Look Forward | Episode 14: Economic Insights: Lessons from the Past with Nathan Stovall

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Andrew Critchlow: [00:00:00] Hello, my name's Andy Critchlow. I'm head of news at S&P Global Commodity Insights, and welcome to the Look Forward Podcast from S&P Global. In today's rapidly shifting Markets success depends on anticipating what's next. The professionals who excel are those who can spot emerging trends before they fully materialize.

The Look Forward podcast delivers exactly that insights to help you prepare for tomorrow's opportunities and challenges. We bring you expert perspectives on macroeconomic trends, capital markets, energy transition, and global trade. With a sharp focus on what these developments mean for the decisions that will shape your tomorrow.

This podcast connects you with S&P Global's Look forward council bringing cutting edge research on long-term trends and transformative [00:01:00] market shifts. Together, we are committed to providing the forward-looking intelligence you need to navigate uncertainty with confidence. Welcome everyone to this edition of the Look Forward Podcast.

My name is Andy Critchlow, head of news at S&P Global Commodity Insights, and I'm delighted today to be joined by my colleague Nathan Stovall, head of FIG Research at S&P Global Market Intelligence. Um. I've just started reading the book 1929 by, uh, uh, Andrew Ross Sorkin, um, about the great crash. Um, it's a subject that's definitely in the public domain at the moment.

People are talking about this, how do they start these financial crises? You know, you as a journalist, you reported on a couple of them, but you, you've got a bit of a historical interest as well, Nathan.

Nathan Stovall: I do you, if you're gonna cover the banking sector, you need to think about this. They're thermometers of the economy and [00:02:00] really a good lithmus test of when things are getting outta whack.

And I think it's really two very simple, high level things. Valuations get completely stretched and often that usually happens because we get over our skis. We borrow more than we have, and I think in both cases what gets us there is that we've convinced ourself that there's something new that changes the narrative, that says that this time is different.

That allows us to take excessive levels of risk and allows us to justify one valuations getting to a certain level or two. Borrowing into a certain level. We're having that comp to 29 now, given what we're seeing, you know, in the broad markets right now with valuations going to levels that we saw caught in in the late nineties, early aughts with the the .com bubble, it's a little bit different because you've got real learning power at some of these companies.

But a lot of it is [00:03:00] rhymes with what you've seen historically, which is the expectation for something to happen, and that we've pumped up valuations on that basis. But, but I often look at it is at the health of the economy, health of the consumer, and health of the banking system. And one positive thing I'll say this time is while there's some flashing yellow out there, particularly when it comes to the US banks, there's a number of reasons to believe that we're not heading towards calamity.

That that capital levels are very strong. Leverage is not excessive broadly across the US consumer, though there are pockets of it, uh, and that. Underwriting appears to be better than it has been in the last cycles. The issue is a lot of that risk still exists. It just might be outside of the system. And the question is, if they get it wrong, what are the knock-on effects for the traditional financial institutions?

Andrew Critchlow: So, you know, people getting in over their heads, irrational exuberance, [00:04:00] one area that's a concern. Increasingly, I think, for central bankers for, uh, economists, for policy makers is this area of private lending. Um, and we've seen sort of little flashes of this recently in the US, right?

Nathan Stovall: Yes, yes. And effectively you've seen that that asset class grow considerably since the financial crisis.

And really a couple reasons. One, a prolonged error of of of lower zero rates. So we do what we do well when it comes to capitalism, capital goes, finds the better return. When rates are real near zero, you're gonna take more risk to get returns. And so a lot of money found its hand in private credit because of that.

Outside of traditional fixed income assets and the second being after the financial crisis, you have a, appropriate response to say we weren't regulating this correctly. We [00:05:00] didn't have everything under the tent. We needed to, uh, we need to change the way we're doing things, but as a result, you've pushed risk out of the system.

So private credit has grown. It's. Almost 2 trillion, uh, globally. They've taken big share from banks, but banks have also decided we're not gonna see share completely and increasingly being lending to those firms as well. And we can dig into further some of the mechanics there, but what you've referred to, what we've seen in third quarter earnings, as you've seen some blips on some of those.

Loans from regional banks in particular where they, they were pretty big lumping losses and kind of spooked the investment community. We're not in the camp that, that is gonna be very widespread, but we also, in the camp that things probably get a little bit worse. From here and that, that's one of the areas of concern.

