Morning Report: New home sales fall

Vital Statistics:

 

Last Change
S&P futures 2907 -14.5
Oil (WTI) 53.79 -1.64
10 year government bond yield 1.61%
30 year fixed rate mortgage 3.86%

 

Stocks are lower as we await Jerome Powell’s speech in Jackson Hole. Bonds and MBS are flat.

 

Jerome Powell speaks at 10:00 am, while the markets are looking to see if the Fed trims its sails to what the Fed Funds futures are saying. Some at the Fed have been throwing cold water on the idea that we have entered an easing cycle, but in an era of negative sovereign yields worldwide the die is probably cast for lower rates regardless of what the Fed does.

 

New Home Sales fell to 635,000 from an upwardly-revised 728,000 in June. They are up over 4% from a year ago.

 

new home sales

 

The Conference Board Index of Leading Economic Indicators improved last month. “The US LEI increased in July, following back-to-back modest declines. Housing permits, unemployment insurance claims, stock prices and the Leading Credit Index were the major drivers of the improvement,” said Ataman Ozyildirim, Senior Director of Economic Research at The Conference Board. “However, the manufacturing sector continues exhibiting signs of weakness and the yield spread was negative for a second consecutive month. While the LEI suggests the US economy will continue to expand in the second half of 2019, it is likely to do so at a moderate pace.”

 

Note that China imposed additional tariffs on $75 billion of US goods overnight. The tariffs would apply to soybeans, small aircraft, and crude oil.

Morning Report: Existing home sales rise

Vital Statistics:

 

Last Change
S&P futures 2937 8.5
Oil (WTI) 56.34 0.64
10 year government bond yield 1.61%
30 year fixed rate mortgage 3.83%

 

Stocks are higher this morning on no real news. Bonds and MBS are down.

 

The Fed is at Jackson Hole today and tomorrow. There is a chance that they could say something market moving, so just be aware.

 

Initial Jobless Claims fell to 209,000 last week, while the Markit PMI showed a deceleration. Note the manufacturing PMI fell below 50, which is a sign of contraction.

 

Existing Home Sales rose 2.5% in July, according to NAR. On a year-over-year basis, sales were up about half a percent. Half a percent isn’t anything to get excited about, however it is the first annual gain in a year and a half. “Falling mortgage rates are improving housing affordability and nudging buyers into the market,” said Lawrence Yun, NAR’s chief economist. However, he added that the supply of affordable housing is severely low. “The shortage of lower-priced homes have markedly pushed up home prices.” The median home price was $280,800 an increase of 4.3% YOY. Since the market bottomed in 2012, homes in the lower-priced half rose at a considerably faster pace than those in the higher priced half. In some areas, they more than doubled off the bottom.

 

Inventory remains the biggest issue for sales, with only 1.89 million units in inventory, which represents a 4.2 month supply. This is partly why NAR is working with FHA to increase the universe of condos which would qualify for GNMA guarantees. Sales increased everywhere but the Northeast. The first time homebuyer fell to its recent average of 32%, which is lower than the pre-crisis average of about 40%. Despite the continued disappointment in housing, the homebuilder stocks are doing well and the XHB homebuilding ETF is up about 31% this year versus 19% for the S&P 500.

 

XHB

 

The FOMC minutes were non-eventful, however the statement “Participants generally judged that downside risks to the outlook for economic activity had diminished somewhat since their June meeting.” was a bit of a head-scratcher given they decided to cut rates. Overall, the doves based their arguments on a deceleration in manufacturing, persistently low inflation and risk management. “Several” FOMC members argued against cutting rates, judging the economy “was in a good place” and some worried that lowering the Fed Funds rate would inflate asset prices. Others worried about the signal a rate cut would send to the market’s about the Fed’s perception of the economy. Also, a couple voters wanted to cut rates by 50 basis points.

Morning Report: Why mortgage rates are underperforming Treasuries.

Vital Statistics:

 

Last Change
S&P futures 2922 23.5
Oil (WTI) 56.73 0.64
10 year government bond yield 1.59%
30 year fixed rate mortgage 3.83%

 

Stocks are higher this morning on no real news. Bonds and MBS are down.

 

We will get the minutes from the July FOMC meeting at 2:00 pm EST. Given the dramatic change in the Fed’s posture over the past several months, there is a possibility that it could be market-moving.

