David A. Rosenberg from Merrill Lynch has released an 11 page document called “Some inconvenient truths”. It is worth a read for its frank discussion of our current economic condition.
Depressions are basically long recessions – they can last anywhere from three to seven years, while historically cyclical recessions last 18 months – and tend to follow years of leveraged prosperity of Gatsby-like proportions. Considering that in this most recent leveraged cycle from 2002-07, we reached a point where a record 40% of corporate profits were derived from financial activities, where household debt relative to income and assets surged to unprecedented levels and the personal savings rate briefly went negative at the height of the housing bubble, it is safe to say the down-cycle we are currently experiencing did indeed follow a classic elongated period of leveraged prosperity. It is now reverting to the mean.
Forty percent of profits were derived from financial activities. That blows my mind. Given most of these were short term gains and long term losses, it seems safe to say half of 2002-2007 profits were fictional (and actually losses). When you then think about all of the other profits that are ripple effects from the financial side of things, it is hard to see where there is any real profit growth in the near future.
This was a 20-year secular credit expansion that went parabolic starting in 2001-02 as the Fed and the federal government moved to offset the lingering deflation in the technology capital stock by invoking policies that touched off a massive reflation of the housing stock. Since the credit cycle ended in the fall of 2007, an estimated $1 trillion of bad debt has either been written down or recognized. But considering that total private sector credit market debt relative to national income is still near a record-high of 140% versus a long-run norm of 80%, the meanreversion process suggests that before we can even consider embarking on a fresh credit cycle, more than $6 trillion of excess household and corporate debt has to be eliminated.
Uh, wow. We are possibly only 1/6th of the way through credit/debt destruction.
With the consumption-to-GDP ratio at a record 70%, the personal savings rate barely above 2%, and the homeownership rate still near an all-time high of 68%, it goes without saying that investors looking for growth should look beyond the American consumer and housing market. These areas of the economy, even after they stabilize, are unlikely to be the leaders in the next economic expansion or bull market.
It sure seems that way to me. However, given the status of the US dollar and strength of treasuries, the world’s investment community clearly doesn’t see it that way yet. Maybe they don’t know where to hide.