Andrew Critchlow: And this is the, the area specifically around, you know, some sort consumer finance, so things like car loans, et cetera.

Nathan Stovall: Right? That's where we're seeing some of the first cracks that that's right. Where you've seen some of the [00:06:00] subprime lenders and, and you've seen also cases of, of fraud and you're starting to see things both within this bucket that could be private credit.

Uh, the way it's defined in the US is. Loans to non-depository financial institutions, which have driven a lot of the loan growth, uh, to date, year to date. And there's breakouts within there, and you've seen some lumping losses there, but you've also seen cases of fraud and those are the kind of things you often see early cycle.

Everybody in the bank group and much of the sell side community is pointing to it as one-offs. Well, if there's a bunch of one-offs or cases of fraud, those are the kind of things you start to see when people get a little bit stretched. They get a little bit desperate. They, they commit fraud. It doesn't mean that we're headed towards calamity, but those are the kind of things you see early and, and this has gotten plenty of play and it was a great quote, but it's also one that I think is accurate from JPM's CEO, Jamie Dimon saying when you've seen one cockroach, you know there's [00:07:00] another, and that's kind of, I think, encapsulates.

The, the point there, when you get a series of one-offs, are they really one-offs or are they more sort of a start of a cycle and we think we are heading, we're at least late cycle. And in terms of the, the healthy environment, meaning sort of starting into a credit cycle, but continue to believe that it's one that will be manageable for, for US banks.

Uh, but there could, there's gonna be bigger problems outside of the system for sure.

Andrew Critchlow: So S&P Global recently revised its GDP growth forecast to around 1.9% for 2025 and 1.8% for 2026. So these are below historical trend lines. I think given, you know, the vol, is it volatility in the us? I mean, you know, uh, you know, there's been certainly a lot of.

Policy surprises, some would say tariffs, [00:08:00] um, you know, the geopolitics obviously. Um, you know, and we haven't really fully seen right, the impact of tariffs yet, but, you know, given everything that's happening elsewhere in the world as well, is that a good performance? Is that how, how do you rate that? How, how does it feel?

In the US economically at the moment.

Nathan Stovall: I, I think volatility is quite fair. Uh, to say that you could set your watch to what we've seen from the policy or geopolitical front, I think would not be a correct statement. And I think your point about. Feeling the impact of tariffs? We haven't yet. A lot, were delayed.

We didn't know where they were gonna set. And the line I've been using there is if you think public companies will simply eat a higher cost and let their margins go down and miss earnings over time, you are certainly mistaken. They will either pass it on to their customers or they won't hire as much.

And we've seen a number of weak prints in the labor market. Over the last few months and you wonder if some of that's showing up 'cause of that you wonder, some of it is maybe AI and companies, uh, increasingly adopting AI and solutions, deciding they're not gonna hire, uh, as much [00:09:00] or a little bit of both.

But it feels okay and I think. Part of why it feels okay is two, three months ago you might have thought you might have considered all those things and thought things were gonna be much worse, but we kind of keep chugging along. It's very much a consistent conversation that's been going on for much of this year.

Consumer spending is, is holding up the consumers remaining resilient in the face of all this volatility. Uh, but it's split. It's k-shaped recovery, it's middle income, higher income earnings earners driving a lot of the spend and the lower income segment is getting hurt much worse. And part of that is because inflation is a much bigger tax on them.

And tariffs, you could say, are a similar tax on them in terms of the potential for higher prices than the higher income earners who've seen, who've really benefited from asset. Assets going up, that's who owns the assets in the US whether you're [00:10:00] talking about real estate or stocks, uh, and bonds. So it feels pretty good.

The consumer remains resilient, but not great. And what most of the banks we've heard of the last two weeks talk about is that they feel okay heading in the 26th and they're not flashing, you know, any real alarms. And it's, it's pretty surprising. To, to a lot of people when you, when you take a step back and think about all the noise that has occurred, that we are kind of chugging along.

But one of the reasons for that, and we we point this out all the time, is the consumer has a pretty strong balance sheet right now and 70% of the US economy is driven by the consumer. If you look at household debt to income, going all the way back to 1990, we're right at that pre pandemic average. If you look at it in oh eight, we were at 13.1%.

