Epsilon Theory: Long Term Parking

This recent piece from Ben Hunt is a good read in its entirety (click on post title to access it). Some excerpts:

(…) the problem with the US economy in 2014 is not that there is too much private debt being created, but too little. The danger for US markets is not that there is some private debt bubble about to burst, but that markets have become disconnected from the natural cycle of debt and growth, a cycle which remains decidedly anemic. (…)

First, debt in an absolute sense is never a problem. The problem, as Tony Soprano would be happy to explain to you as he cracks a baseball bat across your knees, arises when your debt obligation outstrips your ability to pay it back. This problem does not exist for households or corporations in the US.

Here’s a chart from Fed data showing household debt service obligations as a percentage of disposable income. Debt servicing has not been this easy for American households since the Fed started compiling the data in 1980.

For corporations, here’s a chart from Bloomberg data showing the ratio of net debt (debt minus cash) to EBITDA (earnings before interest, taxes, depreciation, and amortization) for the S&P 500. This is a very standard measure of liquidity and leverage, and today’s ratio of 1.37 is less than one-third what it was before the Great Recession. The cold hard fact is that US corporate balance sheets have not been this strong or less levered in more than 20 years.

Here I disagree with Ben. There is something wrong with the aggregations. Today, the financial condition of the “haves” is very, very different from that of the “have less” and the “have nots”. If you doubt that, please read “Generation Renter” below. Same thing with corporations. A lot have net debt and a few have gigornous net cash levels. The aggregate is but a useless camel.

But here’s more good stuff from Ben’s piece for the bubble watchers out there:

Second, a market bubble can only exist in the form of market securities. If debt is not securitized it never reaches the public market and does not create a bubble. (…) ABS issuance last year was not even equal to what it was in 2000, and is more than $100 billion below its peaks in the go-go years of 2005-2007. Sorry, no bubble here.

Third, even if a high level of poorly underwritten private debt manages to find a high degree of securitization – I’m looking at you, student debt – a bubble can’t exist if the private debts are backstopped by public debt. This was the magic of the Temporary Liquidity Guarantee Program (TLGP), which for my money was the single most important program – far more than QE 1 – in preventing the world from imploding after Lehman’s bankruptcy. (…)

Okay, so maybe there are no private debt bubbles lurking around, and maybe Minsky-esque bubble-bursting isn’t the danger. But isn’t there some sort of danger associated with the $5 trillion dollars in public debt on the Fed’s balance sheet? Isn’t this a dangerous bubble? Yes and yes! But it’s an entirely different (and counter-intuitive) sort of danger than what everyone is shouting about.

First the punch line. The Fed’s public debt bubble can only burst if private debt growth takes off, and the bursting of the Fed’s bubble leads to rampant inflation, not rampant defaults.

Why? Because the massive debt racked up by the Fed in its QE purchases of US sovereign debt and mortgage-backed securities doesn’t work like household or corporate debt. The money for this buying spree never actually enters the real economy, but instead sits in the reserve accounts of the big banks. And that’s where it sits, and sits, and sits … until the big banks use those reserves to make private loans to households or corporations that want to use that money for some sort of real-world economic activity. This private lending activity is what turns reserves into money, and the cascading usage of that money – where it flows through multiple hands making real economic purchases – is what turns money into inflationary pressures and expectations. (…)

But here’s the thing. Precisely because the bursting of the Fed’s public debt bubble through private debt acceleration would be a disaster of unimaginable proportions, I don’t think it will ever happen. So far it certainly hasn’t. (…)

But if the velocity of money never picks up, that means that private debt growth never takes off. And if private debt growth never takes off, the real economy remains stuck in this mediocre, constantly disappointing growth malaise. (…)

The Fed’s bubble is currently parked in the banking reserve system, and I think that’s where it’s going to stay for a really long time. (…)

Here’s another treat, this one from Core Logic:

“Generation Renter” Millennials Delaying Milestone Life Events, Such As Homeownership, to Pursue Different Goals

