Chief Investment Officer
BirdsEye View2016 economic outlook
My good friend Robert Albertson, Chief Strategist for Sandler, O’Neill, isn’t just the best dressed man I know. He is also one of the more insightful people about our economy. He looks at unusual statistics and pairs interesting combinations of data to yield fascinating, and more-often-than-not right, conclusions.
Below is a summary of Robert’s observations on 2015, and some views (mostly my own) on what to expect in 2016.
1. GDP growth shows a secular decline since 1980. In the ‘80s GDP averaged 4.13%; 3.53% in the ‘90s; 2.60% in 2000’s; and 1.80% since 2001. This decline is NOT related to the financial crisis, posits Robert. Rather, it is a reflection of demographic and social changes.
a. Consumer spending is at a historic low. US Personal consumption expenditures, THE major driver for our economy in the past, have declined from an average of 4.28% in the ‘80s to a paltry 1.88% since 2009. Thus, an important source of fuel to our economic growth has been curtailed.
b. While at historic lows, US consumer spending exceeds almost all other countries. Our level is 68% of GDP; China’s is 36%!
c. Labor force has been restrained. Our labor force grew steadily since post WWII. Labor force participation grew from 58% of the population to nearly 68%. In the early 2000’s, well before the financial crisis, that growth has leveled off and started a decline. Today it is nearing 62%. Much of the recent steep decline occurred after the 2008-2010 recession.
d. Certain age groups are “opting out” of the labor force. While the number of 55+ workers has grown significantly, the number of 16-24 year olds has plummeted from a peak of nearly 70% participation to just under 55% today, and the number of 24-54 year olds has declined by over a million people.
e. Consequently, jobs, income and spending are all down. More people are opting out of the work force, and, with that, comes lower macro-economic income, accompanied by lower spending.
2. China continues to redirect resources internally. China account for 25% of global growth, but only 9% of imports. It is Europe that contributes heavily to the global trade demand, and we all know how Europe is doing these days (need I mention Greece?).
3. Consumer spending is highly correlated to home equity. Home equity borrowings peaked in early 2006, having tripled over 13 years. It fell 53% by early 2009, and is now close to parity with consumer spending again. Similar trends can be generally observed between home net equity and consumer spending.
4. US economy growth engine is shifting toward investment and business. Business spending is growing and almost replaced Consumer Spending, despite being 4X smaller. Business spending amounts to 80% of consumer spending between 2009-2014, especially in more recent years, vs. 25% between 2000-2008. It’s encouraging to see investments in energy and other industrial sectors growing again. Major drivers are agriculture, infrastructure, manufacturing and technology.
5. The housing cycle is late. In previous economic downturns housing recovered faster. Single-family housing starts are barely above historic lows. Private investment in residential housing is growing though, stimulated by more appropriate pricing. Historically the average home price was about 3.5X median income. After peaking over 4.8X in 2005-2006 is fell back to 3.4X, and is now nearing 4X, a concerning trend.
6. Credit demand cycle mirrors the economic cycle. Bank lending lags GDC fundamentals by sectors and always has. Commercial lending is accelerating into its 5th year, but we’re seeing demand gradually broadening to other sectors. Commercial Real Estate (CRE) has been growing steadily since 2013, and now matches C&I growth levels. This could be perceived as good or bad news…
7. “shadow banking” system collapsed in 2008-9. Bank loans as a percent of total credit in our economy haven’t changed since WWII. They hover around $50T or less. Non-bank credit is well over $200T, but much of it is government credit driven. When you look at non-bank credit without government credit extension you see a collapse of over $50T, larger than the entire banking system lending portfolio. A $7.5T gap was created by a major drop in Asset Based Lenders, Finance Companies and mortgage pools. The banks already picked $1.6T of that gap, and the Fed picked $3.5T. Mutual funds and the GSEs picked up some as well, but there still remains a $3.5T opportunity for banks to capture.
8. Deposits have proven insensitive to periods of rising rates. Deposits in the system continue to secularly grow almost regardless to the arte environment. They are approaching $4T today.
9. Where are rates going? Short term rates are determined primarily by Fed fiat. The fed guidance implies one rate hike this year and a few in 2016, despite IMF, China and political pressures. Long-term rates are determined by market forces of supply and demand. The supply of new government debt is waning, down from $150B monthly in 2009 to under $50B now. The Federal Reserve was 2/3rd of the auction during the Quantitative Easing periods, and is now gone. The largest swing factor is foreign demand, which exploded during the emerging markets’ trade growth and surplus. Those have now diminished and are barely at a ¼ of the peak following multiple Euro crises. As China reduces reserves, foreign demand declines further. The 10 year treasury is still well below normal relative to nominal GDP (10 year average is 3.25%, 23 bp. below nominal GDP; 20 year average is 12 bps. Below nominal GDP).
10. Industry consolidation is accelerating. Consolidation is favoring the $1-50B category. Banks under $1B are rapidly losing share as a category, and the large are getting larger. Robert predicts, and I agree, that more $5-50B banks will form and prosper during this period of consolidation, as they get rewarded with superior P/Es.
11. The number of smaller banks will continue to decline. In 2Q14 banks below $500MM numbered 5,307, or 80% of bank count. They were >1,300 fewer than their number in 2009. They also contained 6% of the industry’s total assets. We anticipate the decline in numbers and assets will continue and accelerate, down another 40% of the banks.
$500MM-$1B banks have roughly 3% share of the industry’s assets, and are 676 in number, down 37 since 2009. Albertson anticipate a dramatic decline in their ranks in the coming 5 years.
$1-10B banks have 10% share and there are 572 of them, 2 more than in 2009. Both Robert and I anticipate a small decline in their numbers, due to continued growth through mergers into this size category.
$10-50B banks also have 10% assets share, and are 73 in number. They haven’t changed much in recent years, but we anticipate they’ll grow by as many as 15 banks in the coming 4 years. It is this size category that is likely to gain the most share relative to all others given its attractive currency and artificial regulatory hurdles.
US Banking concentration is among the lowest in the world. In the UK the top 3 banks’ assets are 3X the nominal GDP. In the US the number is 40%.
In sum, what should we expect in 2016?
· Continued gradual recovery
· A very gradual rise in rates
· Intensifying competition for CRE assets
· Continued consolidation at all levels up to $100B
· Much opportunity for banks in replacing the shadow banking lenders, capitalizing upon technology and partnering with fintechs, and riding the consolidation wave.