here my answers to one of the emails.

Did my view change after the quake? No. Same direction. Only greater odds.
Many people bet on a Japanese Armageddon before and lost. Is this time different? That I don't know. Making money is different than 'being right'.

------

As I mentioned on my blog, the tragic incidents just make the case more compelling.

Pillars to growth: (A) productivity gains + (B) population growth + (C) capital invest in (A)+(B).

What are the key problems the country currently has:
(A) An already very high level of productivity: where will more productivity come from?

(B) Decreasing population and bad outlook for immigration: a possible solution to this problem, unlikely to happen due to cultural issues. Who wants to move to Japan? Tough society there.
(B) Worsening demographic distribution: reduced labor force
 

(C) Worsening demographic distribution: increased social security spending

(C) Decreasing tax-base (due to the above items)
(C) Bad outstanding gross and net public debt

(C) Private savings don't look too good: this is where I have difficulties in tracking data. I assume that a lot of their savings is abroad.

Their survival in the past years: An economy that gets a lot of its juice from net exports

With the earthquake and the following tsunami, which adds an apparently short/medium term energy problem, what changes from the above?

- Postponing hopes-of-growth to an ‘era’ of even worse demographics.

- Confidence worsens among citizens and business men. Slowing in consumption and private investment

- Even smaller tax-base and tax revenues, at least temporarily, likely for a good period.
- More public spending necessary to rebuilding basic infrastructure / lending to energy generation, bailing companies out: more debt

- Reconstruction costs are not to increase capacity, but to get back to existing capacity. 

**One plus: capacity might be more efficient.
- Likely more businesses which will not be willing to invest in Japan considering its long-term geographic / seismic risks, demographic outlook (less labor supply, more expensive labor, relative to world)

- Revaluation of the 'just-in-time' mentality

- If the corporate tax rate decrease that was being discussed happens, will business really come? Or will tax revenues just plunge?
- Lost momentum in economic growth
- Worsened momentum for the global economy (check out Mexican and American Auto production)

So... regarding the "people died on this trade" comment, many people have bet against Japan, hopefully aware that they could be wrong.

Investing is a risky business and without taking on risks there are no possible returns.

Now we see the early guys were wrong (if they shorted equities they made money!).

But people who bought Greek 5y CDS @ 5bps 4 years ago spent 5bps for 4 years (20bps total) and now are gaining +1200. 1200 – 20 = 1180 / 20 = 59x its LIMITED possible loss (max was actually 25bp).

It works the same for even US/Germany/UK/Japan CDS. Traded below 10bps/year and now are over 50bps. That’s quite a risk-reward bet.

I am sure that all the Central Banks and Governments are against me on this trade, but these are the same guys who said the US was healthy in 2007. And in many other occasions. I read this in many books/reports.. "If it can't go on forever it won't". Not sure who wrote this, but hey.. "It won't" might be within 3 years. It was 2007 for the Housing Bubble. It was 2000-2001 for TMT.

For Japan, the net-trade motor is worse (terms of trade keep getting worse), there is a larger debt-pile, worse demographics, all other developed economies are screwed too. The world is awash with debt... and inflation. If there's tightening... the interest expense becomes birds... it flies all over the place.

How likely is this trade to be successful? I'm not sure, but odds have certainly improved. The bet is relatively cheap compared to its possible returns.

Another very important fact is that this bet is part of a portfolio. It is not an all-in poker play. It is a piece of the puzzle within an investment portfolio. There are bets on currencies, rates, credit, worldwide. This is one of them. Most of them have a similar expected returns, but if the probability of this one goes to 10%-20% its realized return will be multiples of the other more likely bets'. We're trying to get more good trades, than bad trades. We're trying to have larger winners and smaller losses. People who never lose are likely cheating or about to go bust. It's very, very simple.

Good luck to us all!
The Intrigued Trader

*Disclaimer: charts and data are presented as I receive/see them. Sources are usually not checked for validation and my own calculations are of 'back of the envelope'-type. I am aware that some math that I do myself might be wrong and/or misleading to some extent. In financial markets the rate of change of economic data is often more important than the actual level and the perception of 'what is priced in' is more important than 'what is actually going to happen'. This is actually the way people pick entry and exit points. So... yes, sometimes you might say 'This guy is an idiot, this is way wrong!' with a high conviction, being right. Not to worry. Markets are made of expectations and the clash of conviction between its participants. Portfolio managers know that being an idiot is sometimes profitable and being smart is often a bad choice. It is all reality, sometimes good, sometimes bad. By the way: corrections to my analysis and intelligent debate is welcome. theintriguedtrader AT gmail do com

Is Spain the new Greece? Nah, they can't hide a debt-swap with GS!

