Market Crash Storm Watch Note 2 - ratio of household net worth to disposable income

I have expanded my reading to include reports issued by various Federal Reserve Banks in the U.S.

I was impressed by the January 8, 2018 Economic Letter from the Federal Reserve Bank of San Francisco.  In my view it is yet another indicator that a market correction is in the offing.

Valuation Ratios for Households and Businesses by Thomas Mertens, Patrick Shultz, and Michael Tubbs

For me, the highlight of the report is contained in the following paragraph and the accompanying graphic.

Ratio of household net worth to disposable income

The net worth-to-income (NW/Y) ratio—defined as household assets net of liabilities divided by personal disposable income—provides a valuation metric for a broad set of assets including debt, equity, and real estate weighted by the proportion in which they are being held by households. Similar to the P/E ratio, this ratio generally tends to revert toward its historical average and does not remain at extreme values, either high or low, for prolonged periods. As shown in Figure 3, the NW/Y ratio increased notably during both the dot-com boom and the housing boom and sharply contracted during the subsequent downturns.

Government boffins are always cautious about presenting their
findings.  My antennae started to vibrate by the time I reached the conclusion of the Newsletter.

Current valuation ratios for households and businesses are high relative to historical benchmarks. Extending the analysis by Campbell and Shiller (1996), we find that the current price-to-earnings ratio predicts approximately zero growth in real equity prices over the next 10 years. Since the Great Recession, multiple asset classes—real estate, pensions, life insurance reserves, and equities—have been the main contributor pushing the household net worth-to-income ratio to a record high. Historically, these ratios have not remained elevated for prolonged periods, and peaks have been followed by reversions toward their long-run averages. At the same time, the present circumstances, including low current and expected interest rates, may warrant caution against bearish forecasts.

In my view, the net worth-to-income (NW/Y) ratio, when combined with the observations made in previous posts, is yet another indication of difficult times in the markets.

The storm clouds are on the horizon.  Meanwhile, the party proceeds and people are reluctant to leave, fearing that they will miss out on the good times yet to come.  There will be a reckoning.