We're at 11.1%. So we're, we were two percentage points in oh eight above we were out of over our Skis we're not there as [00:11:00] much. Part of that is 'cause we threw a bunch of money at the consumer during the pandemic, and it lasted longer than people thought. And the other is 70% of household debt is in mortgages and most of 'em are fixed rates.

So when rates went up. That that money didn't, the debt service didn't go up that much. That's a big reason why the consumer has held up more and we're not seeing delinquency trends broadly get much worse. You are seeing it as we talked about earlier on those lower income segments, subprime auto and things like that.

That's where you're starting to see the stress and we expect more of that to occur. So kind of that continuation of, call it a K shape for the next few quarters.

Andrew Critchlow: How does this kind of reflect on, bank balance sheets, you know, how important, I guess is first course of next year in terms of earnings for banks.

Nathan Stovall: The, the way it's, it's gonna show up. I mean, it really depends on. The composition for, for most the US banks, it's gonna be fine. At the same time that you have this [00:12:00] progression of delinquencies, moderately going higher for the biggest banks, they have other big engines in terms of fee income and their investment banking businesses and their wealth management businesses.

And one of the thing that you heard of the last two weeks is investment banking, back backlog are the highest level they've been in three, four years. So you have this weird dynamic of, again, you're seeing stress at the lower end of the consumer. You're seeing delinquencies rising. But corporate America and CEO confidence is is high.

They're ignoring a lot of this noise, and they're excited about the prospect of a deregulatory environment. They're excited about fed easing and, and the cost of financing going down, albeit just modestly, but going down and are in somewhat expansion mode, not full scale expansion mode. The one place we're seeing that, you know, is an AI but you're seeing, you know, a real return to, to deal activity.

The question's gonna be if you start to see actual, real cracks in the armor, if these one-offs actually pick up more, and, and we haven't seen that yet. [00:13:00] And one of the reasons is it's this weird dynamic of, growth has been slower for banks. They haven't grown their own portfolios as much as they want because they face this competition for non-banks, primarily private credit.

And at the same time, while they bristle about that, that's actually kind of propped up asset values, particularly when you look at things like commercial real estate where you thought there was gonna be great challenges. One rates are higher. Higher debt service, two challenges on, on remote hybrid work, and

Andrew Critchlow: everyone's back to the office, right?

So

Nathan Stovall: well and to a degree, but some of those. Some of those properties are still pretty challenged. I mean, you've got some things underwritten, you know, at 2019 levels that when the loan's coming due and they could have five year or six year terms, they'd have to refinance it and, and re underwriting that property at today's levels.

Uh, not, not that attractive, but one of the good news for the traditional lenders is the competition that I alluded to. It's coming in from outside the sector. A lot of that money raised from private credit when it came to CRE, they thought they were gonna be able to [00:14:00] purchase assets at distress prices, but you haven't seen a lot of that.

The banks haven't been forced to blow out their portfolios. They're not likely to do so. And the private credit firms aren't gonna give that money back. So they've been making a lot more direct loans and helping support, uh, the broader CRE market. And you could make the same comment about the broader commercial market.

Again, there's plenty of credit availability to borrowers right now. When you get, going back to where we started, when you look at cycles and when things get really ugly is when lenders deliver. And hoard cash and credit's not available and suddenly you can't expand and everybody sits on it and it doesn't grow.

We do not have that problem now, in part because of all of this dry powder sitting outside of, uh, the bank space.

Andrew Critchlow: And all that dry powder I, I imagine wants to get involved in AI data centers. This new part of the economy that, you know, that wasn't there in 2007?

Nathan Stovall: Uh, a hundred [00:15:00] percent. I mean, it, it's looking at a lot of places, but that is definitely an area that's attracted a lot of attention and it makes sense for private credit firms to finance that rather than some banks, big banks can get into it.

But I mean, those are big projects and that's the bull case for private credit. Big, large loans that might be a little bit further out the risk curve if only just for the size for a traditional lender, uh, something that that might be. Not necessarily hypothetical, but, but based on a, a future expectation, uh, but could be higher reward, uh, and, and would require a, a, a deeper level of attention and, and comfort with having ex a bigger exposure like that.

That feels like it checks the box for private credit to me in a really good way. And we've certainly seen them go after the, those kind of credits, but also other big lumpy, lumpy credits as well.