(…) The homeownership rate for 25- to 34-year-old Baby Boomers (born in 1946 through 1964) was 51.6 percent in 1980, but for the same age cohort in 2012, it was nearly 14 percentage points lower at 37.9 percent. Marriage often drives the desire to become a homeowner, but it is happening later and later with each successive generation. The share of 18- to 32-year-old Millennials that are married was 26 percent in 2013, down from 36 percent for Generation X (born in the early 1960s through early 1980s) and 48 percent for Baby Boomers when they were the same age. (…) but their focus on higher education has increased. The proportion of Millennials between 25 and 32 years old with a bachelor’s degree was 34 percent in 2013, up from 24 percent for Baby Boomers when they were the same age. The rise of educational achievement has been occurring steadily and started well before the Great Recession began in 2007. Educational attainment is theoretically an investment in future income earning capability, so the fact that Millennials are more educated than prior generations should prove beneficial for their ability to become homeowners in the long term. However, in the short term, they will carry higher debt loads, and those with less than a bachelor’s degree are facing stiffer economic headwinds.

The Pew Research Center examined household incomes by generation four years after each generation went through a recession. They analyzed the real median incomes of 25- to 32-year-old households in 2013 (four years after the 2009 recession ended), Generation X in 1995 (four years after the 1991 recession ended) and Baby Boomers during the early 1980s, adjusting for changes in household size. The Millennial generation’s median income was $57,200 in 2013, compared to $54,100 for Generation X, and $54,800 for Baby Boomers. Yet, the comparison is very different when segmenting incomes by educational attainment and generation. The median income for Millennials with a bachelor’s degree was $89,100, 3 percent higher than Generation X ($86,300) and 16 percent higher than for Baby Boomers ($76,800). Millennials with bachelor’s degrees are doing well relative to previous generations.

Differences really emerge when looking at those with less than a bachelor’s degree. For those whose highest educational attainment is some college attendance, Millennials’ incomes are 6 percent lower than Generation X and 12 percent lower than Baby Boomers’ incomes. For those with only a high school degree, Millennials earned 12 percent less than Generation X and 19 percent less than Baby Boomers. While income inequality has increased for the country as a whole, there is more income inequality among Millennials than prior generations.

Delaying marriage, taking the time for educational achievement, and lower income levels for those who have not gone to college has slowed the rate of household formation for Millennials. In 2012, 36 percent of Millennials were living with their parents, the highest share in at least four decades according to the Pew Research Center. Since Millennials are becoming more educated and delaying household formation, their labor and balance sheet profiles are on lower trajectories relative to previous generations.

According to new Federal Reserve research, Millennials are less likely to be in the labor force and have half the net worth of Generation X and Baby Boomers at the same age, a massive difference. That is due to the associated debt with increased education, as well as lower incomes for those who didn’t go to college. Additionally, educational debt is associated with increased non-student debt because students, with limited or no income while studying, finance living expenses in addition to educational expenses. The share of households under 40 with student debt was 37 percent in 2013, the highest share on record.

While Millennials were severely impacted by the Great Recession, they were on a fundamentally different trajectory than their predecessors even before the recession, particularly as it pertains to education, debt and income. The cascading impact of Millennials’ changing economic impact is hampering their ability to achieve homeownership, which puts an increased emphasis on entry level affordable homeownership, such as condominiums. Unlike their predecessors, only a minority of Millennials are homeowners, so perhaps a more apt nickname for this cohort is Generation Renter, or Generation R.

Home Builders’ Confidence Index Posts First Gain Since December A gauge of home-builder confidence rose this month for the first time since December, though it reflected continued concern over weak buyer demand.

The National Association of Home Builders’ confidence index rose four points to a seasonally adjusted 49 in June, the trade group said Monday. (…)

The rise in the NAHB gauge this month reflected a marked improvement in its measure of current sales, which jumped to 54 from 48. Measures of future sales and buyer traffic also improved, though the latter rose to just 36.

