Changing Dance Partners

October 14, 2018

by Steve Stofka

This week’s stock market activity helps us remember some simple rules of investing. Many of us confuse mass and weight. Mass is the resistance of an object to a change in speed or direction. Weight is the force of gravity on that object. Using this model, let’s compare the masses of stocks and bonds. On Wednesday, when stocks fell over 3%, the price of a broad bond composite barely moved.

Bonds act like a big cruise ship, more resistant to changes in wind and wave than a sailboat. The cruise ship’s progress is ponderous but predictable. Stocks behave like a sailboat which moves in a zig-zag fashion, changing directions to cope with wind and wave. Sometimes, the sailboat makes a lot of progress in calm waves with a favorable wind. November 2016 through January 2018 was one such period when stocks made steady progress.

On the previous Wednesday, October 3rd, a “rout” – a half-percent drop – in the bond market indicated a global unease. A half-percent move in the stock market occurs weekly. The last half-percent drop in the bond market was on March 1st 2017, eighteen months ago. Let’s look at that incident to help us understand the pattern.


Post-election, the stock market rose for three months, then plateaued for two weeks following that bond rout. Bonds drifted slightly lower and then, on March 15, 2017, charged higher by .6%. Within a few days, stocks lost 2-1/2%. On May 17th, bonds again surged, and stocks fell 2%.

The gigantic size of the bond market dwarfs the stock market. An infrequent daily shift in the pricing of the bond market signals a long-term recalculation of future risks and profits in both the bond and stock markets. When large shifts in the bond market happen frequently, stock investors should pay attention. Between Thanksgiving 2007 and the end of that year, the bond market experienced ten days of greater than 1/2% price swings! It signaled confusion and was a warning to stock investors that rough times were coming.

The bond market’s YTD price loss of 4% marks the probable end of a multi-decade bull market in bonds. The bond market is so stable that a small loss of 4% can mark the largest loss in decades.

We are seeing a change in dance partners. As an example, the stocks of high growth companies rose 20% from February lows. That was almost twice the gains of the SP500 broader market. Many of these are small and medium size companies whose growth is hampered by the greater cost of borrowing money in an environment of rising interest rates. The owners of growth stocks wanted to take some profits this past week but could not find buyers at those high prices. In the past week, prices of those stocks fell 8%. Cushioning the fall of some stocks is the large stockpile of cash – $350 billion – that U.S. companies have stockpiled for buybacks of their own stock. Some of that money was put to work in Friday’s recovery.

The U.S. stock market has been the one of the few bright spots in a global marketplace that has turned down this year. This week begins the reporting for the 3rd quarter earnings season so we may see more price swings in the days to come.

Consumer Credit

It is very iniquitous to make me pay my debts; you have no idea of the pain it gives one. – Lord Byron

October 7, 2018

by Steve Stofka

The total of all consumer loans, excluding mortgages, is almost $4 trillion. The Federal government owns $1.5 trillion of that total, most of which is student loans, which have tripled in the past decade. According to the Dept. of Education, 11% of student loans are in default, three times the credit card default rate and more than ten times the auto loan default rate (Note #1).

Over a five-decade period, the stock market has risen when consumer credit rose. Below is a chart of consumer debt outstanding as a percent of GDP (Note #2).


This a decade long indicator, not a timing tool. Notice that the ratio of credit to GDP (blue line) rises during recessions (shaded gray) when GDP, the bottom number in the fraction, falls. When the recession is over, credit falls as people fall behind in their payments, loans are written off, etc. Now GDP starts rising again while the top number, credit, is falling.

Auto loans make up 28% of outstanding consumer credit and currently have less than a 1% default rate. If we adjust the total of consumer credit by the extraordinary growth in student loans, auto loans make up 39% of total consumer credit (Note #3). We saw a similar percentage in the mid to late 1980s when savings and loans aggressively extended auto loans and mortgages. In the late 1980s and early 1990s, a third of all S&Ls failed.

Typically, people do not count vehicle depreciation in their budget, but they should, just as businesses do. Example: the average yearly take-home pay is $52K. Let’s say the average car, new and used, is $24K and depreciates $2400 a year (Note #4). Let’s say that the average person saves about $2400 a year to make the math easy. The $2400 that goes in the savings bank is simply offsetting the $2400 in depreciation. There is no savings.

In addition to depreciation, many of us don’t include the cost of inflation in our budget. Six years from now, a replacement car, new or old, could cost an additional 15%. Without adjusting for these “hidden” costs, we may think we are getting by. Over time, however, we add these hidden costs to our credit balances. We put less down on the next car and get longer auto loans. The average loan length is now 5-1/2 years. As soon as we are done paying off one car, it is time to get another (Note #5).

The economy is strong, and it needs to stay strong so that households can pay back their loans. The ultra-low interest rates of the past decade have reduced the monthly debt payments for many. For the past two years they have leveled at 5.6% of disposable personal income, the mid-point of the past forty years. For every $20 that a person takes home, they are paying $1 to service their consumer debt. The average yearly debt service payment would be about $3000 on a $52K take-home pay.

In response to the strong economy, the Federal Reserve has been raising interest rates to a more normal range. The 30-year mortgage rate just hit 5% this past week. Rising interest rates raise the monthly payments and reduce the loan amounts that borrowers can qualify for.  Many younger workers are unfamiliar with a world of normal interest rates.  They will have to learn a new math.



1. Student default rates . Default rates reported by the credit agency Experian .
2. More detail on consumer credit here at the Federal Reserve ()
3. I made the adjustment by subtracting $1 trillion in Federal student loans from the current total of credit. This pretends that Federal loans grew 15% in the past decade, not 300%.
4. The average amount financed on a used car is $17,500 (FRED series DTCTLVEUANQ). New car loans average $29,800 (FRED series DTCTLVENANM).
5. A buyer of a new car holds it for 71 months according to Auto Trader.



Amy Finkelstein is a MacArthur genius award recipient who studies trends in health care. Proponents of Medicaid expansion projected that lower income families would better control and plan their medical care under Medicaid. Instead they have used the ER even more.  She found that people visit the ER more, not less. Although families report better health and more confidence in their financial security because of Medicaid expansion, measureable health outcomes have shown no change. WSJ article (paywall) is here. Her citations on Google Scholar.