America's Impending Debt Crisis: This Won't End Well For Stocks

Summary

  • Stocks may have found a short-term bottom, but out there on the horizon the next crisis is lurking.
  • Despite the short-term positive indicators surrounding stocks, it is important to keep an eye on the big picture.
  • The U.S.'s enormous spending addiction has created a massive debt bubble that is going to lead the economy to its next financial crisis.
  • Consumer, government, credit card, auto loan, mortgage, student loan and just about any other debt you can think of is at a new record - and it won't end well.
  • America's impending debt crisis is likely to materialize within the next few years, and when it does, its destabilizing effects will be felt deep throughout the financial system.

Source: M3WealthAdvisors.com

America’s Impending Debt Crisis

Stocks rebounded nicely over the past week. The S&P 500/SPDR S&P 500 Trust ETF (NYSEARCA:SPY) has surged by roughly 5% since hitting what appears to be a short-term bottom at the height of the recent correction. The fundamental landscape surrounding stocks seems to be stabilizing and appears constructive in the short-to-intermediate term. I'll even go out on a limb and say that the stock market bottom is probably in for now.

SPY 1-Year Chart

Source: StockCharts.com

The oversold indications projected by the RSI and CCI, the dip below 20 in the full stochastic, the textbook bounce off the 200-day moving average, massive sell volume, as well as other factors suggest that the badly needed correction may have come and gone. Moreover, S&P 500 futures had a successful retest of the lows, which happened in after-hours trading, thus it doesn't show up in the SPY chart. Nevertheless, most indicators point to a return to higher prices for stocks in the short-to-intermediate term.

The short-term positive catalysts likely to propel stocks higher throughout 2018 include increased economic activity, GDP expansion, moderate inflation, a soft dollar, tax cuts, deregulation, increased government spending and positive sentiment. These underlying fundamental elements are likely to drive stock prices higher in the near term.

However, it’s not all good news. Looming on the horizon is America’s impending debt crisis - a predicament so severe, it poses an imminent threat to the U.S. economy and is likely to inflict immense carnage on stocks when it arrives.

About SPY

SPY is the first major and most popular ETF in the world. It's designed to mimic the exact movement of the S&P 500. The SPY Index fund has roughly $277 billion in net assets, and each share in the fund represents a fraction of the holdings. SPY provides investors with exposure to the S&P 500 index, which is widely regarded as the most significant stock market average for U.S. equities. Since SPY tracks the exact movements of the S&P 500, I will use SPY and the S&P 500 interchangeably throughout the article.

The Origins of The Upcoming Crisis

Let’s face it, the U.S. has an enormous spending problem. Overspending and living beyond normal means, coupled with Wall Street’s insatiable appetite to make money, played an instrumental role in leading the economy and the stock market off a cliff in 2008’s economic debacle. It’s evident that in the current global order, the U.S. is one of the leading nations propelling the consumerism trend to new extremes. Corporations are continuously producing an increasing number of products; consumers crave these products, and they expect them immediately. Hardly anyone is taught to save for anything anymore. Instead, we are conditioned to want a lot of unnecessary products, and we’re granted an instant pathway to these things via cheap credit. Any system that willingly enables instant gratification in this way is likely to have some downsides and is bound to produce some adverse unintended consequences from time to time.

Consumer Debt is Becoming a Big Problem, Again

Just look at the massive consumer debt all around us. Consumers have the highest-ever credit card debt, student loan debt, car loan debt, mortgage debt and just about any other kind of debt you can think of. Total U.S. consumer credit is now up by a staggering 45% over the 2008 peak, and it is going to become increasingly more difficult to service this monstrous debt load in a rising rate environment. This will inevitably lead to a wave of defaults in various segments of the economy, and could ultimately eclipse the overall damage produced in the 2008 crisis. Some of these numbers are truly staggering:

Source: BusinessInsider

  • Credit card debt: $1 trillion
  • Car loan debt: $1.2 trillion
  • Student loan debt: $1.5 trillion
  • Mortgage debt: $15 trillion
  • Total personal debt: $18.86 trillion

The personal debt picture is bad, and there are already significant signs of strain in the system. The overall balance of student debt is now over $1.5 trillion, up an astounding 500% since 2003, and delinquencies are exceedingly high on this debt at over 11%. A tsunami of student loan defaults is likely to hit the economy in the next few years, which will likely produce all sorts of unfortunate consequences for consumers and the broader economy alike.

