Is Student Debt A Serious Problem?

Brian Westbury is a well-respected economist at First Trust, and he recently published an article on two big concerns weighing on the minds of investors in regards to debt accumulation since the end of the financial crisis:

  1. Most of the economic growth since the crisis has been fueled by borrowing. Consumer credit is up nearly $1.1 trillion since mid-2010 (the largest increase in such a period), which simply cannot be explained as anything other than a “credit binge.”
  2. Student loans are the next “bubble,” as the amount of debt has exploded by 274% since mid-2010 and accounts for two-thirds of the $1.1 trillion. Consumers will never pay these loans off, let alone afford to buy a house, car, or any other goods on credit.

He believes that these fears are overblown, and I tend to agree with him. To understand why, let’s dig into some of the data he uses to support his conclusions. 

According to his research, total personal income is up $3.2 trillion over the same time period, which is way more than the growth in credit. This is VERY important. Why?

I have written extensively about why the U.S. government debt situation is not and will not be a problem for several decades. One of the key components to my argument is that it’s not the amount of debt that matters but rather if one can afford the debt.  

Here’s an analogy to simplify the situation. If two neighbors have the same $1 million mortgage, but one makes $500,000 a year and the other $50,000, then the neighbor with the higher income should be far better off. 

Mr. Westbury uses the exact same logic for consumers. Currently, consumers’ monthly mortgage, rent, car, and credit card payments have been hovering at the lowest share of income since the early 1980s. This phenomenon is a result of (1) incomes growing faster than debt and (2) low interest rates. Simply put, most consumers can afford their debts. 

In regards to fears that these debts will somehow drive the U.S. economy into a recession, here’s an excellent quote directly from the article: 

“If the US does have a recession, credit stress will increase, it always does.  But that recession will not be caused by the overall debt burden itself.

Let me be clear. I do not condone the use of excessive debt. I don’t want the government to spend like drunken sailors, and I certainly don’t think that an 18-year old with zero credit history should be given $200k to study something that could almost never generate a return on investment. However, these concerns on their own cannot cause an $18 trillion economy to fall apart.

The bottom line is that student debt is a problem, but it isn’t one that will deliver another 2008-style downturn. If you don’t believe me, just take Mr. Westbury’s word for it:

 “So, it’s not the debt that is a problem, it’s what the debt is paying for.  Student loans won’t bring down the economy.  But they have created a bubble in education. Outside of this, the consumer and economy are doing just fine.”

Click here to read the full article.


Why Aren’t We Seeing The Benefits?

When oil began its decline back in June 2014, most economists and investors believed that if prices could remain low for an extended time period, those economies that import oil and/or consume lots of oil would benefit. 

The logic goes that if consumers are spending less at the pump, and if companies are paying less for oil, then both would have more money to spend elsewhere in an economy. 

The U.S. was supposed to be one of the biggest beneficiaries of cheap oil. Sure, those who work in the industry would suffer from job losses and bankruptcies, but the net benefit was expected to be big because our economy fits so well into this investment thesis for three reasons:

  1. Despite the surge in domestic oil production over the last 5 years, we still import most of our oil.
  2. The U.S. is the largest consumer of oil in the world.
  3. Over 70% of our economy consists of consumer spending.

Add these up and the output is the largest consumer of oil is now paying less for the commodity, so Americans should have a lot of money to spend elsewhere in the economy. 

So far, only a portion of this thesis has played out. According to the Financial Times, cheaper gasoline prices saved Americans $126 billion at the pump in 2015, which equates to around $1,000 per household. 

The other half of this thesis, the part where Americans were going to spend these savings elsewhere, has yet to happen. Admittedly, there have been some signs of spending reacting to cheaper gasoline. For instance, sales of sport utility vehicles surged last year to an all-time high of 17.5 million, and drivers hit the road to cover a record 3.2 trillion miles.

But consumer spending as a whole has yet to see any real bump. In fact, the data point to Americans saving more that spending. The personal savings rate rose to 5.4% in February, which is the highest it’s been in over three years.

Economists are perplexed and now trying to hypothesize why we haven’t seen more consumer spending and increased economic growth from the fall in oil prices. Unlike many out there who claim to know the answer, I truly don’t know because it’s still too early to tell. However, I’m also not that concerned for two reasons:

  1. Saving money at the pump is mostly a zero-sum game. Meaning, there simply cannot be a downside to the overwhelming majority of consumers by paying less for something that they don’t even want to buy in the first place. 
  2. Given the amount of debt accumulation and pain experience during the deleveraging years after the financial crisis, I don’t necessarily consider a rise in the savings rate to be a bad thing.

