Deutsche Bank: 'The Bears Have a Problem'

Consumers and credit aren't signaling a downturn.

Six Bear Markets Over 30 Years

If financial markets are a leading indicator for real activity, the U.S. economic expansion is about to turn south in a hurry.

The most recent evidence, however, suggests that the world's largest economy remains resilient in the face of a sluggish external backdrop and falling stock prices. The consumer is in fine shape, and credit creation has not abated.

"The bears have a problem," asserted Torsten Sløk, chief international economist at Deutsche Bank, in a research note. "The problem is that the challenges in the energy sector are not spilling over to the broader economy and the macro data is not deteriorating."

Bears hibernate for a winter, not for decades. The decline in the manufacturing sector's share of U.S. employment and output has not gone unnoticed by most prognosticators who predict (or fear) that a U.S. recession is coming. A slide in the ISM Manufacturing index to below 50 has therefore become a necessary, albeit insufficient harbinger of a looming contraction in activity.

As such, the common case for how the downturn in commodities and emerging markets will come home to roost in the U.S. goes a little something like this: Carnage in financial markets will prompt banks to reduce access to credit at the same time companies find it more expensive, creating risks for both employment and capital spending. Inasmuch as tighter credit conditions spread to consumer-oriented segments, they would crimp purchases of everything from homes to durable goods accentuating the downturn.

And with headline growth relatively sluggish—running at just 0.7 percent in the fourth quarter—any such speed bump threatens to bring activity into negative territory.

The tailwind provided by the U.S. consumer, who has largely elected to save funds that would have otherwise been deployed at the pump, has not accelerated over the past year. However, the negative effects of tumbling oil prices typically materialize much more expeditiously and have not been enough to derail the U.S. economic expansion.

Growth in consumer spending may not be as robust as hoped, but it is also nowhere close to recessionary levels. The labor market hasn't rolled over, either.

"Since 1960, the median increase in the unemployment rate in the year before a recession is 0.4 percentage points," wrote UBS Deputy U.S. Chief Economist Drew Matus. "The past year has seen a drop of 0.8 percentage points."

The increase in the share of Americans who have quit their jobs also augurs well for wage growth and, in turn, consumer spending and the continued repair of household balance sheets, the economist observed.


"The Federal Reserve Bank of Atlanta is tracking 2.7 percent for Q1 [gross domestic product] on the back of strong consumer spending," added Neil Dutta, head of U.S. economics at Renaissance Macro Research. "Ex-trade and inventories, the two most volatile sectors of the GDP accounts, real GDP is tracking 2.8 percent. Yep, call in the IMF."

Meanwhile, the epicenter of the bear case for the U.S. economy—a general, across-the-board decrease in credit provided to businesses and consumers—has shown no signs of materializing.

On the contrary, UBS's Matus tracked core bank loan growth (a composite of commercial and industrial, mortgage, and consumer credit flows) and found that, rather than decelerating amid the crumbling commodity complex and swelling credit spreads, loan growth has been picking up steam:


"Core bank lending also does not suggest we are close to recession," he explained. "Typically, core bank loan growth decelerates heading into a recession on both a 3- and 12-month basis."

The resilience of credit creation is somewhat surprising, given the extent to which junk bond issuance was tied to the shale revolution. But according to Deutsche Bank's Sløk, it has a relatively simple cause: Banks aren't on the hook for losses to the same degree they were during previous cycles.

"In plain English, the reason why we are seeing no signs of a slowdown in bank lending or consumer borrowing is likely that the losses in the energy sector are not located inside the banks but instead among investors globally, which have essentially no leverage and are well diversified, and hence much better able to shoulder energy sector losses," he wrote.

If credit is flowing and the U.S. consumer continues to spend, the world's largest economy may prove to be an island of stability, even if its strength is not sufficient to buoy activity globally.

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