“Goldman Sachs did not leave the house before it began to burn; it was merely the first to dash through the exit – and then it closed the door.”
–Michael Lewis, The Big Short
September 12, 2024 – In a bull market, Washington takes a backseat to Wall Street. A financial crisis will trump a political one. Money is at the heart of the game in both cities after all.
Yesterday, we looked at how the Federal Reserve was unprepared for the next financial crisis. Its bloated balance sheet will take too long to slim down before they’re back to buying up troubled assets again.
Cutting interest rates will buy some time, but it will also leave the Fed with a less powerful tool if they need to make a deep cut during the next crisis.
Today, our portfolio manager Andrew Packer connects a few dots on the consumer front. Personal balance sheets matter. And consumers are leveraging up at a dangerous time late in the market cycle. They’re banking, hard, on lower rates as junkies will when jonesin’ for their product.
Andrew’s dots paint a picture that’s more Picasso than Monet when it comes to the art of forecasting economic trends… it’s not the soothing image of water lilies and clear skies. Rather, it’s a sign of the economic distortions that will continue no matter who accepts the public housing at 1600 Pennsylvania Ave. in January. Enjoy ~~ Addison
Bulls Make Money, Bears Make Money, Vampire Squids Show You the Trend Change
Andrew Packer, Grey Swan Investment Fraternity
“The world’s most powerful investment bank is a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money. “
That’s from Matt Tiabbi in a 2010 essay that appeared in Rolling Stone.
It describes the behavior of none other than Goldman Sachs during the housing bubble, financial crisis, and its aftermath.
The fact of the matter is, most of what Wall Street bankers did leading up to the housing crisis was legal. That’s why so few went to jail, even as millions lost their homes.
Yes, the bankers got greedy. But everyone got greedy. That was part of the bubble.
- Lenders who loosened standards to the point where a home could be sold to someone without an income were greedy.
- Homeowners who bought a home they couldn’t afford were greedy.
- Banks that were able to slice up mortgages into tranches and sell them off as “safe” securities to third parties got greedy.
- Strippers buying multiple condos? Yep, greedy.
Goldman’s behavior still stands out above all. They helped fuel the bubble, and, if you’ve read or seen the film The Big Short, they held back on reevaluating their holdings until they could position themselves short the market.
They say bulls make money and bears make money. The vampire squid knows when to switch between both.
There’s even a narrative out there that it wasn’t until counterparties were going to be unable to pay Goldman that marked the real peak of the 2008 crisis.
From there, it was up to Goldman alumnus Hank Paulson, then Secretary of the Treasury, to make the case for a bailout. And he succeeded.
Simply put, Goldman has the golden touch.
So fast forward to today. Why is Wall Street’s “King Midas” (and Main Street’s Vampire Squid) taking a $400 million loss this quarter?
On the surface, it looks like a bit of accounting magic. But the company has sustained a very real loss in selling off its consumer lending business, GM Card.
As CNBC reports:
In late 2022, Goldman began to pivot away from its nascent consumer operations, beginning a series of write-downs related to selling chunks of the business. Goldman’s credit card business, in particular its Apple Card, allowed rapid growth in retail lending, but also led to losses and friction with regulators.
Goldman may be best known for lending to Wall Street players, corporate giants, and even entire countries.
But over the past few years, it expanded into consumer lending. They became a big player in the buy now, pay later, or BNPL space. It was also the first off the wagon, even willing to take a loss today to do so.
The data tells us why. Simply put, consumers are tapped out.
Let’s start with the debt side of the equation. It’s rising. It’s continued to rise even as interest rates have ratcheted up to their highest level in 15 years.
We can also see that consumer debt rises, but there’s a mini-cycle as debt rises in the fourth quarter of the year, then declines in the first quarter.
That’s in-line with going into debt for holiday spending, then paying that down, even as the overall totals continue to rise.
We can also see that the pandemic led to a pretty unhappy year for consumers.
Even with soaring spending on items to work from home and deal with the pandemic, overall spending declined. And out were the big holiday spending, and likely vacation and travel spending that can also take a hefty bite out of the family budget.
In 2022, as the world largely reopened, we learned about terms like “revenge” travel, getting back at the Covid virus by taking that expensive vacation after all. With interest rates at historic lows, it was easy for the debt to soar, and even trend past its long-term trendline.
Rising debt is just half the equation. Having the assets to pay down that debt matters too.
And much like closing the barn door after the horse has escaped, it was only after the pandemic kicked off that people – and companies – started stashing away money for an emergency:’
Total savings nearly quadrupled in 2020 at their peak. That was partly fueled by stimulus checks for households and PPP “loans” for businesses.
As that money took time to wind it way into the financial system, it took time for inflation to take off.
Today, what really matters is that the excess pandemic-era savings is long gone. It’s even lower than after the housing crisis, when there was residual fear lasting for years.
In short, consumers have blown through their excess savings. Their debt is soaring. Interest rate cuts can’t come fast enough.
Position Your Portfolio for a Crashing Consumer
This trend hasn’t ended yet. But it’s getting close. This holiday season may be the last hurrah for consumers before their total debt load and depleted savings catch up with them.
It likely means a big slowdown in spending. And given that some estimates put consumer spending at 70% of the economy, it poses a very real danger for the headline economic data that moves markets.
Add in the possibility of any number of crises, from a government debt crisis to rising global tensions, and it’s clear the markets could face some fireworks in 2025.
For now, we’ll see some seasonal weakness in September and October. And likely another event or two similar to August’s “carry trade” tantrum that blew up markets, only to just as quickly blow over.
Going into the holidays, or more importantly past the election, we’ll likely see a year-end rally. That’s typical for election years. Where we go after that depends substantially on consumers.
Investors should consider scaling back consumer cyclical stocks by the end of the year. You can stick with defensive stocks, but consumer plays to an expanding economy may be the worst bet once consumers start to tap out.
Remember, they don’t ring a bell at the top.
But consumers are nearly out of savings. They’ve just about maxed out the credit cards. And Goldman Sachs is already heading for the exit. With those three signs in place, maybe you can hear a faint ring after all. ~~ Andrew Packer, Grey Swan Investment Fraternity
So it goes,
Addison Wiggin,
Grey Swan
P.S. “I’m a hell no,” said Rep. Thomas Massie (R–Ky.) on X earlier this week. “Congress is spending our country into oblivion, and this bill doesn’t cut spending.”
And thus begins the much anticipated annual “kicking the can” event in Washington. This year might be extra special as it promises some fine grandstanding and more than a few quizzical laughs.
It’ll be a fine spectacle, for sure, given it’s vibe time election season, too.
Occasionally, representatives like Mr. Massie above will speak up about reckless spending. The Freedom Caucus makes a run at containing spending around this time, too. But their voices usually get buried among a host of more prescient political considerations before the final deal gets struck.
Ho hum, we all know deficit spending on debt in the end leads to “inflation,” so… let’s go prosecute some grocery stores for price gouging instead. Makes perfect sense.
Please send your comments, reactions, opprobrium, vitriol and praise to: addison@greyswanfraternity.com
