Submitted by Porter & Co.
The U.S. economy runs on credit. When America’s credit engine sputters, so does the economy.
And right now, we’re majorly overdrawn.
Banks are tightening lending standards for consumer loans -- a reliable leading indicator for an economic recession. Over the last twelve months, the percent of U.S. banks reporting an increased willingness to make new consumer loans has plunged deep into negative territory:
Banks are wary of making new loans right now because consumer defaults are on the rise. The chart below shows the recent acceleration in delinquency rates on credit card debt:
In the latest round of earnings calls, every major American bank reported a surge in credit provisions (capital set aside to cover future loan losses). For instance, J.P. Morgan reserved $2.3 billion for potential loan losses in Q4, a 49% increase from the prior quarter.
Here’s Why The Consumer Lending Pullback Is A Big Deal
Over the past year, as inflation has eroded incomes, the consumer savings rate has plummeted to a record low of just 2.2%. In a recent survey, 64% of Americans reported that they are living paycheck to paycheck. As a result, they’ve turned to plastic, racking up a record $930 billion in total credit card debt, up by nearly $200 billion since 2020.
But with defaults on the rise and banks pulling back on lending, this source of spending is now drying up. Typically, American consumers take out roughly $20 billion to $30 billion in new credit card debt each month. In December, that figure fell to just $7.2 billion.
Fewer loans and fewer credit cards means less spending… and corporate America is feeling the pinch. S&P 500 companies are on track to post their first negative quarter of earnings-per-share growth since the COVID crash.
What’s more, the consensus estimates for the forward earnings of the S&P 500 just turned negative. This is a rare occurrence on permabull Wall Street – but when it happens, it usually precedes a steep drop in stock prices.
Despite the recent rally in stock prices, the key leading indicators of economic growth all point towards a sharp recession looming on the horizon. This includes rising default rates, tightening credit, and deteriorating corporate earnings.
The only question now is whether Jerome Powell will accept the short-term economic pain of a recession to stamp out inflation for good. The alternative path of easing rates too soon risks a repeat of the nightmarish “Great Inflation” of the 1970s, and a lost decade in economic growth and financial asset prices. (Interestingly, rising credit card use also played a significant role in the ‘70s debacle.)
All things being equal, we’d rather deal with a sharp, one-time recession than another ten “lost years” of inflation. But the ball is in Powell’s court now.
How to Bulletproof Your Portfolio, No Matter Which Path Powell Takes
The Fed, like Mary Poppins, “never explains anything” – or, if it does, it’s always open to interpretation. As former chair Alan Greenspan once remarked: “If I seem unduly clear to you, you must have misunderstood what I said.”
Only Powell knows his own intentions. Meanwhile, investors need to focus on building a portfolio that can withstand a range of potential outcomes.
Focus on defensive, capital-efficient names (we refer to these as “Battleship Stocks”). Find high-income securities like preferred stocks and REITs. And get broad exposure to commodities, and energy in particular.
High-quality energy companies can offer both offense and defense in a portfolio. In a recession, the current trend of underinvestment in fossil fuels should accelerate, boosting energy prices for many years.
Conversely, in a 1970s replay, energy will provide one of the few safe havens during a high-inflation environment (just as it did in 2022).
You can read more of our energy research here.
