Market Commentary 10/7/2022

Posted on October 7, 2022 by Damon Germanides

More Pain On The Horizon As Fed Pivot Is Deferred

The decent September jobs report had a “good news is bad news” effect on the markets. Traders were looking for signs that the Fed’s super-sized rate hikes are lowering wage inflation, which would indicate that overall inflation may be coming down. While wage growth eased and the overall jobs picture declined, it was not enough to sway the Fed from its restrictive stance. More likely than not, another .75 bp rate increase will occur at the next Fed meeting. Combining these large rate hikes with the balance sheet runoff, also known as QT, is quickly creating very cramped financial conditions. Our suspicion is that it will not take much longer for the Fed to break something in the financial system. Risks are high for a black swan type of event. There is real destruction happening in the marketplace as riskier bond yields start to tick up again. Oil is now over 90 and investor confidence is crumbling. It seems unlikely that the Fed can orchestrate an elegant economic soft landing. Caution remains the word du jour.

It is going to take time for real estate prices to adjust, especially in the way many of us believe they will. It is simple math. If your cost of carry doubles this quickly, prices and cap rates must adjust despite a limited supply. Next week holds a lot of critical news for CPI, PPI, retail sales, and bank earnings. Buckle up as it is going to be a rough ride as we anticipate these updates. We hope things will not be as painful as the Fed wants us to believe.

Market Commentary 9/30/2022

Posted on September 30, 2022 by Damon Germanides

Mortgage Rates Ease As Economy Shows Signs of Slowdown

Market pain remains the theme. There are simply too many variables to consider for anyone to know what is going to happen in the economy. The UK shocked markets this week when conflicting policy decisions by different parts of the government caused bonds to soar. In addition, the Pound plunged and pension funds cried for help as their treasury positions got smoked. Losses from the UK pensions were magnified due to leverage. Back here in the US, still the best place to invest by far, markets remain rocky. The bond market is back in charge of the direction of equities, real estate, and all other asset classes. Want to see where the world is headed? Continue to watch the 10-year Treasury for a sign. Should it move above 4.000%, there is the expectation pain for the markets will be even more exacerbated. Hopefully, it can find some footing under 3.500%- 3.750%. This would help bring the fear premium out of mortgage and other debt markets. While financing costs remain high, it does not benefit the economy for activity to crawl to a halt. As historical events like the Great Financial Crisis of 2008 and Covid 2020 have shown, it is hard to restart the economic machine once it’s stopped.

Has Inflation Reached Its Peak?

The Fed’s favorite inflation gauge, the PCE, came in hotter than expected yet again. However, markets shrugged off this bad news as bonds and equities early on in the trading session, but markets fell apart in the afternoon. This may be a sign that we have reached peak inflation as this report did not cause the market to panic. Our internal conversations with clients support the notion that the economy is slowing. Business owners are starting to hunker down, retail sales of luxury items are slowing (a sign that even the rich are beginning to worry), restaurants seem much less busy and the residential and commercial real estate markets are materially slower.

With negativity at 2008 levels across financial markets, perhaps we are nearing the end of the damage to the economy and markets. It is hard to tell, but valuations have certainly come in. A reasonable bottom in the S&P may be approaching (3,200 – 3,400). The Fed will continue to tighten, but, the pace with which they have gone so far may justify a pause or slow down to .25 -.50 bp increases over the coming year-end meetings. This column previously advocated rate hikes and was not excited about ongoing stimulus or other money giveaways, all of which are of course inflationary. However, the Fed message is clear now, and doing too much too quickly to combat inflation may unnecessarily damage the fragile global financial system. We think the Fed, like us, is seeing the economy weaken and confidence deteriorate to the point that inflation will subside.

