Consumers Are Borrowing As Much As Ever

Includes: RXI, VCR, XLY
by: Erik Gholtoghian

Consumer spending accounts for roughly two-thirds of GDP growth in the United States. Consumer credit is, therefore, an important factor to consider when forecasting the near future for the economy. Below is a chart showing total outstanding credit in the United States over the prior ten years.

Click to enlarge

You can see from the chart that outstanding credit (mostly from credit cards) is approaching record levels again. This means that it is likely that consumers are getting pretty close to maxing out on their credit cards and other lines of credit. It also means that this prior "recovery" over the past two years was fueled by illegitimate means. Meaning, the growth was fueled by consumers who used money they did not have.

There are many, many factors which can be looked at to help determine if the economy is about to seize up again as it did during the financial crisis, but consumer credit ought to be watched by more people. The focus is usually on non-farm payrolls or GDP, but consumer credit is a leading indicator rather than a trailing indicator, in that it allows one to see how leveraged the economy is getting. The more credit outstanding at the time the economy stops functioning, the harder asset prices will fall.

This data leads to a rather simple conclusion. If consumers finally reach a point where they have reached their borrowing limits, and there is no job growth to save them, it is likely that those consumers will no longer be able to buy anything. And because consumption makes up two-thirds of GDP, all of the pieces are in place for a recession. My personal observations lead me to believe that consumer credit will climb significantly all summer, which could make the economy as weak as ever going into the coming election season.

A further conclusion could be that it might be wise to reduce exposure to those sectors of the economy that most rely on consumer credit. Funds such as the Select Sector SPDRs Consumer Discretionary Fund (NYSEARCA:XLY), Vanguard Consumer Discretionary Fund (NYSEARCA:VCR), and the iShares S&P Global Consumer Discretionary Sector Fund (NYSEARCA:RXI) are all excellent choices to short if one wishes to hedge this component of the economy out of their portfolio.

Individual companies that would also be good short candidates would be companies that heavily rely on credit cards in the purchase process. Hotels stand out as one of the most vulnerable industries due to the requirement to use a credit card.

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