Market Commentary 6/17/2022

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 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 3/25/22

Flattening Yield Curve Worrisome As Economic Growth Slows

I feel as if I have seen this movie before. With that thought in mind, the idea that this time may be different is what makes previous patterns in markets hard to handicap.  But, make no mistake, a flattening yield curve is a worrisome sign. This is especially concerning, given how hot inflation is currently running and where low-interest rates are at present.  The bond market had a terrible week as 30-year mortgage rates hit near 5.000%, which is a dramatic increase from the 3.25% or so rates were at the beginning of the year. I also find it strange that the equity markets are surging on a week when bond yields have risen to levels not seen in several years. The erratic behavior of the market is one reason why it’s so difficult to both predict the future or place big investment bets in one direction or the other. Even when all signs point to an outcome, that outcome may not happen.   

Take housing as an example. Given the lack of housing supply, the way in which rates will affect housing demand remains uncertain. I do expect sales to slow as the combination of very high inflation and much higher mortgage rates are not favorable. Yet, at the moment, many real estate brokers remain very busy and our office has a near-record amount of purchase volume.   

One of the great joys of my job is speaking to so many people each and every week. One client who is in the online retail business informed me that as soon as gas hit $6 per gallon, the business fell off a cliff.  Disposable income is getting eaten up by life’s necessities in a way unseen in over 40 years. Gas prices, food, rent, you name it, and the price is higher.  There is much talk of the strong possibility of a 9%-10% CPI print.  Should this happen, the Fed will need to act quickly and strongly with at least a .50 bp increase in rates and perhaps even do so sooner than their next meeting.  Inflation is beginning to erode economic growth. Bond guru, Jeffrey Gundlach, said recently that he is on recession watch. He looks at the 2-10 and 5-10 Treasury spread as one of his main predictors of a recession. Should both of these spreads go negative from very flat, he fully expects a recession.  A steepening yield curve will give the all-clear. 

Now for the positives. One, real estate has historically been an excellent hedge against inflation. This means that should the markets swoon, investors may want the security of a hard asset such as real estate. Two, a more downbeat mood opens the door to better negotiations between buyers and sellers.  As the market normalizes, there is a chance there will be more homes for sale or that sellers will be willing to work with potential buyers in ways that have not been seen over the last two years. Finally, rates are still attractive from a historical perspective (real rates are deeply are negative when measured against inflation), especially adjustable-rate mortgages (ARMs).  While it seems likely the 30+ year bull market in interest rates has been broken, let’s not forget the 10 year Treasury is still only at 2.48%. 

Market Commentary 3/18/2022

Inflation Is Real As Fed’s Hawkish Signals End Of Ultra-Low Interest Rates

Inflation is real. Consumers are getting hit at the pump, in the grocery store, and beyond.  Don’t be fooled, inflation will not magically go away any time soon. The reality is that the Ukrainian-Russian war will keep oil high as well as, some other key commodities. China and South Korea are in lock-down due to a surge in cases that will add more disruption to the global supply chain. Pile on the other disruptions over the last year and it seems virtually impossible that inflation will cool anytime soon. The Fed will continue to act as it has moved its focus from Wall Street to Main Street. With employment next to full and inflation anywhere from 5% – 8% (and probably going higher), there is a minimal political will to keep interest rates low. Although equity and real estate investors love low-interest rates, Fed inaction has caused inflation to become embedded in the economy. As a result, inflation will be harder to tame. I was happy to hear the Fed admit some error with inflation and offer a stance on rate hikes and balance sheet tightening.  The old saying of “don’t fight the Fed” applies not only when interest rates fall, but also when those same rates rise. Be careful of more volatile markets as the Fed raises rates and all investments become re-rated based on higher discount rates. This will lower the present value of all investments.

Mortgage rates are up dramatically. The 30 year fixed rate touched a low of about 2.500% during the pandemic. That same rate is now near 4.000%, which is a 60% rise. This impacts the demand for housing and the pool of available refinances. The one wild card is the low level of new and existing inventory (which I have spoken about) as a natural floor to prices dropping by much, even in the face of higher interest rates.  Nonetheless, higher rates will hurt economic growth as everything from home loans, to corporate, auto, and personal loans will come with higher interest rates.  This will limit the amount of money available to consumers to buy other goods and services. Luckily, our office is still seeing strong demand for purchase money loans, a sign that the higher rates have not cooled the market just yet.  We are witnessing savvy buyers negotiate better prices. 

The overall global market remains very hard to handicap. There remain several headwinds that could create a “flight to quality” scenario into U.S. Treasuries including escalation by Putin, a new variant of COVID, or shutdowns in China and throughout Asia. This could further complicate Treasury yields.  The world is also experiencing geopolitical tensions at a level not seen since the Cold War. I am keeping an eye on the flattening yield curve as a recessionary signal, as well as the VIX index as a sign of bullish/bearish sentiment as the equity markets work through varying degrees of concern. I will also be monitoring consumer sentiment and housing demand in the coming months. 

Market Commentary 3/11/22

Spreads Widen On Mortgages As Inflation & War Weigh Down On Markets

The global economy remains on edge with the war in Europe and surging inflation. Many of us are worried about the state of the world, our savings, and the cost of living; especially after two years in a pandemic. Consumers are very concerned about the rising costs of food, gas, as well as other goods and services. Too many headwinds remain to write with any conviction about where the economy or the markets are headed. It certainly feels eerie, but may encourage some greater risk-taking for those who can stomach the volatility. Fearful times usually present opportunities. However, no one can say for certain if this time will be different. 

