Tag: market commentary

Market Commentary 6/10/2022

Posted on by Damon Germanides

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

Posted on by Damon Germanides

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

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 5/13/2022

Posted on by Damon Germanides

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

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 4/22/22

Posted on by Damon Germanides

Fed Speak Shakes Markets As Rate Hikes Loom

Markets remain confused about Fed policy.  The Fed voting committee was out talking up their points this week. Suggestions of a .75 bp increase in Fed funds were discussed, with some Fed members supporting this increase and others stating that this high of an increase was unnecessary. Many investors have found this situation both mystifying and frustrating. I have written previously that the Fed should have raised short-term rates sooner as well as stopped QE earlier.  Many of us did not believe the Fed’s “transitory” stance on inflation as autos, homes, food, and other essential goods have increased dramatically in price over the last couple of years.  Now, the Fed is way behind on inflation and is facing several challenges: a tight labor market, rising prices in oil and food, high rents, and supply chain challenges.  It may be too late for the Fed to slow inflation in a timely manner absent a major drawdown in the equity markets. This drawdown would have ripple effects throughout all segments of the economy.  A few more days like Thursday and Friday in the equity markets, and the wealth effect the equities market creates will be under pressure, ultimately dragging on consumer sentiment and business and consumer spending.

Interest rates are rising quickly. Banks are increasing spreads on rates. There was a recent article on the negative impact floating rate loans (which move up or down based on SOFR + margin) are having on businesses as those loan rates surge and increased debt service payments for companies.  For perspective, the 2-year Treasury was ~.50% in November 2021 and is now ~2.67%.  The bond market has been the first to react to Fed policy as of late after having shrugged off the idea of higher rates for many years. While the long bond has flirted with 3.000%, short-end bonds have shot up in anticipation of several rate hikes in the coming months. The equity market finally got the message this week.  The 2 – 10 year Treasury spread is under .25 bp, suggesting heightened concerns about a recession sometime in late 2022 or 2023. 

Mortgage rates remain elevated.  The 30-year mortgage rate is now above 5.000% from most lenders.  It is becoming harder to qualify borrowers as rates have risen and rates are no longer considered “cheap money.” How this affects the real estate market given the supply constraints in some markets such as Southern California is yet to be determined. It is worth noting that the combination of higher rates, the increased cost of living, and a very volatile equity market, will weigh on the minds of new home buyers.  Home prices may need to come down to adjust for the many households being impacted by the pressure of added costs.  There was not much to celebrate this week. It is starting to feel as if harder times are ahead of us for the coming year. 

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.