US Federal Reserve

When Japan ruled the world

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30 years ago 32 of the 50 largest corporations by market cap were Japanese. Telco NTT was #1 followed by 4 megabanks. Scroll forward to today and there is only one Japanese corporation that makes the Top 50 cut – Toyota Motor (#35). Now, the top 33 of 50 companies are American – Apple, Amazon, Google, Microsoft and Facebook.

 

The gender unemployment gap

Changes in the Gender Unemployment Gap during Recessions

Another interesting piece was written by the St Louis Fed showing the gender unemployment gap of men relative to women. A negative spread shows that women have lower risk of unemployment relative to men in the 24 months after the start of a recession. Looking at the chart we see that in 1960 & 1969 female unemployment tended to rise relative to men after a recession began but in the following downturns of 1973, 1980, 1990, 2001 and 2007 the situation reversed. Participation rates for women in the workforce hovered at around 40% in 1970 vs 60% today. In 2007, the most aggressive spread emerged in favour of women by over 2%. The Fed report does not include what types of roles that women tend to do. Switching to the Bureau of Labor statistics (BLS) it makes sense that women over time have been retrenched at lower rates than males due to field of employment.

Women today tend to occupy more jobs in education, nursing, healthcare (defensive industries) whereas men tend to work in more construction, agriculture and manufacturing specialties (levered industries).

In 2017, employment breakdown between men and women was as follows.

employment of men by industry BLS的圖片搜尋結果

Another interesting table from the BLS was that of educational standards of 1970 compared to 2010. As we can see more women are pursuing higher levels of education. 67% in 2010 took some college or higher degree vs only 22% in 1970. One would imagine in 2018 those numbers are higher again.

Where men once went to college in proportions far higher than women—58% to 42% as recently as the 1970s—the ratio has now almost exactly reversed with women comprising more than 56% of students on campuses nationwide, according to the U.S. Department of Education (DoE). Some 2.2 million fewer men than women will be enrolled in college this year. By 2026, 57% of college students in the US will be women.

It will be interesting to see how the gender unemployment gap develops during future recessions with a far higher level of educated women in the workforce.

The financial health of Millennials

Changing Balance Sheet across Generations

The St Louis Fed has published a report on Millennial balance sheets, comparing them to Gen Xers. The average value of total assets was lower among millennials than Gen Xers. Millennials held an average of $162,000 of assets relative to Gen X’s average of $198,000. The report also found that Millennials held a slightly higher level of total debt, at an average of $72,000 compared to Gen X’s average of $67,000. However the composition was markedly different – average student loan levels surged from $4,200 for Gen X to $14,700 for millennials. In short, millennials’ average asset position is lower, while they hold slightly more debt, which leads to an average net worth of $90,000 for millennials and $130,000 for Gen X.

In closing the report notes,

We observe that millennials have been going to school longer and delaying major life events. Thus, it makes sense that they hold lower levels of assets. They have had less time in the labor force, and a smaller share of them have moved out on their own, which contributes to the lower levels of residential assets. However, they have shown a higher propensity to save for retirement and to avoid credit card debt.

Why discontinue?

USFEDBS

This is a chart of the change in the US Fed balance sheet, a series that has just been discontinued. Is this because the Fed is about to step up its activity and offering wider disclosure on tapering activity might spook markets? Given that 72% of the growth in S&P earnings has been driven by buybacks since 2012, it stands to reason the market is not exactly providing the type of confidence inducing organic lift the index reflects. Bank of America revealed that “net buying of Tech sector in the 1H was entirely buyback-driven.” 

Kind of reminds CM of the day Bernanke’s Fed announced it would no longer report M3 money supply a year before the financial markets headed into the GFC. CM estimated on p.4 of a report several years ago that M3 money supply by 2018 on constant long-term growth rates would turn into around $35 trillion from the $10 trillion at the time it was discontinued.

