Before getting started, we should make one thing clear: this is not an article about America's balance sheet, per se -- a topic sure to bore the reader almost as much as the writer, and we are not here to bore either you or ourselves.
Instead, we will use the balance sheet as perhaps a quirky method of putting investors' lingering debt fears in context. And with debt, context is everything -- most headlines discuss it in absolute terms, or compare it to other figures that primarily serve to confuse.
Debt-to-GDP ratios, for example, have their uses, but measuring a level (debt) against a flow of economic activity (GDP) isn't keeping like with like. Better, in our view, to weigh debt against assets and see what shakes out -- just like a bank would. Do so, and it becomes clear investors needn't fear U.S. debt -- whether household, corporate or government -- sinking stocks.
Let's start with U.S. households, supposedly threatened by surging student and auto debt. Total household debt increased $146 billion in the second quarter to $15.2 trillion -- up almost half a trillion dollars since the previous year.[i]
But household assets rose over 10 times more -- up $1.8 trillion in the second quarter and $8.7 trillion since last year![ii] Household assets now stand above $111 trillion, dwarfing liabilities.[iii] Now, there is an obvious rebuttal: What if the people with rising debt aren't the people with soaring assets?
And it's true, averages obscure extremes. But mortgages make up the bulk of household debt (73.2%), and banks' tighter mortgage standards during this expansion are pretty legendary.
As the now-old joke said, for a long time, you couldn't get a mortgage unless you didn't need one. Mortgage loans comprise less than half of household debt's total rise since its bottom in the second quarter of 2013.
Another gauge of residential real estate loans' health is homeowners' percentage of equity. During and shortly after the financial crisis, this dipped below 50%, a first. It has now bounced back to 58.4%, its highest level since the first quarter of 2006 (during the housing boom),[iv] as house prices nationally make record highs.[v]
While there are some people saddled with six-figure student loans and unpayable subprime auto loans, these aren't representative of the broader market. The median student loan balance is $17,000, owed by college grads with well-paying jobs.
Credit card debt also gets attention, but most of the increase since 2008 stems from accounting rule changes, and there is no evidence higher credit card balances are an economic driver. Not coincidentally, household debt service -- interest payments relative to income -- is near record lows and, since 2012, is below any point in the prior three decades.
Exhibit 1: Household Debt Affordable
Source: Federal Reserve Bank of St. Louis, as of 9/22/2017. Household Debt Service Ratio, Q1 1980 - Q1 2017.
Nonfinancial corporate business liabilities increased $204 billion last quarter and rose $830 billion from last year to a record high $19.1 trillion.[vi]
But again, it's impossible to tell whether this is onerous or not without proper scaling. Nonfinancial corporate businesses' assets rose $830 billion in the second quarter alone and $2.7 trillion over the last year.
They're also at a record high and over twice liabilities at $42.4 trillion.[vii] Once again, there is the question of who holds what. But diversified indexes of corporate bond yields -- for investment grade debt and higher risk "junk" bonds -- take into account various classes of borrowers and their market weightings.
Yields and their spreads above lower-risk Treasurys are near record lows, suggesting minimal Corporate America credit risk. Markets may be wrong of course, but it isn't likely when they incorporate all widely known information.
That is, U.S. corporations are flush with cash and have been meeting their financial obligations by and large. Moreover, default rates -- even among high-yield issuers -- are far below levels seen in early 2016, when very low-quality energy firms squeezed by oil below $30 per barrel failed to service debt.
In September, U.S. federal government debt topped $20 trillion, garnering headlines. But again proper context is necessary. For one, it refers to gross debt. Net debt, which excludes money the government owes itself, is a more benign $14.6 trillion. (Net debt includes the Fed's holdings, as it is technically a private institution.)
Treasury's interest payments relative to tax receipts are now around 7.3%, less than half 1980s and 1990s levels.[viii] Not that the U.S. was in danger of defaulting then, just that concerns are even more misplaced now.
To see why the U.S. isn't over-indebted, Ken Fisher in The Only Three Questions That Still Count constructs the "Aggregate Hard Asset Balance Sheet of the United States."
Roughly speaking, add up the U.S.'s assets (financial and tangible). Then calculate the U.S.'s return on those assets; take U.S. total income (GDP) and divide by total assets. As of the second quarter, it's about 10.8% -- and that excludes impossible-to-value assets like national parks.[ix]
Compare that to the U.S.'s borrowing costs like a good CFO would. The appropriate level of debt is the amount where marginal borrowing costs equal marginal return on assets. Today, the average interest rate for all U.S. debt is 2.3%,[x] a fifth of America's return on assets.
If anything, the U.S. is under-indebted. Yet widespread conventional wisdom believes America is being crushed under unsustainable debt loads when it's rarely been easier to pay for that debt -- because the assets backing it tower over the nation's liabilities and generate much more income than it costs to service.
Stocks move on the difference between sentiment and reality, and the current wide gulf between the two suggests positive surprises for markets well into the future as debt problems fail to materialize.
[i] Source: Federal Reserve, as of 9/21/2017.
[v] The July S&P/Case-Shiller National House Price Index is 3.8% above its bubble peak and 40.3% above its post-bubble low.
[vi] Source: Federal Reserve, as of 9/21/2017.
[viii] Source: Federal Reserve Bank of St. Louis, as of 9/22/2017.
[ix] Source: Federal Reserve and Bureau of Economic Analysis, as of 9/26/2017. US Return on Assets = Nominal GDP divided by Total Assets (Domestic nonfinancial sectors; total financial assets + households and nonprofit organizations; nonfinancial assets + nonfinancial corporate business; nonfinancial assets + nonfinancial noncorporate business; nonfinancial assets), Q1 2000 - Q2 2017.
[x] Source: TreasuryDirect, as of 9/26/2017. Average Interest Rate on Total Interest-bearing Debt, January 2000 - August 2017.
Fisher Investments is an independent, fee-only investment adviser serving investors globally. To learn more about Fisher Investments, please visit www.fisherinvestments.com.