So interesting stories making rounds this morning...

09:51:27  XXXXXX XXXXXXX: Basically saying that after the upcoming local elections, Spain will reveal much larger than expected deficits.

FT May 16th - ‘Hidden’ debt raises Spain bond fears

The report notes that the risk premium for the regions, as measured by the interest rate spread over benchmark German Bunds, is double that of the Spanish state, suggesting the markets have little faith in their ability to pay and will be reluctant to refinance them in the months ahead.

 

FT Alphaville May 18th - Spain’s peripheral problems – €26.4bn of hidden debt?

Bloomberg Jan 4th - Spain’s Catalonia Region Says Missed 2010 Budget-Deficit Target

UBS's WM Chief Economist - 2011: A Volatile World

A simple presentation on the debt issues of our beloved globe that speaks about that one currency basket I have been interested in since last year.

Andreas was in Brazil presenting this to local investors. I wasn't there, but hearing about this presentation I got interested and went after it. Enjoy.

2011 05 16 - UBS - Andreas Hoefert

*Disclaimer: charts and data are presented as I receive/see them. Sources are usually not checked for validation and my own calculations are of 'back of the envelope'-type. I am aware that some math that I do myself might be wrong and/or misleading to some extent. In financial markets the rate of change of economic data is often more important than the actual level and the perception of 'what is priced in' is more important than 'what is actually going to happen'. This is actually the way people pick entry and exit points. So... yes, sometimes you might say 'This guy is an idiot, this is way wrong!' with a high conviction, being right. Not to worry. Markets are made of expectations and the clash of conviction between its participants. Portfolio managers know that being an idiot is sometimes profitable and being smart is often a bad choice. It is all reality, sometimes good, sometimes bad. By the way: corrections to my analysis and intelligent debate is welcome. theintriguedtrader AT gmail do com

Japan: The Land of The Setting Sun

*** PRESENTATION UPDATE: June 2011 ***

Find below a presentation I put together in January/February about Japan.

After reading a lot about the subject from people like Kyle Bass, Hugh Hendry, John Mauldin, David Einhorn and others, I decided to study it too. I like these guys because they demonstrate they have sound investment processes and play their ideas through ways that give them a big upper hand in case they're right x what they would lose if wrong. A lot of money managers do the opposite. They gain small for a long time until they don't. And they're gone.

The data presented was sourced from a variety of entities and might not be 100% accurate/on the spot, but it sure gives you a very good idea about where Japan now stands in terms of growth potential, debt sustainability and risk-reward. It hasn't been updated to include after-earthquake/tsunami economic data and governtment/central bank response, however these tragic facts only make the case even more interesting. In my opinion they only increased the probability of my desired outcomes.

At the end I presented trade ideas that, together, from what I call the pillars for the bet against Japan.
Pricing has, of course, changed since then, but not a lot. As others have mentioned, the asymmetry is huge.

The final word on this trade is simple: confidence. If the music stops for JGBs, Japan could be gone quickly.

And if the trade proves to be correct the owner of the bets must therefore be worried about who the counterparties are. Because OTC dealers could be wiped out.

The Tail Chaser - The Land of the Setting Sun

*Disclaimer: charts and data are presented as I receive/see them. Sources are usually not checked for validation and my own calculations are of 'back of the envelope'-type. I am aware that some math that I do myself might be wrong and/or misleading to some extent. In financial markets the rate of change of economic data is often more important than the actual level and the perception of 'what is priced in' is more important than 'what is actually going to happen'. This is actually the way people pick entry and exit points. So... yes, sometimes you might say 'This guy is an idiot, this is way wrong!' with a high conviction, being right. Not to worry. Markets are made of expectations and the clash of conviction between its participants. Portfolio managers know that being an idiot is sometimes profitable and being smart is often a bad choice. It is all reality, sometimes good, sometimes bad. By the way: corrections to my analysis and intelligent debate is welcome. theintriguedtrader AT gmail do com

Speaking of currencies...

