Market Commentary 07/01/2022

Posted on July 1, 2022 by Damon Germanides

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 4^th of July.

Market Commentary 06/24/2022

Posted on June 24, 2022 by Damon Germanides

Treasury Yields Dip On Fears Of Slowing Economy

The economy is slowing. This is evidenced by the recent layoffs amidst many technology companies, lenders, and other businesses that were benefactors of stay-at-home and low-interest rates. The leisure industry remains strong as people continue to spend money on experiences and travel, with the exception of restaurants, which seem a lot less busy. Many clients are complaining about the cost of living which becomes exacerbated in a downward trending equity market. The front-page news of a looming recession and its potential certainly does not help quell public concern. Consumer and business confidence remains low. In my opinion, there is a fairly good chance the economy is already in a recession. It certainly feels that way.

Inflation Is Always And Everywhere A Monetary Phenomenon

If the Fed has the resolve to break inflation, it will. More clarity should be available by the end of next week when the PCE inflation reading (the Fed’s favorite gauge of inflation) is released. Should that reading come in hot or as expected, the Fed will most likely go up 75 bp again in July. The old saying that “inflation is always and everywhere a monetary phenomenon” rings true these days. The markets will stay volatile during the next few months as the new terminal rate for rate hiking is established. There’s a big chance that the Fed’s double-barreled strategy of increases in rates and balance sheet runoffs could result in them breaking something in the financial system. Caution remains warranted even during strong rallies like today.

I expect the Fed to move above 3% on Fed funds sooner than later. 40% of Americans are now living paycheck-to-paycheck and are struggling to pay for life necessities. The one positive here is that I think the Fed is now taking inflation seriously enough to ensure that it should come down fairly quickly, maybe by the fall. That is just my best guess. Earlier this week, the yield curve continues to be flat and briefly inverted. This is almost always an ominous sign.

Interest Rates In The Ether

How higher interest rates will affect home prices is yet to be established. My belief is that prices will need to come down. Some models are showing a 20% or so draw down in values. However, in supply-constrained cities like Los Angeles, there are still not enough homes to meet demand. Should interest rates remain persistently high, I imagine home prices will slide even in supply-constrained markets. I am hearing from commercial bankers that higher interest rates will have an immediate effect on cap rates and that exit cap rates have been reduced as well. Cautious underwriting is being implemented across the board, which I applaud. Better to stress-test loan applicants than be sloppy in a rising rate environment. I expect as interest rates remain elevated, refinance of real estate will be used to pay down more expensive personal or business debt. ARM loans and interest-only loan demand has picked up. Borrowers are attempting to offset the rise in interest rates with an interest-only payment.

Market Commentary 8/13/21

Posted on August 13, 2021 by Damon Germanides

Consumer Sentiment Dims As Rates Push Lower To End The Week

Interest rates dipped on a surprisingly negative consumer sentiment report which was the worst reading since 2011. The report was a surprise given the strength of the economy over the past many months and considering the positive trends in inflation, individual finances, and employment. Earlier this week, reports of tapering inflation were welcomed news to the stock and bond market. However, producer prices ran hotter than expected, so the direction for inflation remains a bit unknown.

Fed members have started talking about initiating bond tapering as we see improvements in employment, increased housing prices, and stronger personal finances. Some voting Fed members are pushing for a tightening of asset purchases in September. However, Fed Chair Powell has been adamant that he wants to run the economy hot for longer even with robust GDP growth and the highest inflation readings in years. A cross-current of thinking abounds on where we go from here, but a careful eye must be kept on the bond market in the coming weeks for signals on the overall health of the consumer and potential supply chain disruptions due to the Delta variant and impacts on retail in the US and globally.