As we move into the dog days of August, both equity and bond markets have experienced some seasonal weakness due to Fed taper fears and some weaker-than-expected earnings reports. Historically, August and September are relatively poor months for equities and with concerns about the Fed taking its foot off of the liquidity gas, equities may take a breather. That said, we believe there is a 50/50 chance the Fed will begin to taper their bond buying at the September meeting, but this will be contingent on economic data for the next month.
Retailers delivered mixed results this week with disappointing reports from Macys and Wal-Mart. In both instances the retailers were able to maintain pricing, but volumes were weak. In short, consumers are going to the stores, but they are being more selective in their purchases. Macy’s did state that August back-to-school shopping showed a nice pick up. We have seen some positive recent data with weekly jobless claims continuing to make post-recession lows and consumer confidence has been in an upward trend since mid-April. While these data points are positive, we realize that they are modest and may stagnate. Though the U.S. economy is improving and we are seeing improvements in northern Europe; however, as Cisco CEO John Chambers stated earlier this week, the recovery is “inconsistent.”
With consumers purchasing less, we are seeing a deleveraging of their personal balance sheets. Mortgage debt declined meaningfully as consumers refinanced at lower rates. Credit card debt remained stable, but auto loans saw a nice increase. While mortgage and credit card debt are meaningfully below their pre-recession peaks, auto loan is back to peak levels. We believe that with relatively low interest rates and an aged auto fleet, consumers will continue to upgrade their auto purchases. The average car in the U.S. is now 11.2 years old while in 1995 it was 8.4 years old. For the time being, rising interest rates won’t have a negative effect on auto loans since these loans are based on Prime, and until the Fed begins to raise the funds rate, prime will remain low.
Unfortunately, the deleveraging theme is not occurring for young college graduates as student loan debt reached the $1.0 trillion mark and shows no signs of declining. While one can debate if the loans are “worth it,” the load of debt post-graduation will impair spending. We are already seeing red flags in this market with delinquency rates meaningfully above historic levels. Over 30 percent of student loan borrowers are at least 90-days delinquent compared to 10 years ago when less than 20 percent were. There are now concerns that recent graduates may be less likely to start a small business due to their debt burden. Unlike the mortgage and credit crises of 2007 and 2008 which had a devastating effect on the banking sector, the Federal government (or U.S. taxpayer) back the student loans.
Our Takeaways from the Week:
- Though equities are in the midst of a pullback, we believe stocks will be higher by year-end
- Economic data continues to show improvement, but the pace remains tepid