In this article, I will review the latest bank loan growth data, but first I will discuss what’s driving this market higher and what the Q1 GDP growth may look like.

It will be interesting to see what the actual Q1 GDP growth rate turns out to be because the Atlanta Fed GDP Now forecast expects 0.9% growth and FRBNY Nowcast expects 3.2% growth. At this point in the quarter the Atlanta Fed forecast is fairly accurate as its off by an average of 1.38%. For the NY Fed’s estimate to be met, the Atlanta Fed must be way off and vice versa. The great thing about the NY Fed unveiling a model is that the Fed can point to its forecast as a reason it raised rates. If they differ, the Fed can use either to justify hawkishness or dovishness. These models are not official forecasts, but it would’ve looked bad if both were showing a terrible Q1 GDP report was afoot while the Fed raised rates. The Q1 advanced GDP report will be released on April 28th.

With the rally on Wednesday, most indices are near their all-time high once again. I expected a minor selloff in response to the Fed’s tightening. I proposed that I may have been wrong because the Fed was dovish when it came to the balance sheet. Putting this bull market in context, if the Dow hits a new all-time high, it will be its longest bull market ever. There must’ve been a bifurcation in the Dow and S&P 500’s performance in the 1990s bull market as we are still far away from reaching a record length for an S&P 500 bull market. It’s also the 5th strongest bull market for the Dow. It’s not even halfway to the rally of the 1920s. I doubt the Dow will be able to reach that mark given the earnings stagnation.

One of the biggest reasons the rally has been as strong as it has been for this long is because of investors piling money into passive ETFs. Mutual funds have sold $151.3 billion in stocks in the past five quarters. ETFs purchased $266.4 billion in stocks in the past 5 quarters. The chart below shows the seasonally adjusted annual run rate of ETF purchases. The key feature of ETF buyers is they don’t care about valuations only the low fees they offer. Mutual fund managers may not have been able to avoid the risk events that were the 2000 and 2008 crashes, but ETFs are guaranteeing investors will feel the full brunt of the next crash. Because of this, ETF investors will all flee at once when the stock market gets volatile again. It will amplify the next correction as these investors have little conviction in their holdings. If you don’t buy for valuation purposes, you inherently have low conviction. If you buy for valuation, you become more bullish when a stock gets lower. Low conviction ETF buyers panic when stocks get cheaper.

Besides equity ETFs, investors have been piling into junk bonds. Junk bonds have higher yields than investment grade debt. In expansion periods, their default rates are low, so investors take the plunge. The best time to buy junk debt is actually when the recession is at its peak, but the aggregate cannot, by definition, buy low and sell high. According to the Bank of America Merrill Lynch fund managers survey, 85% of respondents stated high yield spreads were “worryingly tight.” This was an increase from 67% in January and the highest since 2007. There has been a small selloff in junk debt lately as oil prices have fallen. We may be entering a new paradigm where junk debt becomes more related to oil than the level of risk taking in the market and the strength of the overall economy because of the relatively high size of energy-related junk debt as compared to the total.

Studying the loan growth banks are seeing is an important measure of the strength of the economy. It takes on added importance this year because financials are going to have to pick up the earnings slack from the weak retailers and potentially weak oil & gas firms. Loan growth appears to be slowing as of late as the weekly data from March 1st shows 4.6% annual growth which is the slowest since 2014. Business loans grew 3.9% which is the slowest rate of growth in six years. As you can see in the chart below, the dip has been sharp recently as it’s below the 6% long-term growth average. Consumer loan growth was 6.9% which is stronger than other data I’ve reviewed which has shown tightening lending standards for credit cards and auto loans.

Obviously, the slowing in business loan growth needs to be monitored. It is not acting in conjunction with the NFIB small business optimism survey. Many of the other economic indicators I’ve seen look like the chart on the right. For much of the economy, 2016 was the worst year of the recovery. The one difference with this chart is it doesn’t show a rebound in late-2016 like others, particularly survey data, show.

The final point I have is a correction to a previous assertion I have made. In a previous article, I mentioned that higher interest rates may be slowing bond issuance, in turn, slowing buybacks. However, after some weakness at the end of 2016, bond issuance in 2017 has rebounded. Up until Monday’s data, the bond issuance in 2017 is the second-highest on record year to date. I must look for another scapegoat for why buybacks have fallen. It may be a delayed reaction to bond issuance meaning they will resume higher shortly.

Conclusion

Passive investors have driven the market higher. It explains why stocks can rally to prices unsupported by valuations. For a long-term active investor, it’s easy to outsmart these investors as they aren’t even reviewing basic valuations or looking at profit margins. The bank loan growth has slowed recently which is going to take some of gusto out of bank earnings which will be supported by net interest margin expansion due to the three Fed rate hikes this year.