Market Commentary 9/23/2022

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

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 9/2/2022

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 07/01/2022

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 6/10/2022

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 06/03/2022

Strong Jobs Report Supports More Fed Tightening

Concerns over the Fed’s progress on quelling inflation have been heightened considering May’s solid Jobs Report. The 10-year Treasury Bond is now nearing 3.000%. The Fed has publicly stated they see no reasons to pause rate hikes (even after the expected 100 bp hikes expected in the summer) and the Jobs report has reinforced a tight labor market. Inflation will not come down for some time. It may have peaked, but the slide to lower inflation is expected to linger. Since labor makes up over 65% of corporate expenses, rising incomes will continue to put pressure on companies to raise prices when possible. Additionally, commodities inflation (especially oil) remains high. Case in point, gas prices hit $8 per gallon in California recently. 

Lookout: The June Balance Sheet & Major CEO Premonition

Expect ongoing volatility as the Fed is willing to let markets fall to wring inflation out of the system. This includes equities and housing. I advise you to watch the Treasury market closely. The Fed begins to run off its balance sheet in June, but the real action begins on June 15th. It will be interesting to see the effects of QT after so many years of liquidity support in the financial system by the Fed. This reinforces the need to be a fundamental thinker when buying real estate, a home, or any other security. Price always matters. 

Some major CEOs are beginning to warn of a looming recession. These individuals have access to troves of data and have the best minds in the world advising them. It goes without saying that the economy is too complex to truly predict what could happen. Economists and forecasters get things wrong more often than not. However, all this negativity is causing banks to be more cautious in underwriting.  The need for volume is creating competition for high-quality loans. Rate spreads are tight as banks compete to obtain the safest credit candidates in the jumbo space.  Non-QM and alternative documentation loans have fallen out of favor with the investor community. Such products are not getting a bid in the secondary market. Insignia remains focused on portfolio lending solutions for our customers who are mostly self-employed or foreign nationals.  

The combination of a slowing economy and elevated inflation is a worst-case outcome for the economy.  The Treasury market leads the way as a signpost for where the economy is headed.  In some ways, we must hope for higher long bonds as an inverted yield curve portends recession. Given all the debt in the system, one must not forget that things can still get worse. 

Market Commentary: 5/27/2022

Inflation Falls Slightly, Mortgage Rates Edge Lower.

Finally, some good news. The Fed’s favorite gauge of inflation, Core PCE, rose at a slower pace than last month. While this number is still way too high, it did not rise above the April reading that wreaked havoc on the equity markets and spooked the bond market. Personal spending is still going strong, but customers are opting for cheaper-priced goods. This week’s market action – equity higher and bond yields lower – is a welcome break from one of the worst 4 plus months in the market’s history. Nonetheless, there are many headwinds to be mindful of.  The Fed will begin quantitative tightening in June and is slated to increase rates in both of the next two meetings. Additionally, there is a lingering fear that this recent rally is what is causing a bear trap (a quick temporary move higher in the equity markets, only to reverse lower a short while later). This false technical indication inflicts painful losses on investors, pocketbooks, and the psyche. Home sales quickly slowing, consumers are dipping into savings, and  I don’t foresee the Fed reversing course on interest rate increases any time soon. Inflation is public enemy number one and a huge burden on the least wealthy members of our society.  

The Diamond in The Rough: Finding Value In The Current Market

Most of the experts I follow are more bearish in nature, with a target on the S&P of 3,800 to 3,900. This does not mean that one cannot find value during difficult market periods.  For example, a nervous home seller is likely to be more willing to settle for a lower price. In this case, real estate brokers will follow suit and be inclined to negotiate more to make a deal happen. Tougher times create opportunities that cannot be forgotten. The same principles apply to other investments. You just have to be willing to do the work to find value.

As the WSJ and other financial papers write about rising mortgage rates, mortgage rates have quietly and quickly come down. The 2-10 year yield curve has also steepened a bit, providing relief to those worried about a recession. Inflation remains a wild card. Recent lock-downs in China have weakened its growth, which is also quite worrisome.  All of these economic issues combined will keep markets on edge for quite some time. One could say that interest rates have gotten more attractive- when viewed in the context of their downshift. However, with the short end of the curve controlled by the Fed, I hold the belief that the direction of interest rates is higher.  A 10-year Treasury at 3.500% would not surprise me in these coming months, especially if inflation recedes, but not as quickly as hoped for.

