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As most equity markets continue to notch new record highs, the grumblings regarding U.S. debt levels are growing louder. What’s somewhat surprising is how equity markets continue to grind higher even after the Federal Reserve indicated a “higher for longer” stance with interest rates. As the bond market continues to experience heightened volatility, many equity markets are seemingly indifferent.
The Federal Reserve has been clear in their goal of a soft landing, which involves an economic slowdown while avoiding a recession. This is being done with the goal of bringing inflation down to the Fed’s 2% target. This strategy can be tricky as it can end up pushing the U.S. economy into a recession. The Fed is trying to thread the needle, which can be extremely challenging. Many economists are concerned about whether this will cause more harm than good and ultimately lead to a severe stock market correction.
DEBT LEVELS
Total debt has been steadily rising and eclipsed $17.69 trillion at the end of the first quarter. As seen in the chart below, the increase started aggressively accelerating in the past few years.
Now, some level of increase should be expected in an expanding economy as debt becomes more accessible and consumers desire to borrow more in good times. What we need to watch for are default and personal savings rates. Rising debt, in and of itself, is not necessarily a bad thing since it helps fuel economic growth, but there are limits.
Excluding student loan debt, delinquencies have been steadily rising since Q4 of 2021. Credit card delinquencies are now higher than pre-pandemic levels. This is something to monitor along with credit card debt utilization. The number of borrowers who have maxed out has significantly increased. Credit card debt levels have long been a concern, but that alone is usually not enough to upend the global economy.
It is also important to remember that more than $814 BILLION was distributed to American households during the pandemic. Some of that money was used to pay down debt and put aside as a rainy-day fund, so it should be no surprise that we are seeing a rise in debt levels after that money was spent. The trillion-dollar question is whether this trend will continue, or are we likely to see a leveling off?
SAVINGS RATE
While an increase in debt can be alarming, the next question that needs to be asked is “How much are American households saving?” In the end, debt isn’t always bad as long as people continue to save. As seen in the chart below, the personal savings rate as a percentage of disposable income has declined significantly in the past 12 months.
Now, we need to remember that the savings rate soared at the onset of the pandemic, so a reduction was to be expected. As with credit cards, we will want to monitor this closely because a further drop would be troubling for many obvious reasons.
WAGE GROWTH
Wage growth has become a very popular topic over the past few years. Put simply, the more money people have, the more they are likely to spend. While making more is a good thing, it can lead to persistent sticky inflation if left unchecked, as experienced in Q4 of 2021 and 2022. I’d argue a slight further deceleration in wage growth should be welcomed. For inflation to approach the Fed’s 2% target, consumers are going to have to spend less, which is a likely outcome if their wage growth gets back to its historical average.
Of course, we do not want to experience a massive deceleration either, which seems unlikely unless the labor market cools significantly. Currently, we are not too far off the historical wage growth average of 3.3%. This bears monitoring since a slight decline below this wouldn’t be such a bad thing, as that would likely mean a further contraction in inflation.
NET WORTH
OK, up to this point, I know what you’re likely thinking: “This doesn’t seem promising.” I get it. But there are always two sides to a coin. While we need to keep our eyes on some worrisome data points, there are also positives.
The net worth of households and nonprofits has been on a tear lately, eclipsing $156 TRILLION. This is up more than two times compared to the levels achieved at the peak before the 2008 Financial Crisis. As total debt rises, the increase in net worth (assets minus liabilities) has been increasing at a faster rate! With the ability to earn a respectable yield on cash, many are benefiting when, for much of the past decade, they were earning next to nothing.
STOCK MARKET
The stock market is not the economy. Let me repeat: The stock market is not the economy. This is very important to remember. While it’s difficult for stocks to rally in the face of a deteriorating economy, corporations can use methods such as stock buybacks, cost cutting, and cheap debt financing to boost their stock price in lean times.
As seen in the chart above, the earnings per share (EPS) of the S&P continues to climb, even in the face of a cooling economy. While not the desired outcome, this shows that the stock market can perform well even in these situations.
All this is to say that things are never as simple as they seem. The global economy has many moving pieces. There are always things to worry about, but headlines can often be misleading. These data points collectively should be monitored over the coming months to better understand where we stand. Remember to focus on the big picture and not the day-to-day stuff.
Discuss your situation with a fee-only financial advisor.