Andrew Critchlow: Who are the biggest players in the private [00:16:00] credit space?

Nathan Stovall: It's a lot of the big PE firms, honestly. I mean, you've got

Andrew Critchlow: others.

Sure. Apollo, these kind of, yeah. These kind of people.

Nathan Stovall: That's right. Apollo, KKR, Aries, Carlisle. You know, if you look at the top 29 are big PE firms and, and one of the wild things is if you look at the size of those firms today. The, the regulations changed a little bit in, in the US but if you look at their asset size today, they would be considered systemically important bank based on the way Dodd-Frank laid it out, which is a long-winded way, complicated way of saying they'd be effectively a top 15 bank, each one of them on a standalone basis.

And I don't know, I know folks in the banking system recognize that. I think regulators recognize that investors do, but I don't think. Main Street really recognizes just how big this has gotten. And, and that's one of the questions we have because when there is a cycle, there'll be issues and smart players will, will do okay.

[00:17:00] But there's also tertiary players who probably won't do Okay. And what are the knock on effects of that? Because one of the things that happens in a cycle too, you always see it. Problems arise, banks get in trouble and they end up in front of, uh, a bunch of politicians in Washington. Being asked, how did this happen?

Private equity, private credit's not regulated. I mean, they'll have to answer to their investors. That's right. And, and they don't have depositors. So, you know, maybe, maybe it doesn't show up the same way, but. One of the lessons I had coming out of the financial crisis was, which was, you know, a housing bubble bursting.

And I remember a bank in, in metro Atlanta said this to me, who, who got in trouble but made it through. And they said, we felt okay about what we were doing from an underwriting standpoint, but what we missed was when you're lending against a piece of dirt, if the guy next to you is doing something really stupid, you got a problem because the value of that piece of dirt's probably not what it should be.

And that's one of the challenges here. While it's. Kind of [00:18:00] a positive that it's, it's helped support asset values. Has it taken things to a level that may be, the values that we're using aren't, aren't the correct ones. You know, do we need an actual massive correction here because of all the money chasing after?

So a few assets.

Andrew Critchlow: Yeah. My 2007 financial crisis story is around, uh, Dick Fold who was in Dubai. At an event, at the, uh, Dubai International Financial Center and there was a media event. There was a few of us. There was a colleague from the Financial Times. I was at the Wall Street Journal at the time, and, uh.

Um, a very experienced journalist, uh, Eddie o Sullivan, who was the, uh, publisher of Middle East Economic Digest, asked someone who Dick Fold would never have heard of, wouldn't have, never have even heard of the, the publication asked him a question, you know, what's the biggest risk you see to, you know, the global economy and, uh, at the moment and, you know, kind of fooled, kind of pondered it, and then, you know, one word answer, [00:19:00] um, terrorism.

Wow. And literally, you know, um, um, um, you know, a month later, um, um, you know, the, the, the ceiling collapsed around his head and every other banker's head. And, uh, uh, it sticks in my mind as being, you know, slightly, you know, either just not answering the question or, you know, just out touch, ignoring. Yeah, I outta touch.

Yeah, exactly. Exactly. And I guess that's kind of where I'm going with this is that, you know, with the danger, you know, if you are a bank and you're lending and it's open and investors can see it, the risk is more, um, transparent. You are more in touch. You know, you're more in touch with your customer.

You're more in touch with the street. You could argue

Nathan Stovall: you, you could, but one of the things that I continue to talk to folks about, I get to go out and talk to bankers across the country and they don't always love this message, but I say if you go back to 1945, we've had a recession in the US almost every eight years.

We're pretty due. [00:20:00] It doesn't mean that one is coming tomorrow, but the pandemic didn't really count. Yes, we papered over it with $5 trillion in stimulus and, and forbearance and paycheck protection program, uh, loans, and then another 5 trillion in Fed balance sheet expansion. But there was not really air let out of the economy, and it wasn't a bubble.

So it was an unusual time, but you honestly have to almost go back to 12 or 13. That's pretty long in the tooth. And as long as I've been doing this, the good banks had money when no one else had money. And the way they did that is they didn't chase and run after the new thing and they were conservative.

