Loan Delinquencies Cast More Doubt on the Economic Recovery

Tuesday, the American Bankers Association issued a report which showed rising loan delinquencies on several installment loan categories for the first quarter. While that information shouldn’t be all that surprising given the climate of the first quarter, investors quickly hit the “sell” button sending the S&P 500 down roughly 2% for the day. The report painted a very disturbing picture and while the actual statistics only covered the first quarter, the commentary certainly applied to current market trends which is why the market responded so sharply.

According to the report, unemployment is the largest contributor to loan delinquencies, which are defined as loans with payments more than 30 days past due. Particularly hard hit were home equity loans which rose nearly a half percent to 3.52%. The deadly combination of falling home prices with weak employment means that many consumers are simply unable to keep up with these obligations. This is particularly disturbing since for most consumers, the house is one of the last obligations that consumers will allow to lapse. According to James Chessen, Chief Economist for the American Banker Association, “Even if home prices stop falling later this year, unemployment will keep home equity delinquencies high for some time.”

That’s exactly what is likely continuing to happen as the most recent unemployment numbers were even more dismal than economist had predicted. The rising unemployment will have ripple effects in many different sectors. While we have widely discussed the coming weakness in retail stocks, the rising delinquency rates could eventually provide a good short opportunity for financial stocks as well. One more quote from Chessen: ”Delinquencies won’t improve until companies start hiring again and we see a significant economic turnaround.” That turnaround is looking more questionable on a daily basis.

The increase in loan delinquencies along with other weak economic data is likely to continue to lend support to lawmakers calling for more stimulus spending. The international concerns raised a few weeks ago regarding too much stimulus spending (questions largely raised by Germany) may end up being swept under the rug. Unfortunately, none of this economic help is free and we will eventually have to pay for these measures through higher taxes, inflation, or continued weakness if the measures are not successful.

This week marks the official start to earnings season with Alcoa (AA) throwing the customary “first pitch.” Look for weakness both in reported numbers as well as in comments from management on the future outlook. This quarter it will be important to read between the lines as executives try to put on a brave face and give investors a reason to hang on. So take optimistic statements of a recovery with a grain of salt and concentrate on the fundamental data. In particular, stocks with high debt levels and significant payments coming due could be vulnerable for sharp drops.

We continue to look carefully at the precious metal and commodity sensitive stocks. While they have been weak due to the macro effects of unemployment and slow busniess and consumer spending, the long-term effects of printing money will eventually catch up and propel these stocks higher. So as most economically sensitive stocks trade lower on poor news, watch this area carefully for signs of strength. Once the trend begins, I expect a multi-month rally in “hard assets” which could yield 20%, 40% or even triple digit gains on many of the stocks in question. ZachStocks will likely be profiling many of these companies in coming weeks as we work our way through this volatile period.

Comments

[morph366:]

Based on your astute observations about the growing threat of delinquencies I think that you then smudge matters in the following sentence - "Unfortunately, none of this economic help is free and we will eventually have to pay for these measures through higher taxes, inflation, or continued weakness if the measures are not successful."
Which is it to be?
The most likely one If the stimulus measures are "not successful" is further iterations through the loop of increasing delinquency->more distressed asset sales->lower aggregate demand -> higher unemployment etc.
That would seem to rule out tax increases and inflation and provide policy makers with their worst nightmare - a deflationary death spiral.

Jul 09 07:42 AM

[Old Trader:]

"That would seem to rule out tax increases and inflation and provide policy makers with their worst nightmare - a deflationary death spiral."

Re:tax increases.....May I please introduce you to Pelosi, Frank, et.al.? Don't bet on it.

Jul 09 09:25 AM

[ain't no fo...:]

Those who have been watching the U-6 and shadow stats unemployment figures rather than the headline numbers have known for many months that unemployment would exert an increasing drag on housing, resulting in a whirlpool of decreasing home values feeding further delinquencies and foreclosures, feeding further unemployment, feeding further delinquencies, etc etc etc.

Add CRE, credit cards, and other rapidly developing sinkholes, as well as a thoroughly discouraged American middle class "consumer," and we are in the vortex, or as morph calls it, a deflationary death spiral.

Policy makers are powerless at this point to step in front of that train.

Jul 09 10:47 AM

[Zachary Sch...:]

excellent comments all around... The possibility of a deflationary death spiral cannot be overlooked. But with the powers that be intent upon printing our way out of this mess, I would anticipate the end game being a debasement of currency in return for a "paper" bull market. Unfortuantely, a paper bull market really does very little to help consumers or the economy because that paper becomes worth less. Employment will still be weak, and those who have jobs will find their earnings taxed to the breaking point.

These are serious issues. And we can't simply "hope" that things get better as we throw more money at the situation. For the next decade, investors will have to become increasingly creative to find REAL returns and to protect the purchasing power of their assets. But opportunities abound for those willing to consider approaches other than the "buy and hold" standard we have held to for so many years.

Thanks for the comments guys!
zachstocks.com

Jul 10 11:27 AM