Market Commentary 11.11.22

Insignia Mortgage
November 11, 2022

A Welcome Sign of Relief on the Horizon

I believe I speak for all in my profession that Thursday’s better-than-expected inflation reading and subsequent broad rally in bonds and equities was a welcome sign of relief. However, let us not forget that a one- or two-day rally does not make a trend. Inflation is still at 7.70% (but hopefully moving lower), the economy is weakening as layoffs mount and geopolitical tensions in Europe and Asia remain high. The CPI report did take some pressure off of the Fed to continue to move in 75 bp increments, to a more measured approach of 50 or hopefully only a 25 basis point increase. The Fed wants the entire yield curve to be restrictive, which means making interest rates higher than inflation. The reading the Fed prefers, the core PCE was around 5% in November. Therefore, the Fed’s work is probably not done, but fears of rates touching 6% or so have been taken off the table. 

Crypto Collapse – Gold Rallies

One of the great ironies this week was the absolute collapse of cryptocurrencies as more traditional asset classes such as gold rallied impressively.  Crypto is a trillion-dollar asset class (down from 3 trillion) and may still pose some systemic risks.  This may have also been attributed to the massive rally in bonds on Thursday with the so-called “flight to quality trade”. 

A move lower in interest rates will help boost home sales and commercial real estate transactions.  The rate of change in interest rates really hurt the marketplace. Should interest rates continue to fall and should the 10-year settle in at the 3.500% range, a pickup in transaction volume will follow.  Also, equities (not meme and high beta stocks with no earnings) have retraced a good amount of their losses which should bode well for consumer confidence assuming the rally sticks. 

Market Commentary 10/28/2022

damon Damon Germanides
October 28, 2022

Markets Anticipate More Dovish Fed Commentary Next Week

The combination of a strong GDP report, the 10-year Treasury bond decreasing from 4.300% to 4.000%, and the signs inflation may be leveling off (albeit slowly) served as tailwinds for the equity markets.  The result is another winning week. Risk-taking has been reignited, with the “fear of missing out” pushing stocks up, even amidst the multiple headwinds circling the economy. We’re hopeful these animal spirits make their way into the real estate and lending markets. The dramatic rise in interest rates will likely keep investors waiting for either a further reduction in real estate prices or a bigger drop in interest rates. Banks remain both cautious and passive in pricing loans, given that risk-free rates will be near 4.000% next week. 

We anticipate next week to be momentous with the Fed meeting mid-week and the release of the October employment report on Friday.  The probability of .75 basis point increase in Fed Fund rates is over 80% and is the most likely outcome when the Fed convenes. The rip higher in the equities market as well as persistent inflation combined with less than awful corporate earnings will justify the Fed’s continued hike on rates. It is important to remember that the Fed will be moving the Fed Funds Rate up by yet another .75 basis points soon, and these are dramatic moves. The impact of these moves will not be immediate. It takes time for these rate hikes to make their way into the real economy. Experts believe the lag effect of these hikes is around 6 months.  Financing costs for consumers and business owners have surged this year, from credit card financing charges to mortgage and auto payments, as well as business and corporate loans. The higher cost of financing will hurt demand as these costs are absorbed.  Many fear that the Fed’s medicine of swiftly raising rates to cool inflation is worse than just living with inflation. We believe the Fed is correct in addressing the inflation problem, but that their pivot from inflation is transitory. Destroying demand through higher rates is a dangerous prescription and could lead to a financial accident.    

Getting a read on interest rates is perplexing. Inflation is still way too high. The Fed’s preferred gauge of recession probability, the inversion of the 3-month to 10-year Treasury, inverted recently.  This supports the notion the Fed has tightened enough and should take a wait-and-see viewpoint. I am certain real estate brokers and mortgage professionals would welcome a break from what has been a formidable marketplace.