So I'm increasingly trying to sound the alarm of saying, now is the time to be very thoughtful about any new dollar of capital that you're extending or, or, or any, any new dollar of, of, of loans you're making. Because as, as I said earlier, it sure feels like we've gotta be closer to late cycle [00:21:00] than early cycle.

Not just on, only on the length of this expansion, but some of the, the things we're starting to see, we've seen stabilization and, and delinquency trends that they've rose for 10 straight quarters off of historically low levels, but. We're starting to see those one-offs pop up and expect, I mean, we've got a forecast out there.

We expect 'em to go up pretty considerably next year, but nothing akin to a really serious event. So broadly, space does okay. And there'll be outliers though, who absolutely miss that. It always happens. Everybody thinks they've kind of gotten it figured out and that the combination of that of excess and excess excessive valuations.

Excess leverage and thinking that you're not gonna have a problem, I think is what always leads to downturns.

Andrew Critchlow: Yeah, of course. You can never see the top. Um, you know, I, what, what, what impact does the Fed have in all this? In fact, what agency does the Fed have in all of this? I'm guessing, [00:22:00] 'cause you know, there's, there's more cuts predicted, you know, they're under a lot of pressure to cut, certainly.

Mm-hmm. Um, you know, o obviously that's gonna make. Lending more affordable for borrowers. Um, it helps. It helps, right?

Nathan Stovall: One, one of the weird things about it is that, again, going back to the consumer, consumer driven economy, when rates went up, they weren't as in as impacted 'cause they had so much fixed rate debt in terms of their mortgages, so they weren't as impacted.

That means they're also not gonna get as much relief as you might think they would on the way down for corporates, though it definitely matters. You haven't seen, you know, not everything is priced off of short term rates though, and you haven't seen the yield curve move down all that much. You're kind of seeing it gyrate all over the place, and some of that is fed expectations.

Some of that is things like tariffs. Some of that is deficit. So there's other things at at at play here, but. The Fed can [00:23:00] definitely help. One of the challenges that they have is I think for some time they've been in the camp, that they wanna make sure that inflation is dead, dead, dead below the 2% level, and they're not there.

They haven't gotten there, and they're very fearful of going back to the seventies and the lessons of ulca of cutting too fast too soon. So I think it's one of the reasons why we haven't been lower sooner. Given the weakness that we see in the labor market, we are expecting more cuts and that kind of helps.

But the good news is we've gotten this far, is kind of the way I think about it. If, if you had the consumer cracking, we're not even cracking, getting stretched to a level that we're seeing today, call it in 23, particularly after the regional bank crisis or even early 24, it would be a much tougher place for the Fed to be in.

The economy's been resilient through that. And so we're kind of getting to the other side where inflation is, is tampering down, uh, to a [00:24:00] degree and cuts should help ease that. But I don't think it stops a cycle from happening.

Andrew Critchlow: The, um, you mentioned the, uh, labor market, but I think if I go back to 2007, if I might, you know, there wasn't a particular strain on the labor market then, right?

Nathan Stovall: No, and that's one of the weird things. It, it doesn't really show up until it sort of does. You know, in that case, we had some pretty effective triggers where you had huge mispricing of risk, huge mispricing of assets, and then a huge unwinding of leverage driven by Wall Street and the banking system getting in trouble.

The big banks at that time were levered anywhere from 25 to 30 to one. They're levered about 10 to one today. So when they had helped prop up the housing market with a lot of subprime mortgages, or even worse synthetic CDOs that [00:25:00] were tracking said mortgages. So leverage upon, leverage upon leverage, the unwinding was massive because not only sim.

Property values down considerably, but it meant to, they had to hoard cash. As I said, they all suddenly needed to raise money and couldn't extend it, and that meant that it put all kinds of stress on all kinds of corporates, and they had the hoard cash, which meant accelerated layoffs. You don't have that kind of system set up the same way, um, at least with the banking system.

One of the challenges here though is that you've got the shadow banking system and private credit propping up a lot of things and what would be the trigger that could cause an unwinding there? It doesn't work quite the same way, but it's, it's one that we talk a lot about and the smartest bankers we know don't really know how to predict that.

That could you actually see sort of a cascading, they're not funded the same way [00:26:00] as banks. You know, they have committed capital, but they are funded by banks. So if you start to see banks really pull back on some of the lending that we, we were alluding to earlier on loans to non-depository financial institutions and start to say, we're really concerned about that, that would be something that could really accelerate stress and maybe have a cascading effect.

