Tag: global economy

Market Commentary 8/19/2022

Posted on by Damon Germanides

Economy and Interest Rates Present Mixed Signals

Interest rates surged late in the week with the release of the alarming UK and Germany inflation data, especially within the context of a slowing economy. Mixed economic signals in the U.S. did not help markets either with slowing GDP or rising weekly unemployment claims. Nonetheless, there were some good manufacturing reports and a better-than-expected retail sales report. Existing housing sales softened again, resulting in home builders’ confidence being dismal. Housing starts also fell. Since housing is a major component of the economy, the current housing industry status is not positive.

The Fed and The Average American Head Towards Black Swan Event

The inability of the S&P to break through the 200-day moving average is challenging the bullish narrative.  Also, Fed speak, in my opinion, shows no signs of easing. Inflation is a problem, and it must be dealt with.  Talks of 75 bp rate hikes by Fed officials as well as the start of 95 billion balance sheet run-off per month are not accommodative. These discussions also raise the possibility of a black swan type of event.  However, not dealing with inflation now results in harsh problems for the average American. When food and life’s basic essentials become unaffordable to many, the government loses creditability.  This is what concerns Fed officials the most.

Real estate activity has slowed, but every market presents opportunities. Buyers are becoming increasingly more aggressive in negotiating with sellers. The combination of higher mortgage rates and tighter lending guidelines makes qualifying for a mortgage tougher. Thankfully, niche lenders are returning to fill in the gap. Adjustable-rate mortgages and interest-only products are in demand to offset the rise in mortgage rates.

Next week’s Jackson Hole symposium will be watched closely as central bankers, economists and the Fed chairman gather to speak about the economy and fiscal and monetary policy. Stay tuned for this. 

Market Commentary 8/05/2022

Posted on by Damon Germanides

Strong Jobs Report Boosts Odds Of Fed Rate Increases

Wow! A surprisingly upended July Jobs Report added 528,000 jobs and pushed the unemployment rate down to 3.500%.  Odds of a .75 bp increase in Fed Funds spiked after the report was released and bonds sold off swiftly.  While indications like poor retail earnings reports and lower oil and commodity costs support the notion that the economy is slowing, the Jobs Report does not suggest this to be the case. This will embolden the Fed to raise rates faster and further. How this plays out will be of great debate over the coming months. For now, the equity markets took the report in stride and the Dow Index was actually up (as I write my comments).  

When it comes to the economy, traditional signs of movement now indicate uncertainty. Below are a few observations on how difficult it is to predict what the future of the economy holds.

  1. The yield curve is inverted, quite possibly the most reliable indication that the economy may be in a recession, yet junk bond yields have not blown out.
  2. Wages are not keeping up with inflation, but consumers continue to spend, and defaults on credit card and auto loans remain low.
  3. Housing has slowed as interest rates have risen but supply still remains below demand for now and prices have only fallen mildly in Southern California (Insignia Mortgage lends in CA).
  4. The equity market has ripped higher even as revenue and earnings show signs of deterioration
  5. Many other developed nations are hiking rates as well, and the UK not only hiked but stated with conviction a recession is imminent.

Jobs Report And Mortgages

The Jobs report is not helpful in interpreting the mortgage market, as mortgage rates soared after the report’s release. It may be wise to listen to the “Fed Speak” which has a unified opinion that expecting interest rates to fall by sometime next year is wishful thinking. Inflation remains the primary worry for the Fed as the longer high rates of inflation stick around, the more embedded into the economy it becomes. As housing inventory picks up, buyers will resurge as prices adjust to a more restrictive lending and interest rate environment. One positive this week is the re-emergence of some non-QM lenders, who really help the self-employed borrower or unique borrower scenario (as these types of loans do not have to fix into a specific underwriting box). More on this in the weeks to come.

Some other things to consider…Should bond traders change their tune on the state of the economy, interest rates could move up quickly. It is also important to note that Fed balance sheet reduction goes into overdrive in September, with 95 billion per month of run-off.

