Credit Card Spending Growing At An Alarming Rate

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 |  Includes: AXP, COF
by: Vuru

(Editor's Note, December 29, 2013: This article has been revised since original publication as author removed the portions discussing the credit card companies' valuations.)

On October 12th, 2007, the Dow Jones Industrial Average hit its peak of 14,093. Shortly thereafter, the markets had a 50% haircut. Ever since, the DJIA has been slowly gaining lost ground. Credit card companies have followed a very similar path. Between 2007 and 2008, well-known companies such as American Express (NYSE:AXP) and Capital One (NYSE:COF) saw their profits halve in line with the market. The interesting news is that their profits have recovered back to pre-recession levels.

Credit Card Spending

Recently, CardHub.com reported 3rd quarter credit card debt jumped $16.8B, 154% growth year-on-year. This is the first time in the last two years that credit card debt paid down in the 1st quarter had been completely neutralized by the end of the 3rd quarter. They said, "The speed at which consumers are garnering new debt in 2011 is unprecedented."

This points to two possibilities. First, consumers could be starting to take on unsustainable debt loads. Second, the economy could be improving. Let's take a look at both in more detail.

Unsustainable Debt Levels

What's particularly telling is that there's starting to be a consistency to this spending. In CardHubs report on Q2 2011, they said, "The debt in Q2 2011 is a staggering increase of almost $18.5 billion, which is 66% higher than the increase observed on the same quarter one year ago and 368% higher than the increase observed two years ago." (emphasis mine)

This is worrying. It could mean consumers are feeling the effect of high unemployment and are turning to credit card debt to temporarily handle certain costs. This could result in increases in delinquency.

Economic Improvement

The other side of the coin is that this behaviour is the result of an improving economic environment. Personally, I think this is a weaker argument but one worth considering.

The most recent jobs report had the lowest unemployment rate since April, which is hopeful. However, for the decrease to be sustainable, the number of unemployment benefits applications needs to drop below 375,000. We're currently at a seasonally-adjusted 390,000, so not far off.

Additionally, during the July to September quarter, the economy grew at an annual pace of 2.5%. That's the best quarterly growth in a year.

Things are starting to look up. It's possible that people are taking on more credit card debt because they're confident about their employment situation. We may see a massive pay off of credit card debt in Q1 2012.

Verdict

Credit card companies' earnings are cyclical. They experience higher loan losses during recessions and lower losses during booms. With unemployment still being an issue and credit card debt rising at an alarming rate, I'm concerned about a hard fall.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.