We haven't heard that yet, though. Even the banks who had some problems described 'em as one-off and said, we feel good about this portfolio.

Andrew Critchlow: Um, Andrew Bailey, the governor of the Bank of England, he was testifying to parliament, a parliamentary committee this week, and he flagged this risk from some of these more opaque lending markets, um, as a potential, um, risk to, to the economy, financial risk.

Um, what does Jerome Powell say about it? [00:27:00]

Nathan Stovall: I think they're, they're watching it. They're also very careful to say too much about it, and one of the challenges is here is that they don't know anything more about this than, than we do. They're unlike with the banks, they have confidential information that we don't have.

We have great data here at S&P and we can get really granular on the banking system. With private credit in particular, it's very high level and the public. Companies out there will provide disclosures and so you can dig into it to a, to a degree. The place you get better is when you look at specific deals that have maybe traded and you could tie to a specific company and see there, but it's really hard to get a holistic view, and I think it's one of the things that makes banks and traditional lender very nervous and quick to say that the problem is likely outside of the system because.

They understand they need to be regulated. They, they struggle with that. Sometimes it frustrates them, but they will [00:28:00] gladly share that. They feel like, they feel plenty of pressure from their regulators to focus on the quality of what they're doing, but they don't think that that's happening at all in the private credit arena.

And it's not, it's not because they're not regulated. They faced. Scrutiny from investors, but it's not the same thing. They don't have examiners there. I mean, JP Morgan has several fours in its headquarters dedicated to regulators who are there year round. That's, that's the way it works. So it's a very different thing.

And I think it doesn't mean that, I think that they don't have a, an opinion. I think they're just careful saying, we know risk has been pushed out of the system and we're watching it.

Andrew Critchlow: So the way this ends is that they end up having to testify, are forced into. Disclosing far more information and they cease being private in the way they operate and being very public in the way that they operate.

I imagine.

Nathan Stovall: Well, that's a scenario. That's a scenario, but I'll give you another one where maybe this is the way post GFC was supposed to work. You push risk out of the system. You don't have depositors money as much [00:29:00] at risk and. Wealthy people lose some money. Not, not, you know, most of, of, of the globe. Uh, and yeah, there are some pension funds who've, who've invested here and, and so maybe you could see some dicey things there.

But if we've pushed risk out to the system and it went to riskier investments that were funded by higher net worth individuals and there's some lost content there, maybe that's the way it's supposed to work. The question is just how ugly. Does it get through a cycle and we will have one. I'm not saying it's tomorrow, but we will have one.

How, how ugly does it get? And you know, what knock on effects would it have to the economy if, if it actually leads to delivering, then yeah, I think you're right. I think that's where you get there. And Brian Moynihan, the chairman, CEO of B of A said yesterday I was an event, the American Bankers uh Association.

Uh, annual convention where he was calling for the regulation of private credit firms for exactly this reason, because banks are [00:30:00] worried that there could be a problem created outside of the system, and then it'll end up spoiling the party for them.

Andrew Critchlow: Um, Nathan, uh, this has been fantastic. Great conversation.

Um, positive note to end on. What should we look forward to?

Nathan Stovall: I think things are pretty good. You know, we focus a lot on how scary things are right now. Uh, the line I always come back to is I remember a lot of the silly things I saw in oh six and oh seven that I don't feel like I'm seeing as much today.

Uh, we'll get, we'll get a downturn, but we'll, we'll get through it and people are generally cautiously optimistic. So let's, let's hope that that continues to carry through the day.

Andrew Critchlow: What doesn't kill you makes you stronger.

Nathan Stovall: That's right. That's right.

Andrew Critchlow: Nathan Stovall, thank you so much. Um, uh, for listeners of the Look Forward Podcast, I strongly suggest that you check out Nathan's podcast, um, Street Talk.

Nathan Stovall: Yes.

Andrew Critchlow: That's the [00:31:00] one, uh, which is available on, uh, the S&P global .com website. It will be also available, I suspect on YouTube, uh, Spotify, and the Apple Podcast store, just like this podcast, the Look Forward podcast. Thank you so much for joining us, and look forward to the next episode. Thanks.