Debt Rising

As highlighted in the WSJ today, consumer debt has been rising. The Federal Reserve is actually happy about this trend since, they argue, it signals consumers are more optimistic about the future and the economy should begin to recover. My push-back to this argument is what happens should interest rates go up 1-2% after the Federal Reserve finishes its quantitative easing measures? Consumer debt might keep rising but a larger percentage of income has to go to debt service, providing a drag to the economy. Maybe the Federal Reserve intends to keep interest rates low into perpetuity, but I believe their argument is dangerously short-sighted and even "twisted."

My errands took me through a mall this morning and I noticed multiple stores with 70% off sales. This may just be an effort to blow out the last inventory from Christmas, but 70% sales doesn't suggest health, in my view. If anything, it suggests the retailer is competing more based on price than quality, style or service. Chains advertising these sales included Gap and Banana Republic (Ticker: GPS), Limited (Ticker: LTD), Express (Ticker: EXPR), Pac Sun (Ticker: PSUN), and American Eagle (Ticker: AEO). Brooks Brothers (private), Abercrombie (Ticker: ANF), J. Jill (private), and the Loft (Ticker: ANN) also advertised sales in excess of 50%. Hanna Anderson (private), Pottery Barn Kids (Ticker: WSM), and Crate & Barrel (private) all either had Spring inventory or small tactical sales, just to offer my view of healthier looking businesses.

Under my Sagflation thesis I believe there are fundamental deflationary pressures in the economy. One aspect of the deflationary pressure is an oversupply, especially within retail, in my view. Whether it comes from the rise of shopping on the internet or relatively inexpensive financing to expand store fronts, I believe the retail segment likely needs to rationalize. Especially if consumers begin reducing spending because of flat income coupled with rising interest rates, as well as food and gas expenses.

Apparently the consumers in China are continuing to spend. There has been some worry that as Chinese export growth slows that the Chinese economy likely stalls. China bulls argue that domestic spending can make up for the slowing export growth. I remain skeptical of this argument simply due to the numbers involved. Many areas of Europe likely contract this year and the US remains wobbly. I know there are a lot of Chinese, but the fundamental drivers of their economy of construction and manufacturing seemed a little peaky, in my view. Either way, with the rather opaque statistics about economic trends in China, we may not realize how good or bad it is in the country until it is too late.

My portfolio remains largely in cash and corporate debt. The equity markets are near the upper end of their ranges so unless you believe something could cause it to breakout, I believe a more prudent position is defensive. Especially with Europe potentially gearing up again for another round of debt crisis.