Tech still largely leads the strong comeback for companies in Q2, causing a tech-heavy skew in data
Corporate earnings have surpassed their 2019 peak by a large margin, leading this recession to be the shortest-lived on record. However, earnings over the last year have been buoyed by the tech sector as it was able to still produce growth despite the pandemic. Tech companies in the U.S. took advantage of the fiscal stimulus to increase consumer sales, leaving only companies with a strong B2B revenue profile behind as consumers flocked to purchase laptops, tablets, video game consoles, and streaming services to assist in their new work from home lives. Tech’s dominance in the sector can be seen in other areas, as well. Shareholder returns are up despite net debt loads decreasing and the financing gap remaining persistently negative. Large net cash positions held by tech companies are skewing data on returns and likely driving the upward trend. For example, industrials such as Caterpillar are just now beginning to wade back into the equity market; the company is expected to purchase around $1 billion of shares this year in contrast with Apple which plans to purchase 80x that this year and repurchased $71 billion last year.
This dichotomy will likely persist for the next year or two as companies with weaker earnings and balance sheets during the pandemic using excess free cash flow to pay down debt and bolster cash instead of returning cash to shareholders; this is why we see a persistent downward trend in net debt without a commensurate increase in cash balances. Another potential influence is equity market valuations; while valuations have pulled back slightly due to strong forward earnings expectations, equity markets remain very expensive. We believe that companies with more leverage may eschew using cash to repurchase when markets are this expensive while the tech giants are entirely indifferent and will continue to return capital through buybacks regardless of price.
Rising tide lifting all consumers' boats regardless of creditworthiness
U.S. consumer’s demand for new debt grew strongly in Q2 2021. While mortgage debt continues to be the biggest driver of that growth, demand for auto loans is also accelerating strongly. The Federal Reserve Bank of New York’s Center for Microeconomic Data showed that the total household debt balance increased by $313 billion or 2.1% in 2Q21, marking the largest quarterly increase in the aggregate debt balance since Q4 2013. New auto loan originations totaled $201.9 billion in Q2 2021, up 32% compared to the prior quarter and marking the highest quarterly jump since 2005. Consistent with the July 2021 Senior Loan Officer Opinion Survey which noted that banks eased underwriting standards across all three consumer loan categories in the second quarter, growth amongst the subprime borrower category (FICO score <620) was most notable with new subprime auto originations up 51% QoQ. This compares to just 20% quarterly growth in new originations for super-prime borrowers (FICO scores >760). Despite this meaningful growth in the subprime borrower segment at a level that has not been seen since the Q2 2015, total financing to this higher risk segment accounted for just 17.4% of new originations, down from 19% in Q2 2020.
Credit card balances had a material decline in 2020, remain below pre-pandemic levels
Credit card borrowers paid down their outstanding balances in 2020 with fewer borrowers carrying balances. Per the Federal Reserve, the number of adults applying for credit in 2020 declined as did overall borrowing; however, credit card balances for adults laid off in the prior 12 months increased. Given the stay at home mandates, limited mobility, and temporary closure of non-essential businesses, the reduced use of credit and decline in balances makes sense. Those with discretionary income had limited options to spend, perhaps opting to take a conservative financial approach to the economic uncertainty. As of May 2021, 98% of adults with an income over $100k and 94% of adults with an income over $50k had a credit card. At lower incomes (below $25k), the figure declines to 56%. To no surprise, cardholders with an income under $100k were more prone (over 50%) to carry a balance within the last twelve months than those with incomes of $100k or more (38%). Given the pent-up demand for consumers to return to life before COVID-19, we saw a moderate uptick in balances but still well below pre-pandemic levels. We anticipate the trajectory of new COVID-19 cases, possible reinstated mandates, and travel restrictions to impact these balance trends over the near term.
Student loan repayments remain on pause until January 2022
Earlier in August, the Biden Administration announced that the U.S. Department of Education would extend its delay on student loan repayment, interest, and collection through January 31, 2022. This news is anticipated to be the final extension of the pause on student loan repayments that the Trump Administration had first enacted in March of 2020 due to the COVID-19 pandemic. Not surprisingly, the 90+ days delinquency for student loans had a precipitous drop since the start of the pandemic.
According to the Federal Reserve, nearly 3 of 10 adults with outstanding education debt were not required to make loan payments (usually deferments) before the pandemic. Of those making payments, the typical monthly payment was between $200 and $300 a month. That said, provisions in the CARES Act and ensuing executive orders dramatically increased student loan payment relief for borrowers. Though the economic landscape is not as dire relative to the early months of the pandemic, the recent uptick in COVID-19 cases due to the highly contagious Delta variant gives some pause as the unemployment rate still remains elevated from pre-pandemic levels. As such, we anticipate a regression in the 90+ days delinquency for student loans once the student loan payment pause expires, but we do not suspect additional executive orders regarding student loan repayment pauses or forgiveness to be off the table should the economic backdrop or COVID-19 cases materially worsen.
Highly accommodative financial conditions supporting households and businesses but depressing returns
Monetary policies have undoubtedly supported domestic economic recovery following the COVID-19 recession with financial conditions as accommodative as they ever have been over nearly three decades. Because of the extended period of low interest rates, consumers have been more apt to spend, businesses have sought to hire, and credit is flowing throughout the market. However, the methods of enacting those policies for fixed-income investors have weighed on returns. A comprehensive analysis of Fed action is beyond the scope of this report, but this monthly summary would be incomplete without mentioning that investors continue to watch for signs that the Fed may curtail asset purchases.