A Canary in the Technology Sector

 | Feb 11, 2014 | 5:30 PM EST  | Comments
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Last November, when I was reviewing the third-quarter bank call reports, I wrote about the nascent shift away from commercial and industrial (C&I) lending by U.S. banks in the column, An Ominous Shift in Bank Lending.

Now that the fourth-quarter reports are available, this is a good time to address this issue again. There was a dramatic reduction in the origination of C&I loans by U.S. banks in 2013. That could be, and likely is, an indication of an imminent deceleration in U.S. economic activity that is going to challenge the Fed's commitment to the tapering process as early as this spring.

The total origination of C&I loans by U.S. banks in 2013 was about $77 billion. In 2012 and 2011, it was $124 billion and $141 billion, respectively. That's a 38% decline in 2013 from 2012 and a 45% decline from the beginning of 2011. This is important because it provides a proxy for Real Non-residential Fixed Investment, which is what C&I loans are traditionally used for.

Non-residential investment denotes capital that is being invested today with the intention of producing returns in the future. Those investments and the returns intended can be targeted at either top line or bottom line growth.

Bottom-line growth is most easily achieved by investing in technology to reduce internal expenses; this is called productivity enhancement. This is a process that has been accelerating especially rapidly since the Fed Funds rate was dropped to 0-25 basis points in December of 2008 and helped to drive down the carry cost of debt required to acquire the technology. This is also one of the unintended consequences of the Fed's monetary policies as it has helped companies reduce their labor costs rather than create jobs.

This is a situation I have written about on many occasions. It has resulted in payroll tax receipts declining for the past 12 months and actually contracting for the past four.

This is an integral part of a growing economy and increasing technological advancement, and it can be maintained if it is coupled with or followed by companies also using the cheaper debt capital to target top line revenue growth by way of expanding their businesses and investing in new factories, equipment, trucks, etc. This was one of the Fed's primary and intended objectives in reducing the fed funds rate. But that hasn't happened.

Construction and Development (C&D) loans by U.S. banks only increased in 2013 by about $8.5 billion dollars, from about $201.5 billion to $210 billion. Although it's the first increase since the 2008 financial crisis, it is so small as to be irrelevant and an indication that companies are concentrating more on bottom line earnings by way of increasing productivity than on top-line revenue.

The rapid deceleration in C&I loan creation may be indicative of a cyclical peak in the rate of technology investment by companies. This deceleration however is also the exact opposite of the performance of the tech concentrated Nasdaq Composite over the same period, which has been increasing at a faster than exponential rate.

If the current trend in C&I loans continues, the tech sector could be nearing a correction or cyclical reversal of its performance since the 2009 bottom. At this juncture, it would be wise for both investors and speculators to at least put some of the inverse technology ETFs on their watch lists. These issues have been brutalized since the market bottom of 2009.

ProShares UltraShort Technology (REW) has fallen from $360 to about $21 in the past five years and by 50% just in the past year. ProShares Short QQQ (PSQ) has fallen from $80 to $18 and by 30% in the past year. ProShares UltraPro Short QQQ (SQQQ) has fallen over 95%, from about $1,221 to $55 in the past five years.

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