I wish I had a better answer, but unfortunately I don’t think one exists at the moment. If I had to guess, and this is nothing more than just that, I would argue that the reason why Americans are not spending more has to do with the negative effect of falling oil on consumers.

More specifically, the volatility in financial markets has caused a lot of concern amongst the general public, and when consumers are less confident, they tend to spend less. Our economy is not growing all that much, and consumers still remember the last recession all too well, so they may just be playing it safe for the time being. 

If I am right, then this will most likely only be a temporary phenomenon. Falling oil has caused stocks to follow in tandem because traders are concerned that energy companies could go bankrupt, and the banks that loaned them money could then be at risk. However, once the weak companies begin to disappear, the stock market should then become less of a hostage to traders as oil-induced volatility wanes.

Like many other investors, I expected to see more of a rise in spending from cheap energy, but it looks like we will just have to wait a while longer. That’s ok, because although timing these things is very difficult, it’s still an indisputable fact that cheap energy prices is a net benefit to the U.S. economy over the long run.


Terrorism Attacks Emotions, Not Nest Eggs

Western Europe has endured a series of horrific terrorist attacks over the past year, and last week’s bombings in Brussels was a harsh reminder that the problem is far from being resolved. Many investors now fear that these attacks could destabilize the developed world and ultimately risk their financial well being. 

Terrorism is an unfortunate reality these days, and financial markets certainly feel the impact when these gruesome attacks flood the headlines. One such event that Americans will never forget caused the panic circled in red below:

image001Source: Yahoo! Finance

The chart indicates the stock market’s reaction to the attacks on September 11, 2001. The S&P 500 sold off over 8% once the market re-opened, but the panic did not last very long. In fact, the market recovered in about a month. Two questions are worth answering: (1) what specifically caused the sell-off and (2) why such a sharp recovery?

The immediate decline was nothing more than a classic case of panic selling. Emotions rule the short-term movements in stocks, and fear and panic were about as high as they had ever been for most of us back then. 

However, the attacks did not prevent Americans from completing their educational pursuits, going to work, taking their kids to daycare, or buying groceries. Furthermore, Apple did not stop innovating, the internet did not go away, cell phones did not stop changing the way we communicate, and Amazon did not close its doors for fear it’s business model had somehow become flawed.

In short, not even the worst terrorist attack on U.S. soil since Pearl Harbor was enough to derail our economy or our way of life. Fundamentals drive stock prices over the long run, and since terrorism targets our emotions, it rarely has any permanent impact on a developed world’s economy.

The bottom line is that terrorism elicits a range of emotions from fear to anger, and these feelings should be used to do whatever is necessary to make the world a better and safer place. Just don’t allow them to ever impact your investments because they will likely do more harm than good.


When Currencies Become Napkins

I’m guessing that Goldilocks could have had a storied career at the Fed. Her quest for the “just right” amount would certainly help the central bank maintain an inflation rate that is not too high but also not too low.

If the U.S. inflation rate falls below 2%, the Fed becomes concerned that the economy is not growing fast enough and will act accordingly (read my Thought for the Week today to learn more).

On the flip side, the Fed also does not want too much inflation because that often signifies one of two problems. The first is an overheating economy. It may sound crazy, but economies growing too fast usually end badly.

So the Fed will start to get nervous when the inflation rate exceeds 2.5%. If our economy reaches 3% inflation, expect the Fed to drive us into a recession in order to prevent inflation getting out of control.

Hence, the “Goldilocks” level of inflation is right around 2% for the U.S., but every economy is different. To understand the second problem with high inflation, let’s go down south to Venezuela to continue this discussion.

Inflation can also be a sign of poor fiscal and monetary policy, and Venezuela is the current poster child for both. Its leaders over the past several years have spent so much newly printed money that their currency, the Bolivar, is practically worthless.

This picture below recently went viral because it shows just how worthless the Bolivar has become:


Instead of using a napkin to hold an empanada purchased on a street, this person chose to use a $2 Bolivar instead. Why? Because the bill is actually worth less and easier to find than a single napkin!

The International Monetary Fund (IMF) estimates that Venezuela will be tackling 720% inflation in 2016, which is a situation that will eventually destabilize their economy. Here are other ramifications of the stupidity displayed by its corrupt leaders over the years:

  • Basic goods like diapers and car tires are being sold in black markets and require thousands of bills to purchase. 
  • Citizens must bring stacks upon stacks of bills to pay for moderately priced meals while dining out.
  • The $1, $2, and up to $10 Bolivar bills are now worth less than the paper used to print them, and therefore no longer provide any use in their economy.
  • Tourists are now being told to bring their own toilet paper because hotels can no longer stock these basic goods. 

