The day is always darkest before the dawn

I am often known as a very pessimistic, cynical and bearish person. The reason for this is that when I started working in the financial environment on a trading desk it was a few months before Bear Stearns collapsed and just under a year before Lehman’c collapsed. The confusion, panic, pain and volatility that ensued through the first few years of my trading career when sometimes it felt like I couldn’t breathe it was so crazy left a profound impact on me for the next few years and I became untrustworthy of any rally or positive news flow. I was “born into a bear market.” The bias of which stays with you for a long time and its only recently that I have been able to shake it. This is not to say I’m now a full on bull I’m just a bit more flexible and open to interpretation of data and news flow than I used to be.

With this in mind I want to show you two graphs that have left an impact on me of late and confirms by bias that the U.S is certainly emerging from the downturn at a faster rate than its peers in Europe. The first graph  shows you the percentage of household disposable income that is/was used to service debt repayments in the U.S.


See how between the years of say 1995-2007 the trend was to load up on debt and the percentage of the average income being used to service this debt repayment just escalated from about 10% to 14% if income. So 14% of income was being used just to service debt repayments. Now look where that percentage has come back to. We are back where we started. So this has effectively normalised. This is due to the US having gone through a very painful deleveraging process over the last 4-5 years, much more extreme than has or is occurring in Europe. A lot of it may be debt that has been written off also but mostly due to  the fact that the consumer in the US completely retrenched and changed their spending habits. Instead of buying new shiny products they serviced their outstanding debt and have now got to a level where they are much more comfortable. It is the same reason that the S&P500 is trading at a 5 yr high. Corporates have done exactly the same thing.

Pre-lehmans corporates were in the same boat as individuals – borrowing in the short-term to finance their operations lead to outstanding returns but very high  leverage. Obviously the credit crunch put paid to this and they have had to deleverage as well and repair their balance sheets. Mainly through cost-cutting, capital raising and maximising efficiency corporate balance sheets are in a healthier state than probably any time in the last 10-15 years.

Now look at the Michigan consumer confidence, this tells two stories:


While consumers were binging on credit between those years 95-2007 everything was rosy even though we know it was hurting the pay packet more and more consumer confidence was high. This is what a bubble looks like. Then coinciding with the deleveraging process you see consumer confidence drop like a stone. This is human nature,  the pain associated with deleveraging and changing lifestyle comes through in this data series very well. Now look to the very right of both graphs, consumer confidence is on the up and personal balance sheets are in a more comfortable place.

Obviously I have simplified things here 2 graphs does not make an economy, but it does show you why things can go forward from here. There are stumbling blocks to the US progression namely there massive national debt also known as the fiscal cliff (get used to those two words you will be hearing them a lot). But just like corporates and individuals had to deleverage and reduce their debt the US government will have to as well, it wont be tomorrow or next week but over time you will see their debt to GDP ratio decline, especially if the GDP side of that equation is rising which on the face of it looks like it just may be.

What this means for you if you are European? Well unfortunately we are not out of the woods yet. Europe has not delevered as quickly or a savagely as the US have owing to the complicated political structure that delays decision making, you could also point to culutral differences in that perhaps it is not as easy or socially acceptable to walk away from debt in Europe as it is is the U.S. Debt restructuring mixed with deleveraging will be the big theme over next year or so, the only thing you can do as an individual is make sure your house is in order and roll with the punches.

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