Source: Hoyes.com

In addition, the New York Fed recently reported that it observed a 7.5% rise in the share of credit card balances that were severely delinquent. Synchrony Financial (SYF), one of the largest providers of store credit, reported a 30% increase yoy in loan loss provisions. American Express (AXP) reported a 26% yoy rise in loan loss provisions. Capital One’s (COF) charge-off rate climbed from 4.07% to 5.1% yoy. Most recently, JPMorgan (JPM) and Citigroup (C) reported they were expecting a continued rise in credit card defaults as well.

Source: BethKoblinger.com

There is plenty of troubling auto loan data as well. More people than ever before have taken out significant amounts of credit to finance cars in this world of cheap credit. One of the problems is that many of the car loans are subprime. Remember those? Right, they are loans granted to people with little or no credit history, bad credit history, it doesn’t matter. If you had a pulse, you could probably get a car loan until late. Naturally, these loans are not on very favorable terms for consumers. The rates reset much higher after the initial loan period. Moreover, tens of billions in these loans have been securitized. Yes, much like the mortgage-backed securities of the mid-2000s. This market is not as big as the MBS market, but it represents another mini time bomb that could implode a segment of the economy when enough consumers stop paying off their loans.

Government/National Debt

But if you think this is merely a consumer-led issue, it's not - the government is the same way, perhaps worse even. Politicians promise a lot when they are being elected, and they are expected to deliver once placed in office. However, the government doesn’t make nearly as much in tax revenues as it spends each year. For instance, U.S. Federal revenue is up by 82% since 2000, but Federal spending is up by a whopping 138%. The current Federal budget is underfunded by more than $700 billion, and with the new tax cuts, infrastructure projects and other increased spending, this gap is only going to widen in the foreseeable future. Debt, consumer and government, has climbed to absurd levels. The national debt is higher than 105% of GDP, and is only projected to soar higher from here.

Source: Trading Economics

The Problem With the National Debt

The main issue with the national debt is that it must be serviced continuously. And as it grows to obscene levels, it becomes incredibly expensive to service, especially in a rising rate environment, such as we are in now. In the end, the dynamic resembles a snowball effect, where the debt continues to get bigger, interest payment continuously increase, and then splat... the snowball hits a wall and it’s the end. The end may be a lot closer than many market participants perceive.

Source: MortgageCalculator.org

The national debt is comprised of all sorts of debt, notes, bills and bonds. However, a relatively good benchmark to use when estimating interest payments is the 10-year note, as it represents a good average rate for all the various debt vehicles. The 10-year is currently at about 2.87%, so an annual interest payment on $20 trillion at this rate would equate to $574 billion. The actual debt servicing payment was $458.5 billion in 2017, but since rates were quite a bit lower throughout 2017, it makes sense that the servicing payment is consistent with a rate of 2.3%, roughly where the average 10-year rate was throughout the majority of 2017.

Chart5 Year Treasury Rate data by YCharts

As the Fed continues to normalize rates, it is projected that by 2022-2023 the 10-year will be at about 3.5%. We also know that due to the increased spending and tax cuts, deficits are likely to be at $1 trillion-plus for at least the next five years, bringing the national debt to at least $25 trillion by 2022-2023. Therefore, just the servicing of the U.S. debt by this time will be roughly $875 billion, the second-highest budget item by today’s metrics, only behind Social Security.