Market Commentary 10/21/2022

damon Damon Germanides
October 21, 2022

Bond Yields Drop & Equities Rise On Dovish Fed Commentary

Over the last seven days, U.S. equity markets dismissed a number of negative events in order to close the week out higher. Fed speak on Friday helped boost the markets. The Wall Street Journal reported that some Fed members are not certain that short-term interest rates should continue to move up so quickly.  It’s a strange world we live in when the comments from one Fed official can move markets so erratically.  We maintain our residence in the cautious camp when digesting incoming news about company earnings and costs. Whether it be JP Morgan’s Jamie Dimon, or Jeff Bezos of Amazon, many CEOs share a batten the hatches sentiment. Housing and commercial real estate are under tremendous pressure, oil is stubbornly high, and overall input costs continue to rise. Inflation will be with us longer than expected. 

The Fed has hit the markets very hard with what will be four .75 basis point rate increases after the November meeting, within a very short time period. It takes a while for these hikes to make their way through the economy. Banks are seeing an unprecedented number of deposits leave their institutions. It is obvious that liquidity is being sucked out of the economy very quickly. Should the Fed continue with rate hikes at current levels, the likelihood of a financial accident may become all but certain. Therefore, slowing the pace of rate increases is probably wise.

Stay Calm, Stay Cautious, and Take The Market Week By Week.

Until the Fed slows the pace of rate hikes, or, we start to see some signs of easing inflation, both business and real estate activity will be light. It is going to take a moment for businesses and consumers to adjust to a higher-rate environment. Business values as well as real estate values will need space to adjust. The good news is with every passing month, we get closer to interest rates normalizing, and hopefully, inflation moderating. Again, we don’t see inflation dropping to 2% overnight, but gradually leveling off. Calmer bond and equity markets will spur housing demand and fuel consumer confidence.    

One other positive note, public company earnings have beaten expectations. This report supports a strong U.S. economy despite those companies forecasting tougher times ahead. This is both good and bad, as the Fed may use these positive earnings to validate additional rate hikes. The Fed’s mixed messaging amongst Fed Governors presents many different outcomes. For this week, it was a dovish tilt on rate increases, and the market rejoiced. 

Market Commentary 10/14/2022

damon Damon Germanides
October 14, 2022

Inflation Proves Hard To Tame As 10-Year Tops 4% 

A market with no memory is one that can produce a 1,500-point upswing in a day, even when a hotter-than-expected CPI reading was reported (markets are down as I write this on Friday morning).  While a relief rally after a near week of selling was welcomed, big reversals like Thursday’s are symbolic of a bear market. Inflation is a problem and while there are some indications that it has peaked (dry bulk shipping, decline in oil and commodities), inflation is still overwhelming the system. The Fed is set to raise another super-sized .75 bp in November.

We are worried that these massive hikes will strengthen the chances of a financial accident. To date, the hikes have certainly crushed demand for real estate. This defeat is evidenced by the bank’s commentary on origination this morning.  Asset prices will need to adjust to a 7.00% average on 30-year conforming fixed-rate mortgages (although jumbo loans are cheaper).  Both consumer and business debt costs have risen dramatically.  We expect a surge in auto and mortgage delinquencies to follow, as well as an increase in business bankruptcy. 

There is not much to add from the last few weeks commentaries. Rising inflation, combined with the Fed’s expected response to it, continues to manipulate market action. The debt markets are showing signs of stress and banks continue to pull back on lending. A recession is very likely if the US is not already in one. Watching the bond market for clues to where the economy is headed seems logical. Should the 10-year break out above 4%, beware of even more pain.

Market Commentary 07/01/2022

damon Damon Germanides
July 1, 2022

Mortgage Rates Fall As Recession Fears Intensify

Treasury yields quickly raced to well under 3.00% this week. In my opinion, this is not a good sign of things to come. Recession fears have escalated. The long bond acts like this when recession fears rise.  GDP now has economic growth at -2.1%. Micron, a major chip supplier, guided down and reaffirmed what many of us already know. The economy is slowing. The combination of Fed rate hikes and quantitative tightening is a dangerous cocktail for the equity, real estate, and debt markets. I am hearing from several banks that liquidity is quickly drying up. They are weary to lend, and risk spreads have increased. As expected, housing supply has jumped as homeowners look to sell before things get worse, or in some cases unload their second or third home. A violent stock market and bitcoin correction have consumer confidence at a many years low, with liquid savings and retirement accounts down a great deal.  With margins being squeezed and earnings estimates falling, S&P year-end estimates have come down with year-end S&P to be somewhere in the range of 3,200 and 4,100.   

