Juggling Dynamite

Two decades of flat income growth and excessive inflation in shelter and education costs have helped bury adults age 18 to 40 with more debt than any generation before them.   At the same time, 44% of those aged 60 to 70 are still carrying mortgage debt–up from 25% in 2001–and their median loan amortization has 17 years remaining (US Federal Reserve). 

On the income side, just ten percent of those age 50+ have a defined benefit pension plan today; half have zero retirement savings, and those that do, have a median amount of $104,000. (2015 GAO report to Congress).  At the same time, according to research by the AARP, about 90% of seniors say that they wish to ‘age in place’ in their own homes.

For all these reasons and more, cash flow is tight for households and cost reduction is a dominant preoccupation for all ages.  This is driving interest in multi-dwelling homes and inter-generational sharing that was common up to the 1960s when trends shifted toward individualism and familial independence. Bottoming at 12% in 1980, 20%, or 64 million Americans, are now living with two or more adult generations in a single household (Pew research chart on the left), and some 41% looking to buy a home report they are considering accommodating an elderly parent or an adult child.

This is a huge change affecting many sectors of the economy as antiquated models falter and new opportunities in the ‘sharing economy’ unfold.  Less is the new more.  See an excellent update on these trends in The future of housing looks nothing like todays:

“We really think that there’s a policy piece in the future with that that will tie student debt reduction with supports for aging in place, but it’s not there yet,” Butts says. Cities like Boston are already piloting the idea, offering affordable housing to grad students in exchange for help with chores.

…Living with your parents (or your adult children) has plenty of potential benefits–everyone tends to save money, it can potentially benefit health outcomes, and you get to spend more time together.

Just one problem: American housing stock, dominated by single-family homes and connected by cars, isn’t really designed for it.

…“We’re seeing the golf course as less of an amenity these days for senior housing,” says Porter, who has worked with several developers to redevelop golf courses as housing. “The real amenity for seniors is being near their kids and grandkids. I think that comes back to that connection between the boomers and their kids.”

In the first two credit-tightening cycles of the last 27 years, the US central bank hiked its base interest rate 108% from August 1992 to May 2000 (3 to 6.5), and 425% from June 2003 to June 2006 (1 to 5.25).

While household savings were higher coming into those cycles and total debt levels much lower than present, both ended in recession and a 50%+ average loss in stock prices. Going back much further, recessions have followed 93%–13 of 14– credit tightening efforts since the second world war.  (See this link for a good summary of rate history and accompanying events).

Lest anyone misdiagnose the disease here though, the catalyst for recessions and financial market dislocations is not the ‘normalizing’ of lending rates and standards, but rather the years of low standards, excessive spending and poor risk mismanagement that proceeded them. And in this, the 2008 to 2018 cycle will go down as an all-star for the history books.

In the chart below, Deutsche Bank notes that the 15% year-on-year increase in household interest payments to date has already matched the pace that proceeded the last two recessions.  Thus even though base rates remain less than 43% of previous cycle highs today, no one should be surprised that consumption-based economies are faltering and The Mighty US Consumer is Struggling. (Canadians too!).
Similarly, the New York Fed’s indicator showing recession probability twelve months ahead (black line below), and the last eight recessions in blue, has also touched its highest level since 2007.

Economist David Rosenberg explained this historically relevant indicator along with others in an appearance on Bloomberg this morning.  Here is a direct video link.

This epic credit cycle is mean-reverting whether we are ready or not.  Individuals and businesses need a plan to help shield life savings from end of cycle losses (hold and hope are not good), while maintaining liquidity and a discipline to buy assets on deep discount once cycle lows return once more.

A decade of ultra-low yields and financial gimmicks have turned a generation of savers unwittingly into gamblers and fueled a marketing bonanza of ‘high yield’ funds, products and strategies sold to gullible masses hoping for more than the safest assets were offering.  As in the last two cycles, this speculative frenzy was always destined to end with widespread losses, upset and lawsuits.

Sudden price drops in the third quarter of 2018 were a warning shot for anyone willing to see the truth.  For those who fell back to complacent sleep in the rebound that followed, the nightmare is yet unfolding.

Some lawsuits are already underway from UBS clients in a ‘yield enhancement strategy’ who saw losses greater than 20% in 2018 in an investment they were told was ‘conservative’ and ‘low risk.’   See:  UBS clients burned by iron condor strategy:

The goal of the Yield Enhancement Strategy is to give investors better returns or cash flow, typically on assets that don’t themselves yield much, according to marketing materials for YES… [DP: this is a widespread marketing mantra today]

To do that, the YES team uses an investor’s assets as collateral in a margin account to execute an esoteric options strategy called an “iron condor.”…As long as the price stays within the breakeven points created by the spreads, you make money.

When the price moves out of the ‘breakeven’ points, you lose a ton. What could possibly go wrong, right?