 

 

 

Market Commentary 7/29/2022

Posted on by Damon Germanides

Bonds Rally As Recession Worries Intensify

The U.S. equity markets proved resilient taking on both a .75 bp Fed rate hike and a GDP print confirming that the economy is technically in a recession. Two negative quarters of real GDP growth support this status. Inflation continues to be a problem but has likely peaked with the Personal Consumption Expenditure (PCE) coming in at a multi-decade high, but flattening out on month-over-month readings. Now, the great unknown is the pace at which inflation moves off its highs. The Fed’s goal of 2% inflation seems almost fanciful near term. The truth is inflation will be with us for quite some time.  

For Better Or For Worse?

Parts of the yield curve have been inverted. An inverted yield curve remains one of the best indications that the economy is in poor shape and financial conditions have perhaps tightened too much. One must not discount the threat of stagflation, should inflation become embedded in the prices of goods and services even as the economy slows. The equity market is forward-thinking, so even with sagging consumer and business confidence amidst a host of other negatives, the market found a way to rally. Perhaps the worst is behind the markets. Or perhaps, it is a bear market rally. Only time will tell. It is important to remember Fed rate hikes need some time to work through the system. Also, come September, the Fed will be selling close to 95 billion in bonds as part of its QT plan. It will be an interesting third and fourth quarter. 

Troubles abroad cannot be dismissed either. Whether it’s the Russia-Ukraine War, European or Chinese economic slowdown (worse than what the U.S. is currently experiencing at the moment), geo-political tension, or global run-away inflation, the world continues to experience great economic stress kickstarted by the pandemic. Joblessness on a global scale will likely increase as many large businesses are cutting back on hiring. If the goal of the Fed is to break inflation, one unfortunate truth is that job casualties will be unavoidable.

As expected, home prices are starting to fall in response to higher interest rates and stricter bank underwriting. To their benefit, buyers have found themselves more optionality and a selling environment where they have a seat at the negotiating table. Mortgage rates have come down lightly as 30-year fixed rate money note rates can be found at 4.75% or below.  No doubt a big move from the sub 3% range, this same product was being offered at a short while ago but removed enough from the high of 6% plus not too long ago. The move lower in mortgage rates should help some buyers make offers on homes.  Adjustable rate mortgages follow the 10-year U.S. Treasury. As the 10-year Treasury moves lower so do ARM rates. This may take some time as lenders are being cautious given the current headwinds. This should be a boon for the high-end market, especially if sub 4% interest-only mortgages are offered again. 

Market Commentary: 5/27/2022

Posted on by Damon Germanides

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

Posted on by Damon Germanides

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 5/6/2022

Posted on by Admin

Fed Chairman Comments Fail To Calm Markets

Fed Chairman Powell

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.

Market Commentary 4/29/22

Posted on by Damon Germanides

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 4/15/2022

Posted on by Damon Germanides

Economic Worries Intensify As CPI Hits 40 Year High

Central bankers across the globe are raising rates in response to inflation. The world has become increasingly volatile and dangerous with the war in Ukraine, China-Taiwan tension, Israel-Iran flare-ups, Covid lock-downs in China, and rampant inflation globally. The long-term consequences of inflation are quickly becoming a major threat to world harmony.  Rising prices impact the poorest people most, and in any measure of inflation anywhere in the world inflation is at 40-year highs. 

Once thought to be a problem for past generations, the combination of too much stimulus and a Fed that was certain (wrongly) that inflation would be contained even with zero interest rates, has put the Fed Chairman on his back foot.  The Fed definitely has the tools to crush inflation, however, their blunt instruments to combat inflation could also create a recession or worse. Many important economic indicators are flashing warning signs: yield curve inversion, CPI over 5%, and oil doubling in price are major headwinds to the economy.  Consumers are worried while businesses are struggling to keep up with increased costs and a lack of workers. Full employment complicates the story as the economy appears to be healthy, but, inflation readings this high and a Fed committed to multiple rate hikes in 2022 can quickly slow down economic activity (this is what the Fed is desirous of).   

