Market Commentary 5/20/2022

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 4/29/22

GDP Slows As Fed Eyes Rate Hikes

It’s becoming clear to everyone that the Fed failed to act sooner. There is now a 50% -50% chance of a .75 bp Fed hike next week, in addition to the many other indicators that are turning negative on the U.S. economy.  Stagflation is now being talked about as a real threat (stagflation is the combination of slow growth and rising prices). The employment picture remains tight which supports the “no recession” argument, but this time may still be different. The combination of the geopolitical issues in Europe, global inflation, rising energy costs, a zero-Covid policy in China, and general overall unease, may produce a recession quicker than many analysts believe. Big tech names such as Apple and Amazon reported worse than expected earnings and warned of tougher times ahead due to supply chain disruption and margin declines due to inflation. While the major indexes are down from 12% to 23%, many stocks are down 50% or more. Speculation is being sucked out of the equity markets which will affect how investors look at all types of assets: private equity, real estate, and bonds. The risk premium is increasing on investments as both equity and bond markets get hammered. Remember the human psychological component of investing, when every investor runs for the exit, the price is whatever you can get and not what that asset is worth. Watch the VIX index this week, also known as the fear gauge, to blow out as a sign that near-term market capitulation is finally over.

Personal savings is going in the wrong direction as inflation outpaces gains in income.  This speaks to the heart of the issue and why I believe the Fed will let the equity market fall much further than some pundits believe. Why, you ask?  The bottom 40% of the U.S. workforce cannot handle double-digit inflation. The combination of zero interest rates and too much stimulus has now created a massive demand shock, too much money chasing too few goods. While raising interest rates will not solve this issue overnight, the downside volatility in equities will discourage consumers and businesses from spending money. This should quell inflation over time.  The Fed will come to the equity markets rescue at some point (if need be). However, we are a long way away from that conversation. 

The yield curve remains on recession watch as the 2-10 and 5-10 year U.S. Treasuries are flat. This is beginning to affect lending rates across all product offerings since ARM’s vs. Fixed rates are also pricing at nearly the same note rate.  With mortgage rates on the rise, and affordability becoming stretched due to higher interest rates, the housing market appears to have peaked. Unlike 2008, loan underwriting remains robust, so while there could be a drift down in home values, it is hard to see an outright correction on the horizon. There are also many potential homebuyers who gave up the last year and a half on buying a home, who may re-enter the housing market should prices correct slightly. The refinance market is drying up as ultra-low interest rates have pulled forward demand and so many mortgages were written with sub 3.00% debt. As stated previously, caution is warranted as the return of capital becomes more important than the return on capital.

Market Commentary 1/14/22

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. 

Market Commentary 12/17/21

Yields Fall Surprisingly Lower As Fed Acknowledges Inflation Is No Longer Transitory

It was a very interesting week for the equity and bond markets. The Fed Chair, Jerome Powell, finally acknowledged inflation is running hotter than Fed models expected. As employment gains move the U.S. closer to full employment and with inflation running at levels not seen in decades, the Fed simultaneously agreed to start tapering mortgage bonds and Treasury purchases, also known as QE. The Fed also expects to raise short-term rates starting the middle of next year. The Fed Chair stated that if the new Omicron variant creates havoc on the economy, the policy would be subject to change. Long bond yields fell on this news as equities moved higher, anathema to what one would expect on the idea that the Fed would become less accommodative. However, equities ended the week on a low note, and tech was hit particularly hard. The more interesting observation is to understand why long bond yielding is moving lower and why the yield curve flattening. The thought is that bond traders are sensing that a slowing economy is in front of us; possibly a recession. A flattening yield curve must be watched carefully and is now a key indicator used by many economists for guidance as to the health of the global economic recovery. 

We have spoken ad nauseam about inflation not being transitory and we are now being proved correct on this belief. Hard assets such as real estate have long been prized during inflationary periods. That being said, real estate should remain a great hedge against inflation. In addition, low mortgage rates amidst surging inflation is a never-before-seen phenomenon, so while valuations are high, payments remain low. The appeal of paying fixed payment debts with inflating wages creates positive arbitrage and more disposable income as borrowers and businesses continue to lock in low monthly interest expenses.