Also, it is important to note that the 10-year is already approaching 3%, and my projections are for significantly higher rates going forward. The Fed’s projection of 3.5% on the 10-year 5 years from now hardly looks realistic. Therefore, debt servicing payments could be over $1 trillion 5 years from now if the 10-year is above 4%, which it very well might be.

Another element to consider when observing rates is the flattening of the yield curve. The 30-year now produces a yield of just 0.25%, or 25 basis points, more than the 10-year. A flattening of the yield curve often suggests that market participants are anticipating a downturn in the economy to materialize.

It is also important to note that the money to service debt doesn’t just materialize out of thin air, it comes out of tax revenue; therefore, Americans will likely be paying a collective $875 billion, $1 trillion, or more in taxes as mere interest payments to service the U.S. debt.

There is No Denying It: Debt is a Big Problem

It’s clear, debt is becoming a real issue, and unlike other countries that have debt and produce more than they consume for export, the U.S. does not. The U.S.’s trade deficit will easily top $500 billion this year alone, and the foreign exchange markets are starting to notice. FX markets are often most keen to observe such issues and are quick to react. Perhaps this partly explains why the dollar has been tanking over the past 14 months.

Moreover, some major market participants, including Japan and China, are beginning to show a certain degree of concern for U.S. debt, as the dollar continues to fall. U.S. treasuries are not receiving the type of demand they once did, and the Fed is exacerbating this phenomenon by embarking on QT and staying committed to further tightening. Bond yields are rising as a result. This trend is likely to continue, and will cause various debt servicing payments to continue to rise significantly going forward.

The recent shock to the stock market we experienced was likely a warning signal due to rising rates and a weakening dollar, suggesting that an ongoing trend of a weaker dollar and higher rates will produce a destabilizing effect for stocks in the long run. This is not going to be an overnight event, and it may not even happen in 2018, but within the next few years, a major debt-based crisis will likely hit the U.S. economy. This could lead to a simultaneous crisis involving the dollar, bonds, as well as stocks.

Chart^DXY data by YCharts

If the dollar continues to cascade lower due to higher inflation and an ever-increasing higher debt and deficits, then market participants don’t have much incentive to hold U.S. bonds at current or slightly higher rates. This means that to entice demand for bonds, rates need to go up, possibly significantly. In this case, the economy and stocks will not react well, because higher rates are detrimental to economic activity and to risk assets in general, including stocks.

But Enough About The Future, Let’s Get Back to The Now

When Donald Trump got elected, the dollar rallied substantially, as market participants believed that “America First” meant a strong dollar, strong manufacturing, a smaller trade deficit, a tighter budget etc. However, everything turned out to be the opposite. It appears that Donald Trump's preferred policy is a weak dollar and massive loads of debt. Surprise, what did you expect from the self-proclaimed “King of Debt”?

Source: CNN

Whether this policy path is right or wrong is somewhat irrelevant right now - what is relevant is the fact that we are in an environment with massive debt-based spending and a weakening USD. Moreover, this trend is not likely to change anytime soon.

What to Expect Going Forward

In the underlying macroeconomic environment, inflation is likely to continue to rise because an ever-increasing amount of dollars and debt is being implemented to fund the current economic expansion. Yes, the economy is growing, but at what cost? This is not a typical expansionary cycle that is primarily supported by organic growth, increased productivity, innovation, etc. Sure, these elements are present to an extent, but the predominant forces behind the current expansion have been artificially low interest rates, excess liquidity and cheap credit. The Fed may believe it can unwind this situation with minimal side effects, but I am not so sure. It appears that the inflation genie is out of the bottle and is likely to grow significantly going forward.

Therefore, the USD is likely to continue its downtrend. Gold, silver and other precious metals are likely to do well in the underlying environment. Oil and other commodities should continue to appreciate alongside economic expansion and inflation. Commodity-related stocks, and stocks in general, should continue to be favored in this environment barring a significant economic downturn.

