Two Tips for Making Your Profits Rise as Lending Declines
According to the Federal Reserve’s data compiled by Barclays PLC, in the first quarter of 2013, total consumer loans at the biggest U.S. banks fell 0.6%; they declined 0.2% at the smaller banks. (Source: Fitzpatrick, D. and Raice, S., “Drop in Borrowing Squeezes U.S. Banks,” Wall Street Journal, April 25, 2013.)
Similarly, business lending in the U.S. economy is weak, as well. In the first two weeks of April, outstanding loans by the big banks to U.S. companies declined nine percent when compared to the end of March. In the first quarter, lending to businesses only increased 2.7%.
Why does it really matter?
To say the very least, consumers and businesses shying away from borrowing suggests the U.S. economy may be heading towards an economic slowdown. This is mainly because the U.S. economy is dependent on consumer spending, as it makes up more than 70% of the gross domestic product (GDP).
In times of economic growth, consumers have jobs for the near future, and they are able to spend and borrow for things they want. Likewise, when consumers are spending, businesses need to meet the demand, and as a result, they borrow to either invest in new plants or buy new equipment.
Next, this phenomenon of consumers and businesses not borrowing shows that big banks can run into troubles ahead. At their very core, banks are in the business of lending; they take deposits from their customers—those who save—and lend them to others. Less borrowing from customers will eventually shake their core business, forcing them to cut costs to stay profitable.
As bad as these situations may sound, investors actually have many different ways to profit.
One way they can profit is by keeping their focus and portfolio exposure with banks only. They can do this by looking into exchange-traded funds (ETF) like the ProShares Short Financials (NYSEArca/SEF). (Please note that this is not a buy recommendation of any sort, but just an example of what kind of investment strategies investors should consider to profit from this kind of scenario.)
What this ETF essentially does is short the banks and provide investors with the inverse return of the Dow Jones U.S. Financials Index. (Source: Yahoo! Finance, last accessed April 29, 2013.) In other words, if the big banks in the U.S. economy witness a decline in their share prices, this ETF goes higher.
Looking from a broader point of view, if investors are concerned that a slowdown in borrowing is hinting a further slowdown ahead, then they might want to consider a broad market ETF like the ProShares Short S&P500 (NYSEArca/SH). The reasoning behind this is that as the economic slowdown deepens, companies from different sectors will start to see the effects, meaning their earnings will decline. This will eventually result in a broad market sell-off. The ProShares Short S&P500 ETF essentially shorts the S&P 500 index, with investors able to profit as the index declines.
As I have said multiple times in these pages, investors can make money in different market conditions, but one thing they must always remember is that things can turn against them very quickly. Therefore, investors should always look to manage their risk and save their portfolio from a steep decline.