Where Do We Go From Here? Equity, Real Estate, Inflation. 

First, let us start with the equity market. Equities rise and fall and are prone to large drawdowns and rebounds. Many of us got into trouble chasing momentum stocks and high beta tech stocks, which have no earnings power.  Stocks represent ownership in a business, but zero rates and money spraying had fooled many professionals into believing that stocks only go up. The same applies to crypto. 

Two, regarding real estate, price is what you pay, and value is what you get.  Homes are a bit different asset class than other real estate as many homeowners were able to lock in exceptionally low-interest rates. Even if the housing market declines, homeowners will be able to service their debts. Home appreciation over the last few years has been unsustainable. The new listings appearing amidst the dwindling economy warrant the need for a correction. People are becoming increasingly cautious. As interest rates return to the historical mean, speculation will lighten, and buyers and sellers can enter a more even playing field.   

Three, the Fed will beat inflation. It is already happening. It will occur at a significant cost and over time, but inflation will come down. The Fed’s tools are very good at breaking inflation (higher rates and quantitative tightening). The collective negative sentiment compounded with quickly deteriorating financial conditions indicates the need for the Fed to halt its rate-hiking cycle expeditiously. The 2-year Treasury has fallen mightily the last few days which supports the notion of fewer rate hikes ahead.

Finally, it is important to remember that this is a long game. Absent the last 20 years or so, recessions and rebounds were much more common.  Recessions clean out the financial system and are healthy.  Speculators are taught about assessing risk, bad companies die off – clearing the way for new more innovative businesses, and prices reset allowing investors to buy assets for cheaper.  While I may be negative on the markets currently, I am always bullish on America. We have so much to be grateful for, even in tough times.

Have a great 4th of July.

Market Commentary 6/17/2022

damon Damon Germanides
June 17, 2022

Fed Committed To Fighting Inflation With .75 BP Rate Hike…Expect More To Come.

“Don’t fight the Fed” was last week’s theme. Until recently, many of us failed to understand that this statement is tantamount to their management over both easing and tightening cycles.  As stated previously, the Fed’s primary concern is inflation. Their policy decisions will be centered around curbing inflation. Should housing, crypto, or equities continue to get crushed, the Fed will not intervene. The great washout has begun. The Fed is reducing liquidity from the markets by raising short-term interest rates and letting bonds run off their balance sheet. In many ways, the equity market is doing a lot of the Fed’s work. As many equities are down from anywhere between 20% to 80%, we can’t help but feel poorer and less eager to spend. This sentiment will make its way through the economy, and eventually help to bring costs down. This includes costs of goods and services, as well as wages, all of which constitute a large business expense for companies.

Adding Salt To The Inflation Wound: Rates & Real Estate

Mortgage rates are back to 2008 levels. Housing starts are down dramatically.  Consumer business confidence is miserable. The pain load placed on our investments is all part of the plan to crush inflation.  It is disappointing that the Fed and Treasury placed their bets on inflation being transitory. Much of this destruction could have been avoided by slowly removing extra-accommodative policies from the financial system last year.  Now, we face a very turbulent financial period. All this amidst having just a glimpse of a return to normalcy after experiencing a once-in-a-century pandemic. Ouch. 

Part of me never thought we would see 6.00% 30-year fixed mortgage rates again in my lifetime. Yet higher rates are upon us. Housing prices have to adjust in the face of higher rates. Mathematically, you cannot have a doubling of interest rates without an adjustment to home values or cap rates on commercial properties. It will take some time for the market to adjust, but there will be an adjustment. Banks are also tightening credit standards as the fear of a recession increases. Personally, I think we are already in a recession. I don’t believe the recession will be too severe, given the strong balance sheets of businesses and a tight labor market.  However, the Fed is committed to slowing the economy down and they will probably succeed. 

Interest-only loans adjustable rate mortgages (ARM’s) will become much more popular with home buyers, especially with the elevated mortgage rates. It seems fairly certain that short-term rates will come back down if inflation readings abate, but only after the Fed raises rates by as much as 300 bp in the next 12 months. Should the S&P fall by another 20% down to around 3,000, it is hard to imagine the Fed would continue the tightening cycle. Those taking short-term ARM”s may benefit from falling rates a couple of years from now.

