Various measures of U.S. consumer confidence have spiked since the election of Donald Trump in November. For example, the University of Michigan’s survey of Consumer Sentiment was very recently at its highest level in 13 years. As promising as this soft data may appear, the hard data (e.g. GDP) is yet to demonstrate this. Consumer confidence may be too high. In fact, it may be a contrarian signal given Consumer Sentiment peaked approximately twelve months before the recessions of 2001 and 2007 each began.
Consumer Credit Tightening
With respect to hard data, the Federal Reserve reported last week in its Senior Loan Officer Opinion Survey on Bank Lending Practices. The quarterly survey showed banks have begun tightening their lending standards on consumer loans. For example, the net percentage of domestic banks that tightened their standards for auto loans increased to 11.7%. This was the highest level since the data set began less than six years ago. Lending standards on credit cards have also tightened, as shown in the graph below:
This is the first sign of positive net tightening (red bars) on credit cards in 6+ years. The level of net tightening has increased to +8.3%. This is close to the +9.7% achieved in early-2008, when the U.S. economy was already in a recession (began in late-2007). It is also equal to the +8.3% observed in late-2000, which was less than six months before the 2001 recession began. Given the Consumer Sentiment data mentioned earlier, it sure seems like consumers are most confident late in business cycles when lending standards begin tightening.
Bankruptcies Are Climbing
Part of the reason for the net tightening may be attributed to higher interest rates. The other reason may be rising bankruptcies. As shown in the graph below, total bankruptcy filings have been in decline since the economic recovery. The pace of decline (yellow line) though started to wane in 2015 due to the rise in commercial bankruptcy filings. It appears that the decline in total bankruptcy filings has reversed now that consumer bankruptcy filings (which comprises 95% of total bankruptcy filings) are increasing.
According to the American Bankruptcy Institute, total bankruptcy filings increased 5% year-over-year (“YoY”) in both December 2016 and January 2017 (red bars). This was the first time total bankruptcies registered back-to-back monthly gains since 2010. In response to the January report, the Executive Director of the American Bankruptcy Institute said (emphasis added):
While bankruptcies plunged last year to their lowest levels since the implementation of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, filings are beginning to climb. As interest rates increase and the cost of borrowing rises, more debt-burdened consumers and businesses may seek the financial shelter of bankruptcy. – Samuel J. Gerdano, Executive Director, American Bankruptcy Institute (February 3, 2017)
Fear and Greed
Bankruptcy filings beginning to climb when consumer credit is tightening and consumer confidence is near its peak are all classic signs of the end of another business cycle. This cannot bode well for equities, particularly if they are overvalued.
Larry Fink, the CEO of the world’s largest asset manager, BlackRock, seems to agree. He was interviewed last week at Yahoo! Finance’s All Markets Summit. He referred to a chart that overlaid the University of Michigan’s survey of Consumer Sentiment against the S&P 500 Index since 2007. He found it “horrifying” that the two metrics moved in almost perfect lockstep. Consistent with Warren Buffett’s famous quote advising investors to, “Be fearful when others are greedy and greedy when others are fearful,” Fink also said in reference to the chart (emphasis added):
When consumer confidence was the lowest, that the was low point of the equity markets and you should be buying. Maybe you should be selling now. – Larry Fink, CEO, BlackRock Inc. (February 8, 2017)
Whether or not you find consumer confidence to be a contrarian indicator, please consult with an investment fiduciary before making any investment decisions.
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