Interest rates have risen dramatically, especially on 30-year fixed-rate mortgages.  With 30-year money near 5%, adjustable-rate mortgages are gaining traction as the preferred product. While ARM products carry interest rate risk after the fixed-rate period ends, the delta between ARM products and 30-year fixed products is wide enough to be the product of choice for jumbo loans. Should rates move higher (which is likely), expect housing demand to slow. There are already signs that housing has peaked as new home builders are sitting on more inventory, and second home sales are slowing. Finally, one important point to ponder is the massive amount of homes bought by investment companies such as Black Rock.  These institutional buyers may flood the market with homes at the first sign of a slowing down. While a major downdraft in housing is unlikely, it is quickly turning into a buyer’s market in certain areas.  Southern California remains supply-constrained. To date, the rise in rates has not materialized into a major slowdown as of yet. Caution remains the word of choice.

Market Commentary 4/1/2022

Posted on by Damon Germanides

U.S. Economy Complicated By War, Inflation, Yield Inversion & Strong Jobs Data

Nonfarm payrolls added close to 500,000 new jobs in March in an already tight labor market.  The unemployment rate dipped to 3.600%, a tick above the 50 year low of  3.500% back in February 2020. The long-term jobs picture is concerning as there are many more job openings than jobs available. The large number of job openings relative to the population actively seeking work could cause wage inflation to rise faster than economists prefer. Wage inflation is both sticky and a big component in overall inflation readings. Should companies have to pay even more for new hires, those companies will do all they can to raise prices to offset the higher employment cost. This in turn raises all prices, and so on and so forth.  It becomes clear how inflation can become embedded throughout the economy as you game this out, and why the Fed is talking up rate hikes to cool off the economy and lower inflation expectations. 

The PCE, the Fed’s preferred method of inflation came in at 6.40%, a 40 year high. PCE strips out volatile food and energy costs. Many forecasters see a 9% plus CPI number for March. Inflation is real and probably not going away any time soon. Using the PCE as an example, the Fed funds rate in real term is -6.15% when measured against inflation. This is destructive to savers and imposes a hidden tax on the population. Caution is warranted as the Fed’s policy shift stands for the benefit of main street, which may very well come at the expense of Wall Street.   

With the Fed moving away from QE and intending to initiate both higher rates and QT, there is an increasing probability that the Fed may put the U.S. into a recession. This may not occur in the immediate moment, but prior to the end of 2023. The flattening and momentarily inverted 2-10 yield curve is supportive of this thought. How far the Fed will be able to raise short-term rates is unknown, but bond trading supports not much more than 2.00%-2.500%, which still leaves short-term rates negative when measured against present inflation. Fed hikes much higher than this level could be quite destructive given the absurd amount of U.S. debt. The Fed is truly embarking on a journey “where no man has gone before” when it comes to Fed policy. 

Now, a few general observations. The war in Ukraine remains an international concern, but the markets for the moment seem to have moved past the troubling headlines. Also, the oil markets are trading better which will provide some relief to consumers over time. Mortgage rates are no longer cheap and the rise in interest rates will slow the pace of refinances. There are approximately 6 million homes that can still benefit from a refinance, down from 14 million not too long ago. However, the purchase market remains active. The dream of homeownership has not cooled as of yet. On the higher end, many potential buyers we speak to are looking to make gains from the stock market, or crypto market, to buy real estate. The recent volatility which saw many asset classes get crushed early in the quarter and then resurge probably has a lot to do with the desire to move into the safety of real estate. Moreover, lack of supply (as we have spoken about in many blog posts) will provide a natural floor to how low housing in markets such as Southern California may go down, even if the overall housing market is slowed by rising rates.

Market Commentary 3/25/22

Posted on by Damon Germanides

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%.