"Collapse" in lending is not going to cause a recession, bear market, or big correction in U.S. stocks


Every day we hear investors talking about the slowdown in lending, and how that’s going to:

  1. Drag the U.S. economy into a recession.
  2. Cause a big 15-20% decline (or even a 50% bear market).

As we’ve mentioned before, neither of these scenarios are going to happen. Let’s put this debate to bed and examine why loan growth is slowing down.

The chart

As you can see in the chart below, commercial lending is not a very good indicator for U.S. recessions and economic contractions. Lending will often dip while the economy is growing nicely! Some of these dips are random, and others have reasons behind them that aren’t deadly to the economy.
Here is the chart from FRED

Why is lending slowing down now?

There are several possible explanations. We are not sure which one is the main factor, but all of these seem plausible.

  1. As we’ve explained before, energy companies are borrowing less money due to low energy prices. Capital expenditure projects that started in pre-2014 continued through 2015. Only when oil companies realized in 2015 and 2016 that prices would remain below $75 did they cut down on loans. That’s why energy loans only started to fall significantly in 2016 and 2017. There’s a time lag.
  2. The decline in loan growth accelerated when Trump was elected. A lot of capital intensive businesses are waiting to see how Trump’s proposed pro-growth policies will affect their businesses (and thus their need for loans).
  3. The U.S. economy is growing at a slightly lower rate than previous years. Hence loans are still growing, but also at a lower rate.
  4. There is a divergence in corporate America. Relatively capital intensive companies such as retailers and manufacturers aren’t faring so well while less-capital intensive companies in industries such as tech (think Amazon) are growing rapidly. Hence the U.S. economy is shifting towards a less capital intensive mode, and therefore the demand for loans is decreasing.

All of these explanations are plausible, and some of them have occurred throughout history.

The history of declining loan growth

  1. As you can see, loan growth fell slowly but steadily after 1985. This was primarily due to a crash in oil prices in 1985, which was similar to the oil price crash in 2014-2016.
  2. 1995: similar to today, loan growth slowed down sharply in 1995. In July – October 1995 there was a sudden slowdown in economic growth. There was no particular reason, and economic growth increased again by late-1995. Commercial lending growth increased by 1997. This shows that commercial lending is a lagging indicator by approximately 1 year.
  3. The Asian and Russian financial crisis of 1997 and 1998 put some pressure on loan growth. These crisis did not have an impact on the economy or the U.S. stock market in the long run.
  4. Loan growth fell sharply in 1999. 1999 was a year of sharp contrast in corporate America. Tech companies and their stocks boomed, while “old economy” blue chip companies and their stocks languished. Tech companies do not borrow as much money as large cap blue chip stocks, which is why commercial loan growth slowed down.
  5. Loan growth declined throughout all of 2013, and there was no reason for this! The U.S. economy was on fire in 2013 and most economic indicators were extremely positive. This shows you that some fluctuations in loan growth are completely random and do not have any real impact on the economy.

2 comments add yours

  1. Good post Troy. I see this as an outcome of responsible lending by banks or perhaps careful use of credit, both of which are good signs for the economy. At least some lessons should sink in from the years of debt-fueled excesses in both households and companies. On the contrary to others, I see this as a positive sign that the bull market may still have some ways to go.

    • Exactly. Loose lending standards are dangerous to the long term health of the economy.

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