Bearish investors and traders argue that U.S. corporate & household debt is too high. They think that private sector debt will crush the U.S. economy and stock market right now. I disagree. This will be a problem in a few years, but it isn’t a problem right now. Here’s why.
Debt is high in nominal terms
Permabears love to say “debt is now higher than it was in 2007!” That’s a misleading thing to say.
Debt will ALWAYS go up in the long term because
- The economy grows in the long run. Liabilities go up with assets over the long run.
- Inflation means that $100 in debt today is not the same thing as $100 in debt 30 years ago.
That’s why nominal debt is meaningless. Here are examples of private sector debt that seems scary, but are ok when adjusted into percentage terms.
Here’s nonfinancial corporate business’ debt securities.
Here’s mortgage debt outstanding.
Here’s households and nonprofit organizations’ consumer credit.
When put into percentage terms, debt has actually been falling throughout this economic expansion.
Debt is low in percentage terms
U.S. private sector debt levels are not a problem right now, particularly on the consumer side.
The household debt-to-GDP ratio for the U.S. has been falling throughout this economic expansion!
Household Debt Service Payments as a Percent of Disposable Income is more important. It’s easy for consumers to spend more money when debt service payments are low. Rising debt service payments will slow down economic growth because consumers can no longer afford to borrow as much money to finance their purchases.
Notice how debt service payments (as a %) are historically low. This is because:
- Interest rates are still extremely low (historically).
- Debt levels as % of GDP are falling.
Likewise, Mortgage Debt Service Payments as a % of Disposable Personal Income has been falling throughout this economic expansion.
All in all, U.S. Household Debt as a % of Total Assets has been falling throughout this economic expansion. In addition, U.S. Corporate Debt as a Ratio of Profits is below the long term average. Corporations have no problem servicing their debt right now. Many U.S. companies are sitting no record piles of cash.
Most importantly, total U.S. Private Sector Debt as a % of U.S. GDP has been going down throughout this entire economic expansion.
Permabears love to cherry-pick the data to fit their market views. Doing so is dangerous, which is why permabears have been wrong for 10 consecutive years since 2009. They will be right one day. But timing is everything. If permabear XYZ says SELL, the stock market rises 5x and then crashes 50%, permabear XYZ is not “right”. The market is still up 2.5x!
Permabears point to the Delinquency Rate on Credit Card Loans as a sign that the economy and stock market are about to crash.
What they don’t tell you is that the above chart is for Banks not in the 100 largest by asset size.
Keep in mind that the 100 largest banks account for more than 95% of all deposits! We need to look at the delinquency rate for ALL BANKS.
The delinquency rate is still very low, even though it has been rising. This is not a concern right now, but it will be a concern in 2019 and 2020 when this goes higher.
Mortgage delinquency rates are still going down.
Likewise, delinquency rates on commercial & industrial loans are still going down
Delinquency rates on all consumer loans are going up. But the delinquency rate is still much lower than where it was when historical bear markets and recessions started.
When it will become a problem
U.S. private sector debt will not cause an economic recession or bear market in stocks right now. Debt is still serviceable because:
- Interest rates are still extremely low.
- Debt as a % of GDP is still going down.
Debt will be a problem in 1-2 years when interest rates are much higher than they are today. Debt becomes a problem when servicing it becomes difficult.
*We can see that interest rates are still historically low if we use the 10 year Treasury yield as a benchmark for interest rates.