A regional breakdown of the data showed confidence readings above 50 for both the South and the West, while the Northeast and Midwest were below that level. (…)

A survey of economists released this month by the National Association for Business Economics forecast new housing starts will reach 1.03 million down this year, down from 1.1 million forecast for this year in December. Still, that would be a 11% increase over 930,000 units built last year.

U.S. Industrial Production Rises 0.6% Output from U.S. factories, mines and utilities rose in May, the latest sign that growth has resumed in the critical industrial sector of the economy following a harsh winter and mid-spring dip.

Capacity utilization, a closely watched gauge of slack, ticked up 0.2 percentage point to 79.1% in May.

May’s rise reflected a 0.6% increase in manufacturing production, including a 1.5% jump in automotive output and a 1.1% rise in machinery production, and a 1.3% jump in mining output. Those gains were offset in part by a 0.8% decline in utility output.

Total industrial production in May was up 4.3% from a year earlier.

Total IP is up 1.1% (4.5% a.r) in the last 3 months. Manufacturing output is up 1.2%. Manufacturing of business equipment jumped 1.9%, 8% annualized. (Chart from Haver Analytics)

IMF Cuts U.S. Growth Forecast The International Monetary Fund cut its forecast for U.S. economic growth this year by 0.8 percentage points to 2% but said a meaningful economic rebound is nonetheless under way.

EU Inflation Falls, Raising Stimulus Expectations The annual rate of inflation in the 28-member European Union fell to levels seen in the wake of the 2009 global recession, raising expectations that other central banks in the bloc will follow the European Central Bank with stimulus measures.

The EU’s statistics agency Eurostat said Monday that the annual rate of inflation in the broader EU—which includes 10 countries that don’t use the euro—fell to 0.6% in May from 0.8% in April, its lowest level since October 2009, with the exception of March of this year.

In the 18-member euro zone alone, consumer prices were 0.1% lower than in April, and 0.5% higher than in May 2013, Eurostat said. The figure confirmed the preliminary estimate for the annual rate of inflation released earlier this month and was the lowest annual rate of inflation since November 2009, except for March of this year.

Eurostat said the core rate of inflation—which strips out volatile items such as energy and food—slipped to 0.7% from 1% in April, matching the record reached in March of this year and December 2013.

IEA Sees Shale Boom Expanding

The shale boom that has transformed the oil industry in the U.S. will spread beyond North America before the end of the decade, sooner than previously expected, the International Energy Agency said Tuesday, while at the same time warning of significant aboveground risks to conventional supply over the next five years.

(…) a mixture of legal, political and investment constraints have meant shale production has been slow to spread to other countries.

According to the IEA, that is changing faster than expected, with policy developments in Russia and Latin America set to encourage the application of unconventional extraction technologies on a larger scale than ever before.

In its most recent analysis, which takes a five-year view of the oil market, the IEA predicted that tight oil production from outside the U.S. could account for 650,000 barrels a day of global oil supply by 2019.

(…) By the end of the decade the IEA expects North America to produce 20% of the world’s oil supply and to have become a “titan of unprecedented proportions” in oil product markets as its exports of refined products soar. (…)

“While OPEC remains a vital supplier to the market, it faces significant headwinds in expanding capacity,” said Maria van der Hoeven, executive director at the IEA. (…)

According to the IEA, rising oil production in Iraq will account for 60% of the Organization of the Petroleum Exporting Countries’ growth in production capacity over the next five years, but even without the unrest currently sweeping the country, Iraq’s oil industry faces significant challenges from chronic infrastructure bottlenecks.

While Baghdad is targeting output of 8.5-9 million barrels a day by 2020, the IEA cut its forecast for Iraqi production capacity by nearly half a million barrels a day, projecting the country will produce just 4.5 million barrels a day by 2019.

“Given Iraq’s precarious political and security situation, the forecast is laden with downside risk,” the IEA said.