One staple of my in-person presentations to the manufacturing community has always been a chart illustrating credit conditions and their prophetic ability to predict turning points in the stock market.  Within the limits of available data, it is clear that some form of credit stress -measured by defaults or delinquencies- precedes a downturn in the stock market which we can use as a proxy for the direction of the economy.  A brief history of the power of this relationship shows the power of this relationship.

In the Savings and Loan crisis of the 1980’s and early 1990’s, Commercial & Industrial (C&I) and Real Estate loan defaults rose considerably just before a 20% correction in the stock market and recession occurred.  A similar pattern occurred during the Dot-Com recession of the early 2000’s (see C&I loans) and again during the Great Recession (see real estate loans).  The cause and effect logic is quite direct.  When consumption of goods and services moves beyond the ability of firms and people to pay for what they have consumed, there is a drawback in consumption as borrowers pay-off /pay-down their past borrowings, or face repossession or worse.  This creates a significant slow-down in consumption which results in an economic slowdown/recession.  While not all consumers/firms will default on their credit debts, monitoring changes to the proportion of borrowers who are falling behind on their payments is a useful proxy for the greater state of credit conditions.

What do today’s credit markets tell Us?

Government legislation to ease the financial burden of COVID on the economy resulted in many forms of debt being frozen while simultaneously firms and individuals were sent stimulus money to spend as they desired.  These actions depressed default rates -such as for consumer loans- to their lowest levels in decades.   In those credit markets which received less "help" (or distortion depending on your point of view) from the government there are already worrying signs. One example is automobile finance.  Auto loan delinquencies at the end of March 2021 stood at 4.8%; only modestly below their 5.3% peak during the Great Recession.  The rapid rise in the average sales price of new vehicles over the last year (SUVs and minivans now cost 9.3% and 14.9% more than a year ago respectively) and the growing amount of credit being used to fund these purchases -all while the labor force participation rate is lower than at anytime since the 1970’s- is concerning for the long-run.

The coming end to generous government benefits, rising interest rates and inflated asset prices for homes, cars, etc. could create an collective force that easily overwhelms the recent economic growth thanks to government largess.  How individuals fare in transitioning back to self-sufficiency will certainly be evident in the forthcoming months of credit data.  How that transition fares will certainly first appear in credit market data.  For this reason, forward-looking decision-makers should continue to closely monitor credit market conditions, especially in the consumer credit, C&I and real-estate markets.  Higher default or delinquency rates in any or all three of these could forewarn of a pending economic correction. While there is no an immediate worry to the situation at hand, the return of individuals and firms to self-sufficiency is a necessity and the effects stemming from that transition will be significant to your business.