Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

A Debt-Driven Miracle

US data released this week looks pretty good, whether it’s GDP (up 3.6%) or jobs (203,000 non-farm and a 7.0% unemployment rate). But rather than argue as to the veracity or quality of the data, it may be more important to point out just how the news has been derived – or “paid for,” if you will. Obviously, one explanation is the Fed. Another is one that no one cares to talk about, and that’s the debt, or the liability, side of the equation – which, in our case (as a nation), is ballooning in size.

Corporate debt is on a record pace to surpass $1.48 trillion this year (it was $1.0 trillion three weeks ago). The US government is in need of an additional $2.0 trillion in the next year – on top of the $6.0 trillion already accumulated to “shoulder” the economy since the crisis of ’08. And consumer credit (credit cards) is averaging about $15.0 billion a month. So it’s no wonder that corporate earnings have risen and that the economic data has looked half decent – but the all-important question is whether the debt accumulation is sustainable. With rates rising, it doesn’t appear to be so.

That said, there are some dynamics at work that might interest you. Borrowing may be on the rise, but it largely depends on who you are or who you know at this juncture. Below are a few charts that illustrate the state of the housing market. Judging by what you see and hear in the mainstream media, housing is on the rebound. It is true that prices have risen in housing (the Case Shiller index is up 13.4% YTD), as they have in the stock market. But in the face of rising rates and stagnant incomes, finding a loan is becoming nearly impossible for the average citizen. Here’s a look at the charts.

This is the Mortgage Bankers Association Purchase Index. It’s lower than it was during the housing crisis of ’08 – and is in the process of falling again.

MWM 13, 12-6 Chart 1

And this is the Mortgage Bankers Association Refinance Index, currently at crisis lows (seen at the left of the chart) and dropping.
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Both of these indexes measure the number of loans issued and/or loan restructurings that are made by the retail public. And it’s pretty clear by the looks of it that activity in these areas has plummeted. The mystery, therefore, is why house prices have increased as lending volume has declined. The answer is that hedge funds and institutional investors that are funded indirectly through the banks by the Fed now account for up to 60% of home purchases in key markets – with a majority of these transactions rumored to be “cash only.”

That being the case, consumers are getting squeezed yet again between rising asset prices, diminishing incomes, and limited access to capital. Incomes fell in October by 0.1% – reflected we believe in the 3% overall (including the 20% gain in online sales) drop in holiday sales so far this season. Brick and mortar retail stocks took it on the chin in Friday’s trade.

In light of these consumer undercurrents, it’s hard to see the Fed becoming more hawkish next year, as many have speculated. Instead, we believe that the printing will continue, and may actually increase – as Fed governor Charles Evans has surmised. And we may not be alone in that assumption, as the US dollar fell back into bearish territory despite all the hype this week about Fed tapering – see the chart of the dollar below.

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The precious metals may also be responding favorably to the weakness seen in the dollar, not to mention the higher rates at work in the Treasury market (which is also an inflationary development). As an aside, China has announced plans to reduce its US Treasury holdings in the near future. Starting with Wednesday’s spike in gold, we saw a fair bit of short covering, even while the economic data ran positive and tapering talk escalated by week’s end. That may mean that both gold and the dollar markets are discounting a more uncertain future, looking past today’s artificial victories.

In the weeks ahead, we would like to see more short covering and perhaps a corresponding shift to long metals positions before becoming convinced that prices are moving meaningfully higher – but, for the time being, the price action has definitely improved within the context of a depressed environment.

Best regards,

David Burgess
VP Investment Management