For those you who think the U.S. economy is strong, you need to think again. Yes, it’s true: the Trump Trade is on and animal spirts are high. That has been most evident by the soft data provided by consumer sentiment and small business surveys. Expectations of a Trump-led White House that will support businesses through government spending and tax cuts are elevated to say the least. Though the soft data looks great, the hard data not so much. For example, when you look at the trajectory of credit growth, then you will see that businesses, unlike 2 years ago, are not putting other people’s money where their mouths are.
Commercial & industrial (“C&I”) loan growth is very important gauge of the economy. C&I loans are used to finance business expansion, capital expenditures, research and development, and staffing. When companies are borrowing, it usually marks times of economic expansion. When the borrowing tap runs dry though (normally when interest rates are rising), economic contractions normally follow.
Consider the graph above based on monthly data going back 34 years. What you will see is the real (i.e. inflation-adjusted) rate of growth of these business-oriented loans provided by all U.S. commercial banks. The graph starts in the in the early-1980s after double-digit inflation and interest rates were extinguished.
In the three recessions that began 1990, 2001 and 2007, credit growth was still positive in the beginning of each instance. Nevertheless, credit growth eventually went into negative territory (red bars) sometime during each recession. Hence, waiting for credit growth to go negative in anticipating recessions would be a futile endeavor. Nevertheless, how credit growth behaved in each of the past three recessions offers some clues we could use in forecasting.
As you can see from the graph, when credit growth declines to a very low albeit still positive rate, a recession is either imminently or already happening. How low is low enough though? The magic number appears to be approximately +2.3% (yellow dotted line). Let me tell you what I mean.
In the recession that began in July 1990, credit growth decreased to less than +2.3% the month previous (i.e. June 1990). And in the recessions that began in 2001 and 2007, credit growth decreased to less than +2.3% near the beginning and end of their respective recessions. To reiterate, when credit growth decreased to +2.3%, recessions were either imminent or already happening in each of the past 3 recessions.
The challenge the U.S. economy now faces is that its rate of real C&I loan growth peaked at +5.4% in January 2015. This was not surprisingly soon after the third round of quantitative easing ended. Credit growth has since been in steady decline, consistent with rising interest rates. You can also see from the graph that the rate of real growth has been falling at an increasing rate. It has most recently (February 2017) decreased to +2.3% (yellow dotted line), which a level of credit growth that has, looking back 34 years, always led to led to or coincided with recessions.
Given recessions always lead to market corrections, credit growth matters to your portfolio. This is particularly true given confidence in Trump’s ability to follow through on campaign promises is waning since failing to repeal and replace Obamacare.
Whether or not you find credit growth is closely tied to economic growth, please consult with an investment fiduciary before making any investment decisions.
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