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 5/13/2022

Hot Hot Hot – Inflation Data Substantiates More Fed Rate Hikes 

Inflation paired with a sluggish economy wreaked havoc on the equity markets this week. Equities fell hard (before rising on Friday) while bond spreads widened. Inflation remains public enemy number one as a hotter than expected CPI report confirmed what many of us already know…  Inflation is running strong and has yet to subside. Once inflation seeps throughout the economy, it is notoriously difficult to regain composure without the Fed breaking some part of the economy or the market.  Fed Chairman Powell suggested this much when he said he “cannot guarantee a soft landing” with the economy as the Fed raises short terms rates and begins to tighten its balance sheet. 

Prepare For Continued Volatility 

Expect continued volatility as market participants work through their models on where the Fed funds rate will settle in. This will determine if earnings and multiples on equities require recalibration. The highly speculative crypto space had a horrible week with $800 billion in value evaporating from the market. Fears of systemic risk have been discussed but have since been discounted. These types of conversations take place during bear markets and are often preludes to a market blow-up or recession. 

Real estate remains a favored asset class in times of inflation. This should bode well for a housing market that is already constrained by supply. However, in bad markets, all asset classes tend to re-price. It is hard to say if the supply limits are such as to not affect a drawdown in home valuation.  Banks remain eager to lend and with interest rates increasing, we expect a very competitive lending landscape. This should result in lenders willing to take a tighter margin to get money out the door.  Underwriting standards remain robust, so loan quality remains high. This is good for banks and ultimately the economy. We don’t expect a repeat of the 2008 financial crisis, even though we see a tough year in markets.

Interest rates touched well above 3.000% before falling later in the week.  The yield curve remains very flat as we stay on recession alert. With consumer sentiment and business sentiment negative, this should help slow down spending… And hopefully, bring down demand while lowering inflation.    

Market Commentary 5/6/2022

Fed Chairman Comments Fail To Calm Markets

Fed Chairman Powell appeared to be in high spirits after his press briefing on Wednesday this week. His commentary, along with the only a .50 bp hike to the Fed funds rate, was lauded by U.S. equity markets.  Markets appreciated his willingness to take a .75 bp rate hike off the table. They also found relief in the fact that an impromptu FOMC did need to take place to address current economic conditions. Despite the temporary mirth, Thursday’s depletion of markets around the world suggests the Chairman’s comments were flawed.  Critics question the removal of any policy response with so many conditions at play: a tight labor market, aggregate demand greater than what suppliers can deliver, a war in Ukraine, and COVID-induced lockdowns in China. The bond market is skeptical of this rhetoric, as the 10-year Treasury is now above 3.000%. This is an interest rate that many experts believed would not come to light for a long time, if ever.  In addition, mortgage rates are now touching 13-year highs. Equity markets are re-pricing risky assets as speculators are getting crushed amidst fear running high.  

Just How Bad Are The Markets?

The traditional 60/40 stock to bond ratio is down over 10% year-to-date. Ultra-low bond rates have not provided the ballast that higher-yielding bonds would have given in previous down markets. With inflation running above 5%, even as high as 8.5% in some cases, there is nowhere to hide. 

Although investors are worried, it is important to note that the U.S. economy is currently doing well. This is evidenced by the April Jobs report and the fact that wage growth is moderating. The stock market can be irrational and is not always indicative of actual economic health. Inflation does remain a problem. Fortunately, the Fed is doing its job by speaking tough on inflation. High beta stocks have lowered along with other speculative investments.  As consumer and business confidence crumble, prices will eventually come down. The big question is whether the Fed should be tightening more aggressively or continue to proceed with a “go slow” mentality.  Many experts would like to see the Fed move quickly to get in front of inflation and then adjust policy once inflation is tamed. 

Moving Into Creative Financing Options

As we indicated a couple of weeks ago, the WSJ is now writing about rising rates and borrowers becoming more creative with financing choices. Most notably is the move into adjustable-rate mortgage products. ARM loans adjust after a fixed-rate period but have much lower note rates. With 30-year fixed-rate mortgages above 5.00%, ARM products can still be had at rates under 3.00%. While these products are not for everyone, given the escalation in rates, these programs offer lower monthly payments and are becoming quite popular in the current rate environment. This is especially true in more expensive areas like Southern California.  

Watch the full statement from Fed Chairman Powell here.