Heck if this is important, but I will post this anyway. It is an introduction to what will follow.

Below 2 charts.
- UK's Non-EU Trade Balance, 12m rolling sum, in 10^6 GBP.
- UK's Total Trade Balance, 12m rolling sum, in 10^6 GBP.

The trend seems clear. An american high-school cheerleader would say something like "Oh. My.God. The Industrial Revolution is soooo 1800's".

The country has bad deficits, high debt-to-GDP, banks that were nationalized, activity that has been stagnant for the past 6 months, high unemployment, high inflation and still loose monetary policy. Did I mention they're tightening fiscal policy (still loose). Issues with London losing the battle against other global financial centers.

Would you like to buy Sterling? Only if I had the time to go check out the Royal Wedding, my friend!

The GBP is included in the "Printing-Presses" currency category I have here on my side together with the USD and the EUR.

The JPY should be included also as these guys are THE owners of Canon, Kyocera and the likes. They MASTER the skill of printing. They invented Quantitative Easing! BUT, on the other hand, since their stocks have moved down 75% since their bubble peak in 1989-90 and their bonds can't go much higher (bad risk-reward, 30year @ 2.03% with 105% net debt/GDP, 200% gross debt/GDP, bad demographics, low savings rate) they have been investing abroad for years. Their stock of wealth abroad is massive. So, contrary to what is considered common-sense for every other country in the world, the japanese currency, the yen, actually appreciates when there are market stresses. Natural disasters, financial disruptions, etc, all make the Yen go up, especially against the USD. Wow. Now add positive net-exports flows... Positive current-account... and you get the Central Bankers of the world intervening in the market selling the yen to try to stop the trend. Right after the earthquake we heard from a currency dealer 'Our yen books are cleared now. ALL stop-losses have been triggered". That was right after the JPY rose 3.80% in 15-minutes. And the BoJ came to the market.

So if I were to add the JPY to a basket of currencies it would be on the 'long vol' side. Buy long-term deeply out-of-the-money YEN puts while buying some spot JPY. Why? Well, it seems to reduce the overall volatility of the basket in periods of stress.

A basket I am very interested in at the moment is:
- short USD, EUR, GBP (33% each), perhaps short 3-5% AUD.
- long BRL, CLP, CAD, NOK, CHF (30% / 15% / 20% / 20% / 15%)

I'd include the JPY on the long side @ 5% of the basket, to reduce stress-volatility, increase the sharpe of the trade, taking 1% from each other currency, like the CHF.

This basket has a decent carry, especially nowadays!, bets against bad balance sheets and negative real interest rates.
The long side is structural commodities + higher growth + better stablished banking system (CHF = gold) + bit better demographics

It has performed very well since the end of the crisis, 15%+ since June 2010. And I expect it to keep performing well.
Downside risk is massive stress, like seen in 2008, before the printing presses are set to full-throttle again.

Even though the long-countries have better balance sheets they're still net-debtor. A lot of foreign capital within these economies that could be pulled out. Their higher growth is of course dependent on that. Not to mention their foreign reserves that contain US Treasuries, etc.

Anyway... Currency trends tend to last for years, decades and I do not think we're at a turning point yet. If you consider the drivers of growth on the two sides of the equation here I believe the basket is looking good: (A) population growth + (B) marginal productivity gain. The only time this doesn't work is when there's no capital to support A+B, which is global financial stress.

So... what do you think? Emails to theintriguedtrader@gmail.com are welcome with a brief background of yourself.

*Disclaimer: charts and data are presented as I receive/see them. Sources are usually not checked for validation and my own calculations are of 'back of the envelope'-type. I am aware that some math that I do myself might be wrong and/or misleading to some extent. In financial markets the rate of change of economic data is often more important than the actual level and the perception of 'what is priced in' is more important than 'what is actually going to happen'. This is actually the way people pick entry and exit points. So... yes, sometimes you might say 'This guy is an idiot, this is way wrong!' with a high conviction, being right. Not to worry. Markets are made of expectations and the clash of conviction between its participants. Portfolio managers know that being an idiot is sometimes profitable and being smart is often a bad choice. It is all reality, sometimes good, sometimes bad. By the way: corrections to my analysis and intelligent debate is welcome. theintriguedtrader AT gmail do com