Market Commentary 9/23/2022

Posted on September 23, 2022 by Damon Germanides

Markets In Turmoil As Fed Raises Rates Yet Again

It was another brutal week for the equity and bond markets. Fed Chairman Powell reiterated his belief that pain is necessary in order to bring down inflation. The Fed raised by 75 bp and emphasized that more hikes are ahead. Chances are very high of a global recession. Bank CEOs are talking about stagflation, or a combination of slow growth, high unemployment, and rising rates. The volatile gyrations in the equity market make us wonder when something will break. Fear is high as it feels as if we are paying back all of the stimulus and easy money policies we’ve had over the last few years… With interest.

If you listened to the talking heads, you would think there is no loan activity. While the rapid rise in rates has slowed the pace of activity, there are still transactions happening at the right price. With the rise in interest rates, it is harder to qualify for a mortgage. This will continue to put pressure on housing prices.

Famed bond investor Jeffrey Gundlach spoke after the Fed’s meeting this Wednesday and made some good points. He sees the S&P bottoming somewhere between 3,500 and 3,000. He is also noticing some very compelling bond opportunities. In particular, he advised that you should never time the bottom. As the market washes out, you should not sell, but look to accumulate for the long term. This same formula applies to real estate investing. Become more opportunistic while there is panic in the air.

Market Commentary 9/16/2022

Posted on September 16, 2022 by Damon Germanides

All Eyes On Fed Next Week As Markets Remain On Edge

FedEx, one of the premier delivery companies worldwide, warned of a global recession. This is concerning news, given their intimate knowledge of the manner goods and services flow through the global economy. This warning came on the heels of ongoing fears amongst market participants about inflation, Fed tightening, and stagflation anxiety (stagflation is the combination of rising costs, higher unemployment, and slowing growth). One can look at the equity markets as a proxy for deflating asset prices worldwide. Fed Chair Powell echoed this much when he used the word “pain” on two separate occasions when discussing the Fed’s plans to bring inflation down, which is through the combination of higher rates and wealth destruction. One should remember the words “don’t fight the Fed” applies to both uptrends and downtrends.

How Deep Will The Recession Go?

A .75 bp hike on the short-term Fed Funds Rate is baked in at near 100%. However, there is a chance the Fed may go up to 100 bp in hikes. Given the slowdown in housing, the destruction of wealth in many Americans’ retirements, equity/bond holdings, and the grim outlook by business owners, our hope is that a 100 bp hike does not become a reality. Slow and steady may be a better policy. We have advocated for more and faster hikes in previous commentaries, but, the combination of Fed hikes and quantitative tightening (which is just rolling out) may succeed in bringing down inflation. The aim at this point is to avoid a deep global recession. The comments from FedEx should not go ignored. Next week’s Fed meeting is so important, as a too-aggressive Fed could break something, which would not be good. Breaking inflation by way of an international financial crisis serves no one’s interests and would do more harm than good.

The Lending Narrative Continues

On the lending side, higher short-term rates and even higher longer rates impede the ability of new buyers to qualify for mortgages. Home builders are trading poorly as are home improvement companies. Housing is a major component of GDP growth so there is no doubt in our minds that the U.S. is in a mild recession. The bigger question is, how long does this last? When do interest rates top out, how will new and existing home sales and all other property types adjust to much higher interest rates? While there are lenders making practical decisions on applicants, increased mortgage payments have doubled from where they were just a few months ago. This will be a drag on housing prices, even with the limited demand in many large cities. A bit of positive news though, as potential new buyer income is holding up, and many are looking to the current volatile market as a good entry point.

The great Warren Buffet is famous for saying he is greedy when others are fearful. Well, there is certainly fear in the air. Smart and thoughtful purchases of assets such as real estate or high-quality equities may be at the beginning phase of attractiveness.

Market Commentary 9/9/2022

Posted on September 9, 2022 by Damon Germanides

Equity Markets Move Higher, Encouraging Soft Landing For The Economy

U.S. equity markets proved resilient against the backdrop of a Hawkish Federal Reserve. Several voting members of the Fed spoke this week and the message was clear: short-term interest rates are going higher to combat inflation. The Fed wants input inflation to go down (think wages and energy) as well as consumption (think feeling poorer due to home value or retirement accounts being down). However, the equity markets didn’t get the memo and rallied into the weekend.