Hyper-inflation almost always leads to civil unrest. So far, the crime rate has surged, health services are becoming overwhelmed because people cannot buy necessities from aspirin to vaccines, and their economy shows no signs of turning around (particularly because they rely heavily on oil exports that are now 70% cheaper than in years past).

I doubt that this will be the last time a picture goes viral from Venezuela. We can only hope that the citizens boot out those in charge because, at the end of the day, Venezuela still remains a democracy. Only time will tell.


Kevin Spacey Should Stick to House of Cards

I spent a few minutes last night checking out Kevin Spacey’s Wikipedia page to get a rundown of his life and list of accomplishments. Although I am not much of a fan of House of Cards, it’s tough to argue that he has had anything short of a stellar career in Hollywood.

However, what I failed to uncover during my analysis of his background was a single shred of investment experience. He has never managed an investment firm, received any financial certifications, or graduated with a degree that indicates some level of formal financial education. Based upon my findings, I would go as far to say that he lacks even a single credential to indicate that is qualified to offer investment advice to a dog, let alone the American public.

My words may sound harsh and pugilistic, so allow me to explain the genesis of my rant. Five minutes prior to visiting his Wikipedia page, I had seen him on TV in a paid advertisement for an equity trading firm. 

He spoke in a way that was to inspire confidence in those who watched. His words commanded viewers to be brave and take control of their financial future by trading stocks online. An actor as popular and talented as Kevin Spacey can surely empower every day citizens to trade in and out of markets on a daily basis. Right?

What a complete joke. It blows my mind that the U.S. government has effectively banned cigarette advertisements, but this garbage is somehow allowed to be aired on national television, when the negative effects of day trading can be arguably as dangerous to consumers.

Let’s walk through the logic of why this firm hired Mr. Spacey by observing two indisputable conclusions regarding his background. First, he’s an outstanding actor, and second he has zero experience managing money. So, would this firm hire him because of his financial acumen or because he’s really good at making an audience believe a fictional story? I’m going with the latter to this rather obvious question. 

Why they would knowingly try to deceive viewers requires an examination into the incentives of the firm. Equity trading companies make money from commissions on trades. When their clients buy and sell stocks, they charge a fee to facilitate the trade. 

Hence, the more their clients are trading, the more money the firm collects. What’s even more impressive about this business model is that they don’t have to care whether the equity market is rising or falling. All that matters is the total volume of buy and sell orders that get submitted on their website (volatile markets are even better for trading firms because volumes surge during panics). 

Only two outcomes exist for 99.99% of all day traders – either they will be lucky or they will be wrong. There is simply no way to trade stocks in such a manner to build a safe and secure retirement. Now, there are a select few people in this world who are highly skilled traders with vast experience. But this cohort does not trade through websites advertised on TV. 

The bottom line is that the only winners from Mr. Spacey’s advertisements are himself and the firm that hired him. Those who feel empowered to go out there and trade, let this be the reality check you need to ensure you don’t inflict any real harm to your financial future.


Either You’re Lucky or You’re Wrong

The fourth quarter was pretty rough for global financial markets. In fact, I would be hard pressed to name one major asset class that was positive after accounting for fees, inflation, and currency effects.

Years like these make us anxious to hear from market pundits and investment managers on how various asset classes will perform in 2016.

This question is certainly warranted given the events that have transpired over the last few years, and investors want to know that they are with a manager who is good at predicting annual returns because he/she seemingly has a “feel for the market.”

Unfortunately, annual forecasts are almost always wrong, and the very few who will get it right will be nothing more than lucky. Predicting annual returns from an asset class as emotionally sensitive as equities on a consistent basis is virtually impossible.

Fear and greed are incredibly powerful and unpredictable forces that create dislocations in equity prices. These often take months to normalize and wreak havoc on short term forecasts. For example, who predicted that China devaluing their currency back in August would cause mass panic, to the point where hundreds of U.S. Exchange Traded Funds (ETFs) that owned no Chinese stocks halted trading? 

For that matter, who would have thought that Greece would act so recklessly, and that the actions of the leader of a country that represents less than 1% of global GDP would cause U.S. stocks to fall? 

