This week, there was a lot of focus on potential financial stress. We’re seeing higher credit card delinquencies, higher commercial real estate delinquencies, and an increasing reticence of foreign central banks to hold more dollars. Despite Fed rate cuts, both housing prices and mortgage rates have continued to rise making homes even more unaffordable. Estimates for a 2026 full recovery of Macau gross gaming revenue miss the key point for Las Vegas Sands $LVS: The lucrative mass and premium mass markets have already experienced a full recovery. Finally, we explain how liquidity can affect asset pricing. It’s ok to buy illiquid assets if you have a high enough return expectation.
This week, we’ll address the following topics:
- We’re heading for a debt crisis and that’s not counting BNPL
- Fed rate cuts were supposed to improve housing affordability
- Even without a functional BRICS option, the dollar is losing share as a reserve currency
- The Macau gross gaming revenue estimates aren’t wrong, but they are misleading
- Let’s discuss liquidity when investing
With both star DKI interns moving on to excellent new positions, new intern, Josh Reaves, got promoted from “new guy” to “senior intern” in one week. In his first real week with pressure to produce, he came through as expected. This week’s 5 Things reflects meaningful contributions from him. We expected great things from Josh and he’s already delivering.
Ready for a week of concern about debt and the dollar? Let’s dive in:
1) An American Debt Crisis:
Recent data has shown that U.S. credit card, auto loan, and commercial office loan defaults have peaked to levels not seen since the Great Financial Crisis. Over $24 billion in credit card balances were added in the third quarter of 2024, up 8.1% from a year ago, boosting overall card debt to $1.2 trillion. Reports show that 36% of consumers took on debt this holiday season. Lower-income households ran through their Covid “stimmies” a while back, and are now tapped out. Financial distress has been spreading with inflation pushing the cost of living into stressful territory for many. The result has been a spike in delinquencies, with over $46 billion in loans being written off in the first three quarters of 2024 alone. With high interest rates and the still-high auto costs, borrowers are also increasingly being driven into delinquency on their auto loans. The Fed reported over 7.7% of auto loans in danger territory, levels not seen since 2010.
The whole system is leveraged. This is concerning.
DKI Takeaway: This debt crisis doesn’t just extend to the consumer. The overall delinquency rate of CMBS (collateralized mortgage-backed securities) has spiked to 6.6%, with office delinquency rates reaching an all-time high of 11.0%. Many commercial properties are selling at a fraction of their original price, while historic levels of vacancies keep them unprofitable. This has created a perfect storm where landlords can’t make interest payments or refinance their loans, because the spaces don’t bring in enough revenue. The issue has also caused slight increases in delinquency rates of multifamily and some retail spaces. Many landlords rest their hope on interest rate cuts that may not come soon enough. Even worse, these debt statistics don’t include buy-now-pay-later loans which are growing fast. DKI has been talking about a bifurcated economy for two years. This is a perfect example of where we’re heading.
2) Fed Rate Cuts Were Supposed to Improve Housing Affordability:
Typically, housing prices and mortgage rates move inversely to each other. When mortgage rates rise, housing prices tend to drop, and vice versa. Homeowners can afford a certain monthly payment whether it goes to principle or interest. In our current housing market, this relationship has been challenged. While the 30-year fixed mortgage rate sits around 7%, rental prices and home costs continue to soar.
With mortgage rates rising to reflect higher projected inflation, the buying power of the consumer is reduced. This normally leads to reduced housing prices. Even though we are in a more normal interest rate environment, U.S. house prices have risen over 4.3% in 2024 alone. Even rental prices have continued to increase, with a 5.6% jump in 2024, compared to the average year-over-year change of 2% – 3%. We now have a situation where homeowners who secured lower rates are reluctant to sell, restricting housing supply. Home Builder Spec Inventory has hit its highest level since 2008, with over 124k houses completed but unsold. Affordability is terrible and empty supply is rising. What could go wrong?!
Housing prices up. Rental prices up. Mortgage rates up. Supply growing.
DKI Takeaway: One thing we’ve been talking and writing about for a while is how trapped the Federal Reserve is. Higher inflation expectations have caused long-term Treasuries to rise in yield despite (or because of) recent Fed rate cuts. Massive overspending out of Washington DC has meant that actions by the Fed no longer have as much impact as they would have a few years ago. DKI wrote an eBook over a year ago called Counter-Intuitive Inflation explaining this phenomenon. The analysis is still relevant so we invite you to check it out here.