Markets can sometimes react in a way that may seem irrational initially, but over time proves correct. In my mind, the equity rally suggests inflation may be coming down and job destruction may be happening more quickly. The so-called soft landing for the economy will be the result of Fed tightening. My prediction is there is more pain ahead. Volatile markets both up and down will be the norm for the balance of the year. The Fed will err on the side of higher interest rates for longer, which will put continued pressure on bonds and all investable assets. Remember, it takes time for the Fed’s policies to work their way into the system. That is why caution in this type of environment is so important. Don’t fight the Fed.

75 bp seems to be the likely direction in short-term interest rates when the Fed meets later this month. That number was forecasted to the Wall Street Journal to help mitigate any surprises. The cost of debt is rising quickly. Higher yields are becoming attractive for savers, which is one positive to this so-called “return to normal interest rate” journey central bankers are taking us on. Real estate prices are adjusting as expected in the face of higher interest-carrying costs. Buyer and seller negotiating is back in vogue and all offers are being looked at.

One interesting phenomenon that’s presented itself has me particularly excited to share. This past week Insignia Mortgage has located three new lending sources which specialize in the following: (1) financing high-net-worth domestic or foreign borrowers, (2) a new regional bank that offers attractive interest-only jumbo loans, and (3) a new commercial bank that offers investment property loans up to 20 million dollars. As rates have increased, so has the appetite to lend for those banks that didn’t chase yield to near zero. While business remains challenging, all is not lost in this wonderful free market economy we get to live in.

Market Commentary 9/2/2022

Posted on September 2, 2022 by Damon Germanides

Russia Gas Closure Spoils A Goldilocks Job Report

Equity markets were soothed earlier in the day due to an as-expected August Jobs Report. Hourly earning increases fell and more people entered the workforce. This is a sign that inflation is forcing people to accept jobs and re-think life without work. A volatile stock market has pushed older workers back into employment, as retirement accounts have been jeopardized by the traditional 60% stock/40% bond allocation this year. And, just when you thought the equity markets were gaining some footing… Gazprom, the Russian-controlled gas company, shut down its pipeline to Europe citing an oil leak. This news was not unexpected but took equities and U.S. Treasury yields lower. The markets are in some mood. It is virtually impossible to estimate where the U.S. economy, real estate prices, and interest rates are headed. There are simply too many variables to consider and too many black swans circling

Navigating The Gazprom Effect

Taking the Fed at face value, a 50 bp hike is certain. However, one cannot rule out 75 bp, especially if oil starts surging again in response to the Gazprom news. The Baseline Fed Funds rate is gaining support for settling at around 4.00%. Inflation is starting to show signs of moderating, but it is mathematically improbable that it will fall to the Fed’s target rate of 2% in 2023. Wall Street has had to reevaluate the higher interest rates for a longer Fed narrative as the interest rates start to do their job. Meanwhile equity and bond prices have fallen, real estate is under pressure, and business confidence remains between cautious to downright negative. The return to a more normal interest rate environment is resetting asset prices.

I want to say a few words about the manner in which I write this weekly blog. While I am personally inclined to be a little more conservative in my thinking, I do my very best to paint a weekly picture of what I am reading. In addition to the news and other industry sources, everything shared in terms of the economy’s direction is combined with the feedback I receive from our network of clients and bank executives. Lately, the current environment is not too positive. In my opinion, we are already in a recession. That is probably going to get worse before it gets better. However, one must remember it is during times of heightened volatility and turmoil that some of the best investments present themselves. So, while I am not bullish on the economy at the moment, I do believe patience will pay off in the form of lower house prices, and better entry points for non-housing investments.