The chart below, courtesy of Bernstein Research, is one example of how poorly annual consensus estimates have predicted future outcomes. The green bar indicates the size of the difference between consensus estimates of annual U.S. GDP growth and the actual value at year end since 1969.


If annual consensus estimates were even remotely accurate over the past 45 years, then the green bars would be so small that they would be barely visible to the naked eye. Instead, the opposite is the case, which indicates that predicting GDP growth over a one-year period is extremely difficult.

This conclusion comes as no surprise considering the sheer number of variables that can impact GDP on such a short term basis. For example, who could have possibly predicted that bad weather and a labor strike at one of the busiest ports in the country would grind our economy to a halt during the first quarter of 2015? 

That’s not to say that predictions are completely useless. The process of forecasting an annual return forces a manager to think about all of the complexities in economies and financial markets, which creates a blueprint that we can then use to isolate the factors that drive asset prices. Therefore, as the year progresses and events transpire that were not predicted, we are able to assess the true impact to the economy and act accordingly. 

Investors, on the other hand, are best served by using a manager’s forecast for more than just a measure of perceived skill. Comparing a forecast to the actual return at year end will give very little insight into a manager’s aptitude because (1) a year is often too short of a time period, and (2) you must dig deeper to eliminate the possibility of luck.

Rather, ask the manager how he/she derived the forecast and how he/she plans to act throughout the year if their original thesis turns on them. Only then will you get true value from their predictions for the coming months. 

Simply put, annual forecasts are rarely accurate, but they are still a critical component to investing and provide tremendous value to both investors and managers alike. 


Happy New Year! Now Take A Deep Breath and Relax…

Happy New Year!

Global financial markets are getting whacked today because of two primary concerns:

  1. Fears reignited over China’s economy weakening led to their equity market triggering a “circuit breaker,” which effectively shut down trading early for the day to prevent further panic (by the way these never work all that well).
  2. Saudi Arabia and Iran are at each other’s throat (again) over diplomatic issues that appear to be escalating to a rather unstable level.

Markets selling off on such absurdity is indicative of emotional, not fundamental responses. First, the U.S. has next to no reliance at all on China’s economy, and the weakening manufacturing sector should be expected, given their push to become a more consumer-driven economy (much like the U.S.). 

Second, Saudi Arabia’s decision to sever ties with Iran should come as no surprise to those who follow the politics in the Middle East. The real question to ask is if it matters from an economic and financial perspective (humanitarian issues aside). If anything, I would strongly argue that the unrest in the Middle East is even less relevant today than a decade ago. Why?

Imagine if ISIS has hit the scene in 2006. Where would the price of oil gone? My guess would have been $350/barrel. Back then, if someone in Baghdad had sneezed too hard, it seemed as if oil would spike 10% in a matter of minutes!

Today, think about the horrors that ISIS has brought that part of the world over the last 18 months, and then compare your analysis to the price of oil. Despite the terrible situation, oil is down over 50%. This data point alone tells me that our economy, and to some degree the global economy, is far less dependent upon Middle East oil, and that’s a huge deal for us all.

Simply put, when has there been a single year in the past half century when investors were not forced to endure unrest in the Middle East? Seriously, think about it for a minute and try to find one year where investors were not rocked by some headline coming out of this region. Personally, I cannot. However, despite the turmoil, the S&P 500 is up over 1,800% since 1980 and over 11,000% since 1965.

My point here is that none of this matters to the fundamental direction of the U.S. economy. Traders and fear mongers may be paying attention to factors that are completely irrelevant, but I’m watching the data come out that suggests that we are doing just fine. Take a look at the headline in the Wall Street Journal today stating that 2015 was one of the best years for auto sales ever (auto sales are an incredibly important economic metric because consumers only buy big ticket items when they are confident that they can support the ongoing expenses). 

Oh, and in regards to consumer confidence, be sure to go back to last week’s economic data to see that the recent consumer confidence numbers confirm the very strong long-term trend. These are the data that I find to be relevant to the world’s largest economy, especially because 70% of our economy is driven by consumer spending. A more confidence consumer spends more than a less confident one.

The sad reality of the world today is that investors have no choice but to endure Middle East unrest. The turbulence in this region has lasted for centuries, and it’s most likely not going to end anytime soon. The good news is that the energy revolution here in the U.S. has made us all far less reliant on Middle East oil, so the unfortunate events that have transpired and will continue to persist have little impact on your portfolio, unless you let it. 

I don’t expect the volatility to go away anytime soon because these are emotional times. However, it takes far more than China and continued unrest in the Middle East to reverse the course of an $18 trillion economy.