Why might rates not move up much? The biggest reason is Uncle Sam’s balance sheet is so massive that a rapid rise in rates will create a payment burden. Furthermore, rapidly rising interest rates would put additional stress on the equities market and hurt consumer spending should stock portfolios drop steeply.  No one has a crystal ball, but a mild rise in rates over the coming year seems likely with the 10 year Treasury leveling off around 2.00% to 2.25%, especially if economic activity slows.

Market Commentary 11/19/21

Renewed COVID-related lockdowns in Europe are providing a tailwind for U.S. bonds as equities are trading down in the news. Further supporting lower bond yields is poor consumer sentiment and a weak Labor Participation Rate.  With 70% of the U.S. economy driven by consumption, there is a growing feeling that the economy may have peaked.  With winter approaching and COVID cases rising in Europe and in parts of the U.S., the Fed may not need to raise short-term rates as we previously believed. It is important to remember that the markets are dynamic and that the pandemic can quickly change sentiment, economic output, and overall confidence by consumers and business owners.

The counterargument for higher yields is that the COVID-related supply disruptions and behavioral changes have created rampant inflation with too much demand chasing limited goods.  Fiscal and monetary stimulus are just exacerbating the issue as more money floods into the system, costs of goods and devices will keep going up. Inflation is a problem for many working-class Americans as food, gas, and shelter costs have risen. Next week the Fed’s favorite reading on inflation, core PCE, will be released and closely read by bond traders and economists. 

It would be wise to take advantage of this dip in interest rates. With inflation running well above 4%, locking in a rate lower than inflation is a great example of positive leverage while locking in a real negative rate. 

07_17_2020_blog

Market Commentary 7/17/20

In the U.S. this week, bond yields slid as a rise in coronavirus infections picked up. Weekly unemployment claims moved higher which also pushed bond yields down as economists view higher claims as a sign that the economic recovery may be losing stream. Many states shut down certain public-facing businesses in response. Small businesses are already suffering and more stimulus will be needed in order to avoid mass unemployment.


Banks’ earnings, which are being looked at closely as a sign of things to come, were mixed with those banks with substantial institutional trading departments reported strong earnings while more traditional lenders such as Wells Fargo reported poor to negative earnings. All banks are reserving more for loan loss provisions, however, there is no consensus yet as to whether the worst is behind us. A V-shaped recovery seems like a long shot, but equities continue to trade under that assumption for the moment. Bond yields support a more prolonged recovery.


Despite all this sour news, some hopeful green shoots have emerged as consumer spending has picked up and housing starts surged. In another positive sign of an improving residential mortgage market, Insignia Mortgage has been seeing some options return to the jumbo lending marketplace, including non-QM lenders with loan programs such as self-employed bank statements and one-year tax return options. 

07_10_2020_blog

Market Commentary 7/10/20

It’s a tale of two worlds as money on Wall Street floods into COVID-19-resistant sectors such as technology and biotech while Main Street struggles and many retail and public-facing businesses face hard times and tough decisions. With many cities and states scaling back on the re-opening of the economy as COVID-19 cases surge, it is becoming harder to imagine a V-shape economic recovery. Even amongst the backdrop of all the political bickering, more stimulus out of Washington seems baked-in, especially for the hardest-hit industries such as restaurants, fitness, airlines, and hotels, all of which employ a significant amount of folks, and they may be asked to close their doors again. Some positive news from Pfizer and Gilead on treatments to combat the virus is encouraging, but even if these treatments prove to be effective, getting these treatments out to our citizens and the 4 billion global population will be a herculean task. 

With little to no inflation and unemployment rates in the teens, interest rates are going nowhere for a while. It is interesting to see gold run above $1,800 per ounce. With global coordinated central bank stimulus packages in the trillions (and rising), there will be a day of reckoning one day in the future, and inflating dollars to pay a historical debt is one way out of this catastrophe. So it’s not surprising to see the rise in gold as a store of real value. Rising inflation is probably years away, but if and when inflation hits, watch out. 

Speaking of hard assets and inflation, residential real estate made a strong comeback after the initial shutdown. Home sales are on the rise and banks are flooded with loan applications. We at Insignia Mortgage are seeing tremendous demand for jumbo mortgage product as non-QM loans return and as our portfolio of lenders continue to work hard to approve loans during this difficult time. We continue to have access to lenders who do not require a banking relationship from customers and who are offering purchase-money loans with as little as 10% down up to $1.5 million, interest-only loans, unrestricted amounts of cash-out, and attractive interest rates, and terms for investment property transactions. 