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Nothing to see here? Throw a deteriorating fixed income market with fewer buyers and corporates that have binged on cheap credit to fuel buybacks, it doesn’t look like the stuff dreams are made of. The chart below shows that quarterly pre-tax US profitability is struggling since 2011. Earnings (E) are not doing so well. It is by the grace of falling number of traded shares (S) that makes the EPS look flattering.

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We took the liberty of comparing corporate profitability since 1980 and correlating it to what Moody’s Baa rated corporate bond effective 10yr yields. An R-squared of almost 90% was returned.

US Moodys corp

Why not use the Aaa spread instead? Well we could do that but looking over the last decade the average corporate debt rating profile looks like this. We have seen a massive deterioration in credit ratings. If we look at the corporate profitability with Baa interest rates over the past decade, correlation climbs even higher.

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We shouldn’t forget that the US Government is also drunk on debt, much of it arriving at a store near you. $1.5 trillion in US Treasuries needs refinancing this year and $8.4tn over the next 3.5 years. Couple that with a Japan & China pulling back on UST purchases and the Fed itself promising to taper (but now hide the results of) its balance sheet. So as an investor, would you prefer the relative safety of government debt or take a punt on paper next to junk heading into a tightening cycle?

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Discontinuation of series always carries a sense of deep cynicism for its true intention. It is not an onerous data set to cull. Sure we can fossick around and try to find it hidden in the archives of the Fed website but the idea is that they probably don’t want to publicise how much more they intend to flog.

Jan 2008 again?

3mthTB

Back to Jan 2008 10yr Treasury – 3mth Treasury Bill spread levels of 0.84% overnight. Shaded areas are previous recessions. I’m sure it is nothing. The friend who sent me the link also sent a Barron’s article last week which interviewed Kiss legend Gene Simmons who believes the Dow is poised for 30,000. He may well be proved right, although I wonder just whether algo trading is linked to Twitter followers. Maybe if Katy Perry starts jawboning about Dow 40,000 we should shut up and buy the trend. More useful than some Goldman Sachs nerd with a PhD in nuclear fission to read the runes…

10-3mthTB

GEzus Priced super far?

US Corp prof.pngIt is not rocket science. Generally higher interest rates lead to lower profitability. The chart above shows that quarterly pre-tax US profitability is struggling. We took the liberty of comparing the profitability since 1980 and correlating it to what Moody’s Baa rated corporate bond effective 10yr yields. An R-squared of almost 90% was returned.

US Moodys corp

With the Fed moving toward a tightening cycle, we note that the spreads of Baa 10yrs to the FFR has yet to climb out of its hole. During GFC it peaked at 8.82%. It is now around 3%.

US Moodys

Why not use the Aaa spread instead? Well we could do that but looking over the last decade the average corporate debt rating profile looks like this. We have seen a massive deterioration in credit ratings. If we look at the corporate profitability with Baa interest rates over the past decade, correlation climbs even higher.

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Corporate America binged on cheap credit over the last decade and given the spreads to Aaa ranked corporate bonds were relatively small, it was a no brainer. In 2015, GE’s then-CEO Jeff Immelt said he was willing to add as much as $20 billion of additional debt to grow, even if it meant lower bond grades. We can see that the spread today is a measly 0.77%. Way off the 3.38% differential at the time of GFC. Still nearly 50% of corporate debt is rated at the nasty end.

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We shouldn’t forget that the US Government is also drunk on debt, much of it arriving at a store near you. $1.5 trillion in US Treasuries needs refinancing this year and $8.4tn over the next 3.5 years. Couple that with a Japan & China pulling back on UST purchases and the Fed itself promising to taper its balance sheet. So as an investor, would you prefer the safety of government debt or take a punt on paper next to junk heading into a tightening cycle?

E0F20948-4A5A-48F1-B8AF-06FA92EBAC7A

In any event, the 4.64% 10yr Baa corporate bond effective yield is half what it was at the time of GFC. Yet, what will profitability look like when the relative attractiveness of US Treasuries competes with a deteriorating corporate sector in terms of profitability or balance sheet?