Market Commentary 6/10/2022

damon Damon Germanides
June 10, 2022

Who’s Most Impacted By Inflation? All Of Us. 

Things are looking grim. Today’s inflation report came in hotter than expected much to the disappointment of the bond and equity markets. Equity markets are getting slammed, while Treasury yields are rising. Today’s report puts the Fed substantially behind the curve on inflation. A dramatic action might be necessary to provide even the smallest form of relief.  Until today, you wouldn’t hear this from most commentators on CNBC – that one cannot take a 75 or 100 bp event totally off the table. This blog has advocated for rate hikes for quite some time and believed a 75 bp hike a few months ago would have been appropriate.  Signaling from the Fed has been very poor, as well as, from the Treasury. Letting inflation run hot was a terrible mistake. Like most Americans, inflation has been evident in our daily purchases for months. Let’s hope the Fed makes the right decisions soon, to avoid recession. It is becoming an increasingly difficult environment to navigate.  In my opinion, inflation, and not the equity or housing market, remains priority number one. So, there will certainly be more pain ahead.

Although consumer and business confidence remains weak, a combination of stock market volatility, the slowing housing market, and 120 oil may be doing some of the work for the Fed. Anecdotally, this week I happened to be out to dinner more than usual, and I noticed that restaurants are less busy. The gas attendant at the local gas station said fewer people are filling up. Bank management is less eager to lend. All these things suggest the economy may already be in recession.  With unemployment at 3.60%, it is hard to envision a major recession taking place. Nonetheless, I am reading about many layoffs, especially in higher-paying jobs such as technology. 

The Housing Market & Our National Reality Check

There is not much good news to talk about. Rising rates and a cooling economy will lead to lower house prices. Supply-constrained markets such as Southern California probably won’t see a big price dip unless the bond market and equity market do not steady, but home prices will come down as demand wanes. This is a positive note for those waiting to buy, but not so much for those who recently bought.

The one benefit of this reset is that wages, the cost of living, and people’s expectations of what a normal rate of return looks like, have gotten a major reality check. There is no such thing as a free lunch, unlimited debt financing, or continued parabolic returns on investments. You can’t spend your way out of inflation. There is now a return to the mean and that is good news for the next generation. Easy money is never easy. Success is earned and above-average returns require skill and thought. 

Market Commentary 5/20/2022

damon Damon Germanides
May 20, 2022

Equity Market Volatility Pushes Bond Yields Lower

It was another week of agonizing volatility in both the bond and equity markets. Big box retailers reported tighter margins due to high inflation. Economists continue to move year-end targets down. One wonders if all of this negativity signifies an end to selling.  S&P touched correction territory before trading higher into the close on Friday.  Long-dated bond yields fell below 2.800%. Trading remains volatile but orderly.  As we have mentioned previously, don’t expect the Fed to step in and backstop the equity or housing market anytime soon.  Inflation is the Fed’s primary concern and they will tolerate a falling equity market and a higher unemployment rate to subdue inflation. Case in point, the WSJ reported that subprime credit delinquencies are rising from historically low levels as the increased cost of food and energy preys on consumers.  Even the wealthy appear to be cutting back on spending. The soaring costs across all corners of the economy are weighing on people’s confidence and willingness to spend.

Impact On Real Estate & The Global Economy 

Limited housing inventory will keep home prices from falling too dramatically. However, given the wealth destruction incurred in both the bond and equity market, it is difficult to see real estate being impervious to recent events. The dramatic rise in mortgage rates over the last 60 days will push some buyers to the sidelines. 

With China shut down, and the world economy slowing, perhaps long-term interest rates will continue their recent descent. This would be helpful to growth stocks in addition to homebuyers, consumers, and businesses. We hope that long rates don’t move too low, as an inverted yield curve would be worrisome. Housing demand remains healthy, which bodes well overall for the economy.  Should this change, we would become very nervous over a deep recession. 

Next week is important for the markets as the Fed’s favorite inflation gauge, the PCE, is released.  The markets will respond favorably should inflation appear to be topping out.  However, should the reading come in hotter than expected, be prepared for a sobering market reaction. 