07_03_2020_blog

Market Commentary 7/2/20

A strong June jobs report pushed equities higher on a shortened trading week. While the economy is still so fragile, back-to-back better-than-expected jobs reports support the premise that quite possibly the worst is behind us on Covid-19. However, new cases have been spiking which is worrisome. The next few weeks will be key as fresh data is released on infection rates, hospitalizations, and deaths. 

If you think of the stock market as a voting machine, the rally higher in stocks and less volatility in the bond market is telling us things are really improving. Yet many customer-facing businesses (retail, restaurants, services) are struggling. Meanwhile, the tech sector rallies based on the explosive growth of services that affect the new normal in the work-from-home economy. How these tech services help or the nearly 20 million unemployed find new opportunities is not yet clear, but never underestimate U.S. innovation and resilience. Pfizer released some very promising Covid-19 vaccination data. It is still early but should a treatment(s) become a reality, all markets (stocks and bonds) would breathe a sigh of relief and economic productivity would surge. 

With the jobs picture improving, the new and resale housing market has improved as well. Supply remains a big issue, especially in tight markets like California. Interest rates are very attractive and the need for more space at home supports a stable housing market and perhaps even one that moves higher in price in certain pockets.  

Local banks and credit unions appear to be picking up the loans the large money center banks simply don’t want to deal with or lack the capacity to close on time. Insignia Mortgage continues to close purchase loans on time and with very attractive rates and terms. Cash-outs without restrictions, interest-only loans, and investment property loans are all readily available through our lending sources. 

06_26_2020_blog

Market Commentary 6/26/20

Major U.S. indexes fell this week as Covid-19 cases surged, putting the economic re-openings at risk. The resurgence of Covid-19 overshadowed what had been positive consumer-related data this week. Consumer spending, which had been on the upswing, slowed down. The notion of a quick recovery is unclear and the rise in infection rates suggest the recovery will be choppy.  Should the economy stall, we fully expect there will be more Fed stimulus and lending programs to help individuals and businesses get to the other side.  

Home buying and mortgage applications, at least in Southern California, have seen a major uptick. We are encouraged by this activity. Housing has been sheltered from this pandemic and is in a much better place than other real estate sectors, such as commercial properties and retail. Our L.A. office has been receiving a surge in applications as borrowers’ businesses recover and interest rates remain at historical lows. While we don’t expect rates to go too much lower, if equity volatility continues to increase, we may see rates drop. 

06_12_2020_blog

Market Commentary 6/12/20

Stocks sold off hard this week following a strong rally last week which had been ignited by a better than expected May jobs report. Thursday of this week (June 11, 2020) was a risk-off day that shook the equity markets as the market digested sobering comments by the Fed chair regarding the economic recovery combined with regional upticks in Covid-19 infection rates. Yet there is a positive takeaway in yesterday’s brutal pull-back. After a dramatic rise over the past several weeks in stocks, sharp sell-offs washed out speculators and may help prevent a bubble. Lately, there has been a lot of chatter about speculators profiting by betting on de facto bankrupt companies whose prices in some instances have surged more than 100% in a single day.  

Friday morning provided some relief to equities with a partial rebound. This is a welcome sign that Thursday’s sell-off was not the beginning of a deep sell-off. Treasury and mortgage rates fell as money moved into the safe haven of government-guaranteed bonds. The Fed’s stimulus operations will continue indefinitely which will keep interest rates very low and will also entice investors into more risky assets such as stocks, high yielding debt, and real estate. 

The Fed is committed to propping up the markets as we work through the process of getting our economy back on track. No doubt this will take time but there are some encouraging signs of a nascent economic recovery. However, the economy remains very fragile.

Currently, mortgage rates are low and may go lower. Lenders are slowly gaining the confidence underwriting files a bit more generously. Housing supply is in our main market, Southern California, and buyers are re-entering the market. These are all welcome signs that the worst may be behind us. Continue to expect mortgage rates to be priced favorably, especially on higher loan-to-value loan transactions, but perhaps not quite as well one would expect. Once banks have a better handle on the direction of deferred payment, we believe pricing overall will improve even further. Keep an eye on infection rates, manufacturing data, and consumer confidence. If these data points move favorably, interest rates on mortgages will price sharper in the coming months.