Despite the market's recovery over the last three trading days, huge vulnerabilities remain for stocks. Amid worries about a trade war, the S&P 500 Index (SPX) is still 7.3% below its January 26 high, as of the April 5 close. Among the bigger forces that could trigger a market crash, massive consumer debt looms particularly large in the opinion of Stephanie Pomboy, founder of economic research firm Macromavens.
As she stated in a lengthy interview with Barron's: "There are two ways a crisis can happen. The slow and boring way is the Fed tightening continues to ratchet up and turns the screws on households and speculative-grade corporations, and the markets begin to anticipate more defaults, and reprice risk. The more spectacular way is if stocks fall because of terrorists or North Korea or whatever, which brings the whole pension crisis to the fore."
Exploding Household Debt
"Households are borrowing 90 cents for every incremental dollar they spend, up from 40 cents four years ago," Pomboy observed, with the upshot that rising borrowing costs will create a crisis for debt-burdened consumers. Additionally, she noted a surge in consumer borrowing right after the Affordable Care Act, which was supposed to reduce health insurance costs, went into effect in 2013. (For more, see also: Why The 1929 Stock Market Crash Could Happen in 2018.)
"Debt service is increasing at a rate that will eliminate the entire effect of the tax cut," she remarked, adding, "For households, you're looking at an annual increase in debt service of $75 billion." According to Federal Reserve data reported by Bloomberg, U.S. household debt rose in the fourth quarter at the fastest pace since 2007. Bloomberg adds that both spending and deliquencies on credit cards are rising briskly, and that higher rates on credit card balances represent "the biggest financial worry for many U.S. families."
Soaring Cost of Necessities
Pomboy noted that total savings rose from $440 billion to $1.4 trillion after the 2008 financial crisis, but now are back down to $400 billion. Much of that massive reduction of savings, she said, is the result of large increases in the cost of nondiscretionary items such as food, energy, health care and housing. "Consumers have had to draw down whatever savings they amassed after the crisis and run up credit-card debt to keep up with the necessities of life," she told Barron's, in the interview published on March 22.
Outlays on food and energy alone gobbled up 30% of the increase in consumer spending during the last six months, she said, versus 11% in the two prior years. This is crowding out discretionary retail spending, and thus she advises investors to "steer clear" of this sector. There also are much wider ramifications. "At 70% of the economy, a drop in consumer spending will impact profits," she noted. Pomboy expects a "one-time lift" from the recent tax cuts to fade in 2019, while President Trump's tariffs "may cause a margin squeeze because of rising costs."
The Pension Crisis
"We are looking at a $4 trillion pension deficit across the public and private sectors in the U.S., after nine years of rampant asset inflation," Pomboy also observed. On a per capita basis, that's over $12,000 for every U.S. resident. "If the market corrects even 15%, and stays there, it will bore massive holes in pensions," she added.
Meanwhile, she noted: "The stock market is utterly dependent on free money, which drove it in the face of lackluster economic and earnings growth. The idea that we can suddenly reverse quantitative easing and have no knock-on consequences for stocks seems a little pie-in-the sky." (For more, see also: Pre-Crash Indicator Near Peak Amid Trade Tensions.)
Where to Invest
Pomboy's clients are institutional investors, such as mutual funds and hedge funds. When asked by Barron's about her own portfolio, she said: "I have gold and an embarrassing amount of cash. I was short the market and managed to capture some of the rout in the first week of February. I have some short exposure still." Regarding cryptocurrencies, she does not understand the appeal, given their "incredible" price premiums and the difficulty of accessing and trading your holdings. Noting that she would rather hold gold coins, she also is certain that central banks will start regulating digital money.
For long-only investment managers, she recommends "underweighting U.S. risk assets versus, let's say, emerging markets and hard assets." She also told Barron's: "You could hunker down in commodities: The CRB Index, on a relative performance basis, is near the lowest it has ever been." Finally, she indicated that "I'd be overweight long-dated Treasuries and underweight the dollar," on expectations that the Fed will reduce its projected four rate hikes this year to three or even two, and perhaps delay its planned reversal of quantitative easing.