Market Commentary 8/26/22

Posted on August 26, 2022 by Damon Germanides

Fed Speech Sinks Market

In his statement at Jackson Hole, Wyoming, earlier this morning, Fed Chairman Jerome Powell asserted that the Fed would “use our tools forcefully” to attack inflation. Powell was abundantly clear (and in my opinion has been clear for some time) that inflation is priority number one for the Federal Reserve. Many on Wall Street are incorrectly assuming the Fed will have their back. In reality, the so-called Fed has put a huge insurance policy at risk-taking for the last 30 years or so. It appears the strike price for this policy to be activated is much lower. Equity markets sold off hard after the speech. The Fed is serious about inflation and warned that further pain is an inevitable future. Powell explained that pain is the “unfortunate cost” that households, markets, and the economy will need to endure to wash out inflation.

The Impact Of Taming Inflation: Intelligent Decision-Making

A sinking stock market will not be good for home sellers. The pendulum has swung quickly, and buyers are in control. The one boon for housing is that supply is still tight. Many buyers have been waiting for a more buyer-friendly entry point to acquire a new home. Dramatically increasing interest rates present some challenges to both buyers and those sellers looking to step up to a bigger home or downsize. Intelligent decision-making is back in style. This applies to all investments and big-ticket purchases. Viewing comparables, cost to rebuild, and cost of financing, are all in vogue. This philosophy was forgotten in the last couple of years as momentum took over. We are going back to basics.

The Fed is gearing up for a 75 bp hike in September. It has been theorized that the Fed balance sheet reduction, also known as QT, is equivalent to another .50 bp. That is the bad news. The good news is by front-loading Fed hikes and also reducing the balance sheet, we are likely nearing the end of rate hikes. A 4.00% Fed Funds Rate seems to be where the Fed is planning to settle rate hikes for quite some time. As a well-regarded hedge fund manager told me the other day, “we are returning to normal discount rates and a more normal investment environment.” This makes sense and is probably good for the economy in the long term. However, this will be painful to some sectors and to more aggressive investors as a return to normal takes hold in the coming months.

Market Commentary 8/19/2022

Posted on August 19, 2022 by Damon Germanides

Economy and Interest Rates Present Mixed Signals

Interest rates surged late in the week with the release of the alarming UK and Germany inflation data, especially within the context of a slowing economy. Mixed economic signals in the U.S. did not help markets either with slowing GDP or rising weekly unemployment claims. Nonetheless, there were some good manufacturing reports and a better-than-expected retail sales report. Existing housing sales softened again, resulting in home builders’ confidence being dismal. Housing starts also fell. Since housing is a major component of the economy, the current housing industry status is not positive.

The Fed and The Average American Head Towards Black Swan Event

The inability of the S&P to break through the 200-day moving average is challenging the bullish narrative. Also, Fed speak, in my opinion, shows no signs of easing. Inflation is a problem, and it must be dealt with. Talks of 75 bp rate hikes by Fed officials as well as the start of 95 billion balance sheet run-off per month are not accommodative. These discussions also raise the possibility of a black swan type of event. However, not dealing with inflation now results in harsh problems for the average American. When food and life’s basic essentials become unaffordable to many, the government loses creditability. This is what concerns Fed officials the most.

Real estate activity has slowed, but every market presents opportunities. Buyers are becoming increasingly more aggressive in negotiating with sellers. The combination of higher mortgage rates and tighter lending guidelines makes qualifying for a mortgage tougher. Thankfully, niche lenders are returning to fill in the gap. Adjustable-rate mortgages and interest-only products are in demand to offset the rise in mortgage rates.

Next week’s Jackson Hole symposium will be watched closely as central bankers, economists and the Fed chairman gather to speak about the economy and fiscal and monetary policy. Stay tuned for this.

