No catchy title on this one, although I could also have titled it "The US Economy, Part III" following on yesterday's blog (highrockcapital.ca/pauls-blog/what-happens-when-an-economist-is-wrong-on-their-predictions) and Tuesday's blog (highrockcapital.ca/pauls-blog/interest-rates-are-going-up).
Although not the largest category of US Bank Assets, Commercial and Industrial (C+I) Loans and Leases are the blood going through the veins of the entire US economy. These are loans and leases extended to commercial and industrial businesses across the US.
Here is the chart of US Commercial and Industrial Loans and Leases (white line) with the S&P 500 overlaid (yellow line).
Notice how the S+P tracks C+I Loans and Leases? The more the economy grows, the more large banks want to take the credit risk of C+I companies and extend Loans and Leases to them and...the higher the S+P goes on this economic growth. That is the circle.
What you can see in this chart is that since the Great Recession of 2009, C+I Loans and Leases have been growing rather steadily (blue dotted line) until June 2016. And the S+P followed C+I lending higher through that period of 2010-2016. Credit expansion = S+P moving higher.
However, what I have noticed lately is that C+I Loans and Leases have largely been moving sideways for the past year (blue solid line) and yet the S+P has ramped up further (solid green line).
Conclusion? To be honest, not sure. What I do know is that we need to watch this closely (not every day or even week but maybe every month) to see if large banks want to continue to grow/expand their C+I lending books or are they beginning the process of shrinking/contracting them. Are these banks more or less positive in the credit quality of these C+I companies they are lending to? The very fact that these banks have not been increasing their collective C+I loan books tells me that they are not quite as positive on the credit quality of these C+I companies, and maybe the economy in general.
And why is that so important? Quite simply, credit (loans, leases, mortgages, bonds, etc) is the lifeblood of the economy; it is the oil in the machine. Without credit, the economy does not grow. Never mind not growing, businesses do not even operate without credit (debt). The more it is available or extended to businesses, the more those businesses can expand and grow, which of course leads to the overall economy growing, which means businesses are producing better cash flows. And what are we buying when we buy a stock (or a bond)? Answer - future cash flow streams. More cash flows = higher stock prices.
Bottom line is - so goes credit expansion, so goes the economy, so goes cash flows and so goes the S+P. One should conclude that the opposite holds true when credit contracts. For now, C+I credit is just moving sideways, but as mentioned, this needs to be monitored closely.