Borrowing binge, corporate cheese-paring and profits

  • Economy
  • Thursday, 05 Jun 2014

REUTERS: Americans are borrowing more, renting more rather than owning, eating in restaurants more and saving less, leading inevitably to questions of sustainability.

That's true both for Americans and for the corporations whose profits they create.

What's more, the kind of financing backing all this indicates that a goodly bit of the balance sheet straining activity is concentrated lower down the income and wealth scale.

Juxtapose this with vertiginous rates of corporate profitability (and intriguing hints that a top may have been hit), and you have the makings of some serious upcoming tests for the economy and stock market.

First, let's look at Americans and their cars. A record 27.9% of all new car sales so far this year were leases, according to, while those who did decide to buy did so with record-long loan terms of 66 months on average.

Interestingly, leasing, which historically has been associated with high-earners in metropolitan areas (think real estate salespeople in California) has been spreading both geographically and down the income table.

The share of leases of sub-compact cars has rocketed 187% since 2008, according to Edmunds, and among compact cars by 13%. As leases are cheaper now but hugely more expensive over a lifetime, this paints a picture of consumers who may be having trouble affording the basics using leases as a way to get vital transportation.

That sobering thought is partly supported by the numbers on the percentage of Americans who own homes, which at 64.8% in the first quarter is in the midst of a multi-year fall, albeit from unsustainable heights during the real estate bubble. This reflects that home loans are, probably appropriately, harder to get, but also in part speaks to the difficulties many have with living expenses and employment.

And yet the Restaurant Performance Index, a trade association barometer of the health and well-being of the industry, is much higher, as you would expect, than during the recession and now stands solidly in territory seen in 2006 and early 2007.

Combine this with a very low 4% personal savings rate and the expansion of consumer debt as measured by the Federal Reserve, and you have a picture of an economy which, if not doing terribly well, seems to be placing a higher priority on consumption now rather than income in the future.

Household balance sheets are still improving as assets rise in value, but the kind of debt being taken on, from car leases to student loans, is often concentrated among the less wealthy.

At some juncture incomes will need to expand more rapidly to make these loans and investments come good.


For investors, this trend toward borrowing among the less well off poses several questions.

In theory, all of this describes a great backdrop for asset owners, though a bit of a dystopian one. House and equity prices are high and rising, while wage growth is anaemic and corporate profit margins extremely high.

That those who have missed out on the asset appreciation party are leveraging up to buy goods like cars and educations, pumping more money into the economy, would seem to support a continued run up in asset prices.

Perhaps they have, but something may be turning. While US post-tax profits as measured in first quarter GDP appear to still be in an uptrend and margins extremely high, some of the underlying figures are showing weakness.

Albert Edwards, of Societe Generale, points out that a different measure, "economic profits," which removes profits on inventory and uses an economic rather than tax basis for depreciation, has shown a sharp fall. Headline profits are up 5.3% year on year, but economic profits are down 6.8%.

A core measure of corporate cash flow as measured in GDP is also down for the quarter, perhaps explaining low investment and also perhaps indicative of the extent to which profitability comes from financial engineering and corporate cheese-paring rather than revenue generation.

"The bottom line is that the US profit margin cycle has begun to turn down at long last," Edwards writes in a note to clients. "It is doing so from elevated but not unprecedented levels."

To be sure, a borrowing binge, even one based on small cars, can go on for a long time, just like high stock market valuations. Unlike housing, as in 2006, borrowing for tuition, cars and restaurant meals would seem to have a lower potential ceiling. 

We, and the stock market, may be close. – Reuter 

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