Market Commentary 8/12/2022

Posted on August 12, 2022 by Damon Germanides

Inflation Cools As Equity Market Surges

While we continue to err on the side of caution, this week we are a little less pessimistic about the economy, inflation, and the fate of short-term interest rates. A surging equity market masks some real concerns about the state of the economy. Remember, a deeply inverted yield curve must be respected. Although many cheered the slowing inflation numbers, inflation is still stubbornly high and becoming more embedded. The US economy is mostly service-based, so as service sector wage inflation continues to climb, food and rent costs continue to rise. Bringing inflation down to the 2% target will take time and some tough decisions by the Fed. However, for now, the equity markets have discounted this bad news. Instead, they focus on the assumption the Fed will not move as aggressively as feared just a short time ago. The base case is now 50 bp hike in September (although I am still in the camp of getting the Fed’s fund rate up sooner than later, as this may cause some short-term pain but will more quickly kill inflation off). The odds of a 75 bp hike have come down to 33% from double those odds this time last week.

Overall, corporate earnings were better than expected but many companies are now reducing guidance. Revenue growth is misleading in a high inflationary environment, as much of its development is attributable to inflation, which also affects input costs and lowers profit margins. Additionally, the rate at which consumer credit card balances have escalated is worrisome. With wages not being able to sustain the cost of living, consumers seem to be dipping much deeper into savings and credit cards.

Now to some positives. Consumer confidence has perked up from last month. Mortgage rates have come down some with 30-year mortgage money options in the mid-4% range. Purchase volume in our primary market is improving, but make no mistake, applications are down overall. More niche lenders are coming into the market as well. This will be good for the higher-priced homes as a large percentage of buyers in the high-end space are self-employed or have more complicated financial structures. While it remains a rough game, our lending relationships are still making common sense decisions on complex loans, which is encouraging.

Market Commentary 8/05/2022

Posted on August 5, 2022 by Damon Germanides

Strong Jobs Report Boosts Odds Of Fed Rate Increases

Wow! A surprisingly upended July Jobs Report added 528,000 jobs and pushed the unemployment rate down to 3.500%. Odds of a .75 bp increase in Fed Funds spiked after the report was released and bonds sold off swiftly. While indications like poor retail earnings reports and lower oil and commodity costs support the notion that the economy is slowing, the Jobs Report does not suggest this to be the case. This will embolden the Fed to raise rates faster and further. How this plays out will be of great debate over the coming months. For now, the equity markets took the report in stride and the Dow Index was actually up (as I write my comments).

When it comes to the economy, traditional signs of movement now indicate uncertainty. Below are a few observations on how difficult it is to predict what the future of the economy holds.

The yield curve is inverted, quite possibly the most reliable indication that the economy may be in a recession, yet junk bond yields have not blown out.
Wages are not keeping up with inflation, but consumers continue to spend, and defaults on credit card and auto loans remain low.
Housing has slowed as interest rates have risen but supply still remains below demand for now and prices have only fallen mildly in Southern California (Insignia Mortgage lends in CA).
The equity market has ripped higher even as revenue and earnings show signs of deterioration
Many other developed nations are hiking rates as well, and the UK not only hiked but stated with conviction a recession is imminent.

Jobs Report And Mortgages

The Jobs report is not helpful in interpreting the mortgage market, as mortgage rates soared after the report’s release. It may be wise to listen to the “Fed Speak” which has a unified opinion that expecting interest rates to fall by sometime next year is wishful thinking. Inflation remains the primary worry for the Fed as the longer high rates of inflation stick around, the more embedded into the economy it becomes. As housing inventory picks up, buyers will resurge as prices adjust to a more restrictive lending and interest rate environment. One positive this week is the re-emergence of some non-QM lenders, who really help the self-employed borrower or unique borrower scenario (as these types of loans do not have to fix into a specific underwriting box). More on this in the weeks to come.

Some other things to consider…Should bond traders change their tune on the state of the economy, interest rates could move up quickly. It is also important to note that Fed balance sheet reduction goes into overdrive in September, with 95 billion per month of run-off.