Take GE as an example. Apart from all of the horror news of potential dividend cuts, bargain basement divestments and a CEO giving vague timelines on a turnaround in its energy business things do not bode well. Furthermore many overlook the fact that GE has $18.7bn of negative equity. Selling that dog of an insurance business will need to go for pennies in the dollar. There is no premium likely. GE had a AAA rating but lost it in March 2009. Even at AA- the risk is likely to the downside.

Take GE’s interest cover. This supposed financial juggernaut which was at the time of GFC the world’s largest market cap company now trades with a -0.17x interest coverage ratio. In FY2013 it was 13.8x. The ratio of debt to earnings, has surged from 1.5 in 2013 to 3.7 today. It has $42bn in debt due in 2020 for refinancing.

By 2020, what will the interest rate differentials be? There seems to be some blind faith in GE’s new CEO John Flannery’s ability to turn around the company. Yet he is staring at the peak of the aerospace cycle where any slowdown could hurt the spares business not to mention the high fixed cost nature of new engines under development. In a weird way, GE is suffering these terrible ratios at the top of the cycle rather than the bottom. Asset fire sales to patch that gaping hole in the balance sheet. Looks like a $4 stock not a $14 one.

Chapter 11 bankruptcy filing trends in the US surging

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The Chapter 11 bankruptcy trends in the US have been picking up in the last 4 years. While well off the highs of the months and years of the GFC and years following it, the absolute numbers of filings has exceeded the levels leading up to the crisis in 2007/8.

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Here we put 2006/7/8 alongside 2016/17/18. The average monthly bankruptcy filings were around 355 in 2006 moving to 429 in 2007 and then 718 in 2008. If we looked at the data in the 12 months prior to the quarter leading into Lehman’s collapse, bankruptcies averaged 463/month. The ultimate carnage peaked out at 1,049 in 2009 (1,377 in Apr 2009). For 2016, 2017 and 2018 (annualized) we get 454, 480 and 521 respectively.

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Bankruptcy filings tend to be seasonal and often show peaks in April when tax season coincides with businesses.

However the %-age spike in bankruptcies in 2008 ahead of Lehman’s downfall was 46%. In the latest recorded month from the American Bankruptcy Institute (ABI) was 81%. This March 2018 spike is the second highest since the GFC hit. April figures will be interesting if we get another lift on that figure. Not even seasonality can explain away the differences. The trends seem clear.

Thinking logically, we are at the end of the generous credit cycle. Interest rates are heading north thanks to a less accommodating Fed. Naturally ‘weaker’ companies will have more trouble in refinancing under such environments. The lowering of corporate taxes would seem to be a boon, but with loss making businesses it becomes harder to exercise tax loss carry forwards.

We’ve already started to see GFC levels of credit card delinquency at the sub-prime end of town. Sub-prime auto loan makers seeking bankruptcy protection have surged too.

Fitch, which rates auto-loan ABS said the 60+ day delinquency rate of subprime auto loans has now risen to 5.8%, up from 5.2% a year ago, and up from 3.8% in February 2014 to the highest rate since Oct 1996, exceeding even GFC levels.

growing number of car loans in the US are being pushed further down the repayment line as much as 84 months. In the new car market the percentage of 73-84-month loans is 33.8%, triple the level of 2009. Even 10% of 2010 model year bangers are being bought on 84 month term loans. The US ended 2016 with c.$1.2 trillion in outstanding auto loan debt, up 9%YoY and 13% above the pre-crisis peak in 2005.

The irony here is that sub-prime auto loan makers expanded lending because new technology allowed these companies to to remotely shut down and repossess vehicles of owners who were late on payments. That game only lasts so long before it forms its own Ponzi scheme.

Throw skittish financial markets, geopolitical instability and the mother of all refinancings coming the US Treasury’s way it is not to hard to see bankruptcies pick up from here.