I remain of the mindset to look for good quality investments which require digging into financial statements and determining if the business has an investible moat around it and a good balance sheet. The meme stocks have been crushed and unfortunately many people have learned the hard way how challenging investing can be. The same thought process applies to buying real estate when volatility picks up and sentiment sinks. The combination of more fear and higher interest rates should be a tailwind for new buyers. Also, with no more easy money being made perhaps buyers will be less excited about bidding up houses. However, the limited supply of homes in big cities such as Los Angeles will provide a floor to prices. This will keep home valuations steady even as the major U.S. indices flirt with bear market drawdowns. 

Interest rates should go higher near term. Regardless, the flattening yield curve must be watched closely and could limit how tight Fed policy may become. Recession talk has picked up as of late. High commodity and food prices along with ongoing supply chain issues do not bode well for GDP growth.  Consumer confidence, the best form of stimulus there is (when we feel good about the world we spend more) has languished. The war in Ukraine touches many emotional nerves and should keep consumer confidence low until it ends (hopefully soon).  Put all of this together, on top of our massive deficit, and it makes one wonder how far the Fed will be able to go with rate increases.

Market Commentary 2/18/22

Yields Dip As Ukraine & Fed Policy Weigh Down On Market

Ukraine-Russia tensions, inflation worries, a more restrictive Fed, and a slowing economy weighed heavily on the equity markets this week. Bond yields surged and fell in very volatile trading, while credit spreads widened. These are all signs that the economy may be headed for tougher times. Although the Ukrainian conflict is scary, the bigger concern is the expectation of rising interest rates that affect consumer confidence, with the calculus on discounting long-duration equities (think unprofitable tech) and housing.  While housing now has a natural floor due to such limited supply, other asset classes such as tech have been crushed by changing opinions on risk.  As the stock market is viewed as a store of wealth, consumer spending could be discouraged if equity losses continue to mount.

It seems as if the Fed has lost control of inflation as members of the FOMC appear on television to express their ideas on how inflation should be tackled.  Aggressive rate-hiking has been discussed and has played a big role in increased volatility in global markets. There is now talk amongst analysts of up to 7 hikes next year.  This may be too aggressive, especially as the equity market cools off.  However, the more conservative estimate of 5 hikes seems more likely. The increasingly important bond market has not been watched very closely over the last two years, due to the ultra-accommodative Fed policy.  The 10-year Treasury yield, as well as the slope of the yield curve, are now being closely watched. The flatter the yield curve, the less of a possibility of additional rate hikes.

Mortgage rates are very volatile and Insignia Mortgage team members have a big advantage over bank loan officers at the moment. Our mortgage brokers have access to many different products and lenders. Our community-based banks and credit unions are holding the line on interest rates as they are focused on keeping production volume healthy rather than raising interest rates. 

Market Commentary 2/4/22

Yields Spike On Blow Out Jobs Number 

The Jobs picture proved to be better than expected as November and December payroll data was revised up by a total of 709,000 jobs. The January employment report gain of 467,000 caught many forecasters off-guard. Most believed the combination of the Omicron variant, reduction in seasonal holiday jobs, and decreased travel spending, would prevent such a robust report.  More importantly, bonds spiked due to the better expected report and the increase in average hourly earnings, which rose .7%, above the .5% expected (remember wage inflation is sticky). The January Jobs Report has all but cemented a March lift-off in short-term interest rates.  A 50 BPS point rate increase can no longer be discounted as the labor market is tighter than expected and inflation is proving to be harder to tame.   

Across the pond is the same story as inflation is smashing records.  The Bank of England raised overnight lending rates and the ECB had to walk back dovish commentary on rate increases as fears of inflation threaten to become embedded within their economy.  Rising global rates will put pressure on the U.S. to act as well.  It can be argued that various central bankers waited too long to raise rates and are now embarking on a rate increase path while the global economic recovery is showing signs of possible slowing. A mixed bag of earnings is providing no clear sign of where the economy is headed.  Common themes in earnings reports relate to ongoing issues with inflationary pressures and supply chains. How much cost companies can pass on to consumers will decide which industries do well and which are hit hard in the coming months.  Oil is now above 90 per barrel. Food and basic goods have all increased in price. If this continues it will hit the economy as consumers’ pocketbooks are getting stretched.     

Volatility in both equities and bonds is expected to continue with the Fed’s focus more on main street instead of Wall Street.  How far markets would have to slide for the so-called Fed to be activated is anyone’s guess. However, with 40% of Americans uninvested in the stock market and really feeling the pinch of inflation and two years of lockdowns due to Covid, the Fed will let markets fall as they beat down inflation. A volatile equity market may be a good thing for real estate purchases as it will provide a more level playing field for buyers and sellers. Rising rates, which are still very low but not in the extraordinarily low bucket any longer, will also keep real estate values from ascending at the recent clip. Keeping home affordability sustainable will be key to the housing market going forward.  For those on the fence and worried about monthly mortgage payments, now is time to move as rates seem headed about 2.000% on the 10-Year Treasury note. Careful attention must now be placed on the 2-10 Treasury spread as it flattens. This could be a sign of tougher times if this relationship is compressed further.  Also, Fed speak in the coming weeks will be watched closely. The markets are fragile and a misstep by the Fed could create increased volatility and large price swings in bonds and equities.  

Market Commentary 1/28/22

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 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.