Household Deleveraging Ending
There has been much written and discussed about how the current economic recovery has been subpar and disappointing compared to prior recoveries. Likewise, there have been as many thoughts about why that is the case and what should be done about it. Ask any economist, politician, or market pundit and you will get a long list of causes and solutions.
Whatever the explanation for the less-than-ideal recovery, there is currently a significant change taking place that should start to provide a meaningful tailwind to the economy. It now appears, after almost six years of healing, households have regained enough confidence to resume the use of credit.
This first chart presents the percentage of disposable personal income that households pay to meet their total debt service and other financial obligations. At the end of 2007, households were paying more than 18% of their disposable incomes to satisfy their debt obligations. This was a level that had been steadily increasing since the early 1990s. Most of this increase was related to rising mortgage obligations that were a function of the prior housing boom.
Since 2007, in just six years, households either chose or were forced to reduce their debt obligations as a percent of disposable income from over 18% to less than 15.5%. Currently, this ratio is at the lowest level in 30 years, reversing the entire buildup since the early 1990s and more.
It now appears this financial obligation ratio is bottoming and could begin to rise again. Supporting this idea has been the recent inflection in total household debt.
Presented above is the total amount of debt held by all U.S. households (in trillions of dollars). Since peaking in late 2008 at about $12.7 trillion, by mid-2013 total household debt declined to a low of $11.2 trillion. In just about five years, U.S. households have reduced their total debt by $1.5 trillion.
This has been a significant event in the credit markets and for the banking industry. In fact, some analysts suggest this was a main cause of the Federal Reserve’s aggressive actions regarding quantitative easing. We tend to agree with this view. In other words, as household debt was reduced, the Federal Reserve largely filled the gap with quantitative easing (bond purchases).
The good news for the economy is that during the last six months, households are again taking on debt. This is occurring mainly due to the mortgage markets. Mortgages comprise about 75% of total household debt and, therefore, are the main driver. Mortgage debt creation appears to be bottoming.
This final chart shows levels of total household mortgage debt going back to 1945. During this 68-year period, there have been 11 official economic recessions. None have seen the kind of mortgage debt contraction that followed this last recession. From the peak in early 2008 to mid-2013, mortgage debt contracted more than $1.3 trillion or almost 90% of the decline in total household debt. For the last six months, mortgage debt has been flat to slightly up.
This represents the removal of a significant drag on the U.S. economy and the credit markets. Even if mortgage debt remains relatively flat in the future, the economy will not need to be offsetting this significant contraction. This should allow healthier parts of the economy to exert more impact and allow for overall growth to improve.
Stronger U.S. economic growth should allow the Federal Reserve to continue tapering bond purchases, help bring down the unemployment rate, and allow interest rates to continue to normalize (see prior Market Commentary, Interest Rates Need To Normalize). All of this should be encouraging for stock investors.
We remain focused on understanding the current trends in fundamentals because it gives us the best probability for success.