However, when the recession does finally arrive, it is likely to cut stocks in half, similar to what happened during the last recession of 2008. So, as the S&P 500 goes on to make new all-time highs throughout 2018, it could get above 3,000, possibly even 3,200 by year's end. Nevertheless, the next recession is likely to cut prices in half, if not more, and ultimately, could bring the S&P down to the 1,500-1,600 level. Also, the current cyclically adjusted P/E on the S&P 500 is 33, and a 50% reduction will put the P/E ratio back in line with its 16.15 median.

SPX 5-Year Chart

Although the S&P 500 is likely to return to making new all-time highs for the time being, there is only so much it is likely to gain before the next recession strikes and prices are forced to correct drastically. My 2018 year-end price target range for the S&P 500 is above 3,000. However, the bear market that is likely to come in 2019/2020 has the potential to wipe out gains that have been accumulating over the past 4-5 years.

USD 5-Year Chart

The dollar has weakened drastically once it became apparent "America first" really means inflation, a weak dollar policy, massive new debt and huge deficits. Although the dollar may experience a short-term bounce off the 88 support level, it is not likely to be a prolonged rally if it even materializes. The overall trend remains lower for the dollar, and it is supported by an overwhelming number of fundamental factors.

Gold 5-Year Chart

On the flip side of a weak dollar, we have gold, silver, oil and other commodities that are likely to perform well in an inflationary/soft dollar environment. We can see that gold has established a strong uptrend since hitting a long-term bottom in late 2015. It should continue to proceed higher along with other commodities and stocks that support these commodity sectors.

The Music is Slowing Down, and This Party Will End Soon

Eventually, the continued rise in bond rates will begin to negatively impact the real economy, likely within the next year or two. Therefore, we should expect the Fed to reverse policy at some point, when the fruition of the next recession becomes evident. In such a scenario, we can expect a lot more inflation and higher prices all around, due to the likelihood of additional rounds of QE and rate decreases. But this does not mean that a significant stock market decline will be averted, and reinforces the long-term lower dollar and higher commodities thesis.

The Bottom Line: Debt is a Big Problem

No matter how you view it, debt is a big problem. Moreover, the greater the amount of debt, the more severe the next recession is likely to be. One of the main issues with our debt, government and consumer, is that it needs to be serviced continuously. And in a rising rate environment fueled by inflation, it is going to become ever more difficult to accomplish. Higher rates lead to much higher interest payments, which diverts capital from consumer spending and stimulative government projects. Also, the Fed will find it increasingly difficult to lower rates in an inflationary environment, as its main mandate is price stability. Therefore, America’s next financial crisis is likely to be a debt-based one, and it may be a lot closer than many people realize.

Source: TheFrugalMillennial

Be careful out there, try to keep your capital safe and don't take on too much debt. Keep an eye out for recessionary indicators, and never be afraid to take profits. Remember, bulls make money, supposedly even the bears make money, but pigs, not so much...

Disclaimer: This article expresses solely my opinions, is produced for informational purposes only and is not a recommendation to buy or sell any securities. Investing comes with risk to loss of principal. Please always conduct your own research and consider your investment decisions very carefully.

To receive real-time updates and get more information about this idea as well as other topics, please visit the Albright Investment Group trading community. Join us and receive access to exclusive content, trade triggers, trading strategies, price action alerts and price targets. Theses value-added features are available only to members of our trading community and are not typically discussed in public articles.

This article was written by

Victor Dergunov profile picture
37.69K Followers
The #1 Service For Diversified Portfolio Profits

Hi, I'm Victor! It all goes back to looking at stock quotes in the old Wall St. Journal when I was a kid. What do these numbers mean, I thought? Fortunately, my uncle was a successful commodities trader on the NYMEX, and I got him to teach me how to invest. I bought my first actual stock in a company when I was 20, and the rest, as they say, is history. Over the years, some of my top investments include Apple, Tesla, Amazon, Netflix, Facebook, Google, Microsoft, Nike, JPMorgan, Bitcoin, and others.

Disclosure: I am/we are long C, JPM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Recommended For You

Comments (389)

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.