Hopes are growing in the bull camp that US shares are on the verge of reclaiming ground not trodden since the collapse of investment bank Lehman Brothers back in September 2008, which sent shockwaves through global financial markets.
But as the US share markets flirt with 18-month highs, it’s worth remembering what the US economy looked like at the time of Lehman’s collapse. As David Rosenberg, chief economist and strategist at Gluskin Sheff, notes, there is a huge difference between then and now.
To start with, the housing market was in better shape 18 months ago. New housing starts were running at an annual rate of 822,000, rather than 308,000 at present, and the Case-Shiller index of that measures house prices in 20 major US cities was sitting at 162, compared with 145 at present. New home sales were running at an annual rate of 436,000, compared with 308,000 currently.
Employment was also much stronger back in September 2008. The US unemployment rate was 6.2%, rather than the current level of 9.7%, and there were 136.3 million people with jobs, rather than 129.5 million at present.
Stronger job markets meant that real personal income (which excludes transfer payments from the government) was $US9.5 trillion, rather than $9 trillion. Not surprisingly, household consumption was also higher. Retail sales and sales of new cars were also stronger. Consumer confidence levels stood at 61, well above the present measure of 46.
The banking system looked healthier. Residential loan default rates across the banking system were running at 5.3%, rather than 10.1% at present. And delinquency rates on credit cards were running at 4.6%, rather than 5.8%. Lending by commercial banks totalled $7.3 trillion, rather than the $6.6 trillion at present.
Government finances were also in better shape. The US budget deficit was $500 billion, rather than its current $1.5 trillion level.
The other big difference is that the dividend yield on US shares was 2.4% 18 months ago, compared with 2.0% at present.
As Rosenberg notes: “It makes absolutely perfect sense for the market to head back to those 2008 levels if – and only if – the broad array of macro indicators can manage to head back to the levels prevailing at that time as well.”
The jury, he adds, “is still out on that one; with deference to the impressive surge the market has managed to turn in and the wall of worries it has either been able to climb or merely dismiss out of hand.”
And it’s not only the US economy that’s going to have to pick up a lot of momentum if it is to keep pace with the galloping share market.
As Dr John Hussman of Hussman Funds warns, the share market will face worrying threats from a possible second wave of credit strains.
He warns that these strains could be unleashed as the first wave of Alt A/Option ARM mortgages come up for reset. These subprime mortgages were freely available to borrowers during the halcyon years, allowing some home buyers to take out mortgages without providing any documentation of their income. Others were able to buy houses even though they were not able to afford the interest payments on the loan. What interest payments weren’t met were simply added to the balance of the loan outstanding.
But as a wave of these sorts of mortgages comes up for reset, lenders are likely to take a much tougher stance. And faced with the prospect of higher interest rates, some borrowers will likely walk away from their homes, particularly since its value has likely sunk below the purchase price.
Hussman warns that the reset of these mortgages could presage a second round of problems in the US housing markets, with banks first reporting a spike in delinquencies in their home lending books, and then increasing their provisions for problem loans.
In addition, he points out that US banks and financial institutions are now required to bring their various off-balance-sheet vehicles onto their corporate balance sheets.
These off-balance-sheet entities will be apparent in the first quarter results of the financial institutions and have the potential to unsettle markets.
It will be interesting to see whether markets remain resilient faced with this potential second wave of credit problems.
This article first appeared in Business Spectator.
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