3) The Dollar is Still the World’s Reserve Currency – and is Still Losing Share:
For many years, the U.S. Dollar has been the dominant global reserve currency, held by central banks to promote and stabilize international trade. As of the third quarter of 2024, these reserves fell to 57.4%, their lowest levels since 1994. Over the past 10 years, this share has fallen almost 9%. While the dollar still remains the leading reserve currency, central banks have been continuously diversifying the currencies that compose their reserves. While the Euro remains the second most held reserve currency at around 20%, some central banks are switching to non-traditional currencies. The share of Swiss Francs, the Australian Dollar, and the Canadian Dollar have seen increases, and gold has reemerged as a safe-haven reserve.
This shift is an effort by central banks to reduce their reliance on a singular currency, which reduces the impact that geopolitical tensions, economic uncertainty, and trade tensions have on exchange rates. It’s also an attempt to reduce the influence Washington DC has on their economies as well as to reduce the impact of dollar-based inflation. Adversarial countries such as Russia and China have strategically reduced their dollar reserves. This comes as a deliberate attempt to push back against sanctions and trade disputes occurring over the last decade.
The top export of the US is losing market share.
DKI Takeaway: Last year, I warned about the possibility of a new BRICS commodity-backed currency. Many dismissed those concerns, but DKI’s general point on this is that nations making up more than half the population of the planet want less exposure to the dollar. Whether that competition comes in the form of a new reserve currency, increasing central bank usage of hard assets like gold or Bitcoin, or more reliance on other fiat currencies, it presents an issue for the US. Lower interest in holding US Treasuries leads to lower prices and higher borrowing costs for the government. The dollar is still the most desirable currency in the world, but it’s been losing share for decades.
4) Macau Gross Gaming Estimates Aren’t Wrong – Just Misleading:
One sell-side firm increased its price target last week for Las Vegas Sands $LVS. Among other things, they cited the expected full recovery of Macau’s gross gaming revenue (GGR) to pre-pandemic levels by 2026. That estimate may be correct, but it’s misleading. The big-spending VIPs haven’t fully returned to the casino gaming tables in Macau and that’s held GGR levels (a measure of gaming activity) well below the 2019 mark. That’s a problem for companies like Wynn $WYNN that focus on the high-end customer. Sands does most of its business in the much higher-margin mass and premium mass mark. Those customers can be 10x as profitable per dollar wagered at the tables. That part of the business has recovered to pre-pandemic levels as Chinese gamblers return to a favorite pastime.
The aggregate numbers hide the full recovery in the mass and premium mass markets.
DKI Takeaway: While we believe that conditions in Macau for $LVS are better than the GGR statistics show, and that all of the re-tendering risk is behind the company, that doesn’t mean there’s no risk ahead. China is facing economic weakness with a property bust that rivals the 2008 financial crisis in the US for loss of property value. So far, it hasn’t hurt Sands’ properties in Asia, but it’s something we’re going to have to watch closely in 2025.
5) How Much Does Liquidity Matter and When Would We Accept Less of it?:
Liquidity refers to how easy it is to turn an asset into cash, without significantly affecting its market price. In financial markets, we have a mixture of liquid products that are often easily bought and sold such as cash, many stocks and bonds. We also have products that are not as easily converted (illiquid) such as real estate, art, cars, or jewelry.
When buying or selling liquid assets, there are deeper markets with more participants, allowing for a quicker transaction that don’t move asset pricing by much. A great example is popular U.S. companies like Apple $AAPL or Tesla $TSLA, which trade significant amounts of volume daily. When dealing with smaller companies with lower market capitalizations, there aren’t as many buyers and sellers in the market for that stock, which means either spending more time trying to trade the asset or accepting the possibility of moving the price yourself.
The Bitcoin market is volatile, but also liquid. Prices may change quickly, but not so much as a result of your buying or selling.
DKI Takeaway: How does liquidity affect an asset’s price? When dealing with an asset that is more liquid, there is a higher level of agreement between buyers and sellers. Therefore, the bid-ask spread tends to be narrower, reducing the impact the transaction will have on the asset’s price. When dealing with less illiquid assets, there is a lower level of agreement on the price of an asset, creating a wider bid-ask spread. This means more money may have to be paid for the asset, as it is harder to trade. While liquidity isn’t always a concern, it’s important to take into account when choosing specific investments. Entering into a highly liquid position ensures your trades will be quick and efficient at consistent prices. In contrast, a less liquid position might mean delayed trades at inconsistent prices, accruing higher costs to buy/sell an asset. Understanding this will help you optimize returns while managing risk in that market. At DKI, there are times we take positions in less-liquid securities because the additional return potential offered outweighs the short-term risk from reduced liquidity.
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