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Financial Industry Insights from Advisors Asset Management
On April 17, 2014
The Three Pillars of the Economy
With recent volatility in the equity markets, which is completely natural and healthy, the talk of a bubble is percolating again. In fact, the cover of The Economist (a favorite publication of mine) displays A History of Finance in Five Crises and how the next one can be prevented. Though it in no way is forecasting an imminent bubble, it feeds on the anxieties of both retail and institutional investors. We get further affirmation of this anxiety on the institutional end when the Merrill Lynch Global Fund Manager Survey shows excessive cash levels from respondents that have signified a contrarian buy signal in the past for equities.
The three pillars of the economy, for today’s argument which will be addressed, are:
1) Households
2) Corporations
3) Banking
When breaking down GDP, normally one would add government contribution to the mix and remove the banking component. For those curious about the omission of the government, the 15-year high of government contribution to GDP was June 2009 when it was at 1.56%. This compares to the 60-year average of 0.43% contribution. Since that high of June 2009, the contribution of government has stood at an actual deduction from GDP of -0.32%. The trend is the government contribution to GDP is declining and is a distant third to households and corporate contributions.
In comparing the three pillars, current leverage scenarios corresponding to past high watermarks, any current fear of bubbles seems quite overdone.
Not only is the debt servicing of financial obligations with households at historic lows, the current reading is actually two standard deviations from its median over the last 30 years. You also notice, of the three most significant corrections, the debt servicing ratio was at a cyclical peak…nowhere near where we currently stand.
The large amount of refinancing of bonds during the last few years as a result of the Fed driving down rates has a profound impact on cash flow for companies both now and in the future. Expectations from many are a net reduction in the float of corporate debt should rates rise. What the Fed flow of funds shows is that companies are actually benefiting from a positive funding gap, meaning there is little reliance on accessing capital markets for daily functions. This has profound impacts on income investors and the tethering of rates in the short run, which we have addressed in the past.
Lastly, consider the absolutely immense amount of liquidity in the banking system. We continue to monitor the Fed-induced increase in the cash holdings for commercial banks, which stands currently at $2.749 trillion, as of April 2014. Recall that up until September 2008, this level was growing at 2.2% per year and stood at $332 billion. Since then, it has swollen by an annual average of 43.38% or a total of 626%.
One other component of the amount of potential for not only expansion in the economy but profits for the traditional lending model is the amount of change year over year in loans and leases for U.S. banks. Currently the year-over-year change is half of what the 40-year average has been.
The historic prices of equities, ambivalent sentiment of consumers and real lack of strength in unemployment are the pulling forces of emotion that traditionally trump logical investment decisions. However, in looking at three key drivers of growth in the economy we find levels that don’t necessarily correspond to naturally occurring corrections spilling into something with more ferocity. “Disruptive Anxiety” is often far worse than “Disruptive Actuality.”
CRN 041714-4149R
Advisors Asset Management, Inc. (AAM) was not involved with the preparation of third party articles linked to on this page and the opinions expressed in those articles are not necessarily those of AAM.
This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at www.aamlive.com/blog/about/disclosures. For additional commentary or financial resources, please visit www.aamlive.com
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