February 20, 2019

The stock market is in “giddy-up” mode, posting a truly impressive eight-week winning streak that has restored almost three-fourths of the fourth-quarter losses. Funny how a retooled Fed policy and a more accommodative trade narrative can turn market lemons into lemonade. And while fourth-quarter sales and earnings are also worth crowing about, those numbers will likely take a fairly sizeable haircut in the current quarter and further out, due mostly to tougher year-over-year comparisons.

The S&P 500 is challenging its next overhead level of resistance at 2,800, where cries of an “overbought” market are sure to emerge. In fact, CNBC’s Steve Grasso reported last Friday that Goldman Sachs was reporting large year-to-date outflows, despite the run up for stocks.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary

Apparently, January 25th saw the largest single-day outflow from the aggregated funds of the SPDR S&P 500 ETF (SPY), Vanguard S&P 500 ETF (VOO), and iShares Core S&P 500 Index (IVV) on record. That statistic initially sparked some “canary in the coal mine” chatter, but it was later thought to be just a large institutional rebalancing of portfolio weighting out of equities and into bonds.

What’s interesting is that, despite those outflows, the S&P 500 closed higher on January 25th. Since then, net inflows and outflows have been fairly balanced, and the market has rallied strongly.

Investors that have fought the Fed and fought the tape or have been spooked by all the bearishness put forth by the financial media have truly missed out on a bonanza, and with momentum still very much in favor of the bulls, it would not surprise me to see a jump in inflows over the next couple of weeks as the “FOMO” (fear of missing out) crowd wanders back in and takes their position.

The Market is Ignoring Massive New Debts – For Now

Even though the major averages are trending back towards their previous highs from early October, some of the structural issues that I have talked about in prior columns are starting to get more attention. While the economy is expanding and unemployment is at historical lows, a record seven million Americans are 90 or more days behind on their auto loan payments (source: Fortune.com, February 12, 2019).

Within the various consumer debt categories, student loan debt currently has a hold on the #2 spot (behind mortgage debt), ahead of credit cards and auto loans. As of mid-2018, over 44 million borrowers owed more than $1.5 trillion in student loan debt (source: Forbes: “Student Loan Debt Statistics in 2018 – A $1.5 Trillion Crisis”). Sheila Bair, the former head of the FDIC, described the student debt problem in Barron’s last year by saying that nearly 20% of those loans are already delinquent or in default. That number could balloon to 40% by 2023, according to a report by the Brookings Institution.

The “buy now, pay later” syndrome that Americans have come to embrace is slowly creeping higher as a drain on household budgets. Everything from furniture, electronics, clothing, medical expenses, travel, eating out, and leisure are being paid for by use of credit cards in an ever-increasing trend. While they offer an artificial bump to people’s expectations for the standard of living they aspire to have, in reality debt is a long-term drain on the bank account. More Americans forego what they can afford now, in cash, but instead choose to buy whatever they want, if they think they can afford to make the payments.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

One area that rarely gets talked about is the underfunded state pension and the looming impact of what 10,000 baby boomers retiring every day has on pension funds. Moody’s Investors Service recently estimated that public pensions are underfunded by $4.4 trillion. As of January 1, 2019, every state in the Union has an underfunded pension, the worst of which is in New Jersey, where only 30.9% of the state’s pension fund is funded, with a total pension shortfall of $168.2 billion being the largest in the nation (source: MSN.com, December 17, 2018).

The Chicago Tribune recently wrote about how the decision to reduce the expected-return assumption from 7.5% to 7.0% for the Illinois Teachers Retirement System resulted in the governor calling for approximately $400 million in additional taxes. If a simple reduction of 0.5% in expected annual returns amounts to a $400 million additional tax bill, then something along the lines of a 3% return in a slow economy would imply the need for $5 billion in additional taxes on the citizens of Illinois. The following chart shows how much in taxes needs to be raised for each half-a-percentage-point in lowered returns.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

And then there is the problem of the rising cost of healthcare, which now consumes one in five American dollars, or $4.4 trillion of the $22 trillion in U.S. GDP, according to www.healthcommentary.org. High health care bills are also the leading cause of personal bankruptcy in America. An aging population that is living much longer is now colliding with the cost of expensive drugs and high-tech treatments and a society that demands premier healthcare for everyone. This is a hard topic to diagnose, but if America moves toward a single payer, the big health insurance companies will be the next “big short,” for sure.

The 2019 federal budget is forecast to be around $4.4 trillion, with only $3.4 trillion in estimated revenue – creating a $985 billion annual deficit – and that does not take into account what could be a $1 trillion infrastructure bill on the way. In fact, according to a New York Times article, “The federal government’s annual budget deficit is set to widen significantly in the next few years, and is expected to top $1 trillion in 2020 despite healthy economic growth, according to new projections from the nonpartisan Congressional Budget Office. The national debt, which has exceeded $21 trillion, will soar to more than $33 trillion in 2028, according to the budget office.”

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

So, while these topics are obviously not of any great importance to the reinvigorated stock market at this moment, they are certainly growing into trends that will be difficult to reverse in the near future, if left unchecked. America’s economy ended 2018 valued at $20.4 trillion, adding $1 trillion from 2017, which sounds solid on the surface. There is a lot of leverage in growing that year-over-year number.

For now, the U.S. stock market seems to ignore rising levels of consumer, corporate, state, and federal debt. This condition might continue for who knows how long, but it’s my view that extreme debt levels contributed greatly to ending the bull markets for stocks in Japan, Europe, and China, and that’s a template we should all pay attention to.

About The Author

Bryan Perry

Bryan Perry

Bryan Perry is a Senior Director with Navellier Private Client Group, advising and facilitating high net worth investors in the pursuit of their financial goals.

Bryan’s financial services career spanning the past three decades includes over 20 years of wealth management experience with Wall Street firms that include Bear Stearns, Lehman Brothers and Paine Webber, working with both retail and institutional clients. Bryan earned a B.A. in Political Science from Virginia Polytechnic Institute & State University and currently holds a Series 65 license. *All content of “Income Mail” represents the opinion of Bryan Perry*


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