 

Market Commentary 1/28/22

damon Damon Germanides
January 28, 2022

Fed Set To Raise Rates Elevates Market Unease

This week’s widely anticipated Fed meeting confirmed to markets that inflation is an ongoing problem. To calm inflation and inflation-related expectations, the Fed is reversing course by running off QE and warning the markets that short-term interest rates will rise this year. They are less concerned about the markets going down, especially given the run-up in asset prices over the last two years.  It is important for investors to understand that the Fed has been very dovish with policy for many years (minus short periods of time that the Fed tried to be more hawkish). It has been understood that the Fed would step in should markets go down. However, with CPI running near 7% and the PCE running near 5%, the Fed is faced with both a mounting inflation problem and a tight employment market, which increases the chances that they will be self-fulfilling.  We believe inflation for goods and services will likely come down, but we are less convinced that wage inflation will cool off. There are simply too many job openings and too few employees willing to fill these jobs. Higher wages will be needed to inspire individuals who have left the workforce back into it. This has pushed the Fed to act on inflation while the U.S. economy is still relatively strong. 

Since the start of 2022, equity, crypto, and bond markets have experienced heightened volatility.  This volatility is probably a good thing in the long term as it will squash speculation (think Meme stocks) and slow growth in asset classes like real estate.  While we all welcome healthy appreciation in the assets we own, outsized year-over-year gains in any market are troubling. Many individuals, especially younger ones, believe markets only go up. That is far from true. 

Volatile equity and crypto markets are positive for the housing market, as individuals seek to buy property for its durability and stability. While rising rates will create more friction between buyers and sellers on an agreed-upon sales price, the stability of owning hard assets cannot be discounted.  Also, lenders remain committed to keeping business flowing. They are taking less of a margin in order to hold down interest rates and lure in prospective borrowers. Keep an eye on the 10-year as it has moved up and is settling in around 1.82%.  A quick rise above 2.22% could be painful for all markets, real estate included. 

Market Commentary 1/14/22

damon Damon Germanides
January 14, 2022

Inflation Tops 40 Year High & Bond Yields Jump

Mortgage rates have risen quickly. As we stated in our previous commentaries, once longer-dated bond yields begin to ascend from historically low levels, the outcome is violent given how quickly interest rates on mortgages move up. This has to do with the way bonds are calculated and the lower level of early payoffs from refinancing transactions as rates rise. The equity markets have also been hurt by rising rates and 40-year high consumer inflation readings. The Fed has admitted inflation is a bigger than expected problem and that it’s time to wind down QE measures by March, as well as start raising short-term interest rates. Thirty-year mortgage rates are now selling well above 3.25%, a dramatic move in percentage terms compared to only a few weeks ago. As inflation outpaces jobs gains, the rise in the cost of goods and services makes our country more vulnerable. From hourly workers to the elderly on a fixed income, inflation is a hidden tax. The Fed is behind the curve due to their extraordinary money printing policies enacted in part with Congress due to COVID-19. Prices in equities and real estate will adjust, but with so much liquidity in the system, we wouldn’t expect major down drifts in value. 

Now, the good news. Inflation on the goods and service side is most likely not structural. Inflation readings should come down over the next 12-18 months. Also, interest rates are still very low. Should bond traders believe the economy is slowing, longer-dated interest rates may not go up that much further. Housing expense remains affordable due to low-interest rates even with housing prices at record highs. A cooling-off of high-risk trading (think crypto and meme stocks) may not be as bad as individuals reassess risk and reward. Finally, the economy remains strong with many millions of job openings. As the Omicron variant (which is more contagious but much less virulent) makes its way through our population, we may finally be able to put the pandemic in the rearview mirror. This should be good for spending and increasing overall economic productivity, as individuals come together again without concern of infection.

However, crosscurrents are everywhere. We are keeping a close eye on the Treasury yield curve, volatility indexes, and consumer confidence readings as signs for where we may go in the coming months. Follow the Fed has been good advice for a long time. We are actively contacting clients and encouraging them to apply for still very attractive loan terms, albeit off the all-time lows. Now is not the time to be complacent.