 

The Trump Administration floated the idea of a payroll tax cut and a capital gains tax cut in order to stimulate the economy. Note that a payroll tax cut would require Congressional approval, which means there is a less than 0% chance of this happening ahead of the 2020 election.

 

Mortgage applications fell 0.9% last week as purchases fell 4% and refis rose 0.4%. The MBA mentioned how much mortgage rates have underperformed the Treasury market: “In a week where worries over global economic growth drove U.S. Treasury yields 13 basis points lower, the 30-year fixed mortgage rate decreased just three basis points. As a result, the refinance index saw only a slight increase but remained at its highest level since July 2016,” said Joel Kan, MBA Associate Vice President of Economic and Industry Forecasting. “The small moves in rates and refinancing are potentially signs that lenders may be approaching capacity constraints as they continue to deal with the largest wave of refinance activity in three years. The refinance share of applications, at almost 63 percent, was also at its highest level since September 2016.” Turn times are certainly getting longer from correspondent lenders as this refi wave caught the entire industry off guard.

 

What is driving the underperformance of MBS versus Treasuries? Capacity constraints are one big possibility – as firms use up their operational excess capacity, they will increase margins. The other issue is that the inverted yield curve is wreaking havoc on MBS investors, who borrow short and lend long. The big agency mortgage REITs  (Annaly Capital and American Capital Agency) cut their dividends recently. Two Harbors also cut their dividend. This is a warning sign that the mortgage REIT sector is losing money as rising prepayment speeds kill the value of their portfolios. Since mortgage REITs are probably deleveraging in response, that means they are either selling MBS or at least cutting back their purchases. That lack of demand means that mortgage rates will be higher than you would expect. So, if you are running scenarios and wondering why you can’t get par pricing at X%, that is a big reason why.

 

McMansion builder Toll Brothers reported better than expected earnings last night. That said, most numbers were down on a YOY basis – earnings, revenues, contracts, margins. Despite the mediocre numbers, the stock is up pre-market. Douglas C. Yearley, Jr., Toll Brothers’ chairman and chief executive officer, stated: “In our third quarter, we had strong revenues, gross margin, and earnings. While our third quarter contracts were down modestly, we are off to a good start in our fourth quarter. Low mortgage rates, a limited supply of new and existing homes, and a strong employment picture are providing tailwinds. We are focused on measured growth through geographic, product and price point diversification, and capital-efficient land acquisitions. We continue to expand the buyer segments that we serve with homes now ranging in price from $275,000 to over $3 million. Our balance sheet remains strong and our book value continues to grow. With ample liquidity, moderate leverage, and limited near-term debt maturities, we have the flexibility to execute on our balanced capital allocation strategy.”

Morning Report: Trump calls for 100 basis points and more QE

Vital Statistics:

 

Last Change
S&P futures 2922 0.5
Oil (WTI) 56.11 0.44
10 year government bond yield 1.55%
30 year fixed rate mortgage 3.78%

 

Stocks are flat this morning on no real news. Bonds and MBS are up.

 

No economic data this morning, and we wait for Jackson Hole comments later this week.

 

Trump called on the Fed to cut rates by 100 basis points and should re-embark on quantitative easing. “Our Economy is very strong, despite the horrendous lack of vision by Jay Powell and the Fed, but the Democrats are trying to ‘will’ the Economy to be bad for purposes of the 2020 Election,” Trump tweeted. “Very Selfish! Our dollar is so strong that it is sadly hurting other parts of the world. [Interest Rates] over a fairly short period of time, should be reduced by at least 100 basis points, with perhaps some quantitative easing as well….If that happened, our Economy would be even better, and the World Economy would be greatly and quickly enhanced-good for everyone!”

 

The Home Despot reported better than expected earnings this morning. Falling lumber prices caused them to take down their sales estimates, and they are worried about how tariffs will impact sales. “We are encouraged by the momentum we are seeing from our strategic investments and believe that the current health of the U.S. consumer and a stable housing environment continue to support our business,” CEO Craig Menear said in a prepared statement. “That being said, lumber prices have declined significantly compared to last year, which impacts our sales growth. As a result, today we are updating our sales guidance to account primarily for continued lumber price deflation, as well as potential impacts to the U.S. consumer arising from recently announced tariffs.”

 

Ballard Spahr weighs in on the new disparate impact rule. Disparate Impact is a concept that was intended to put the burden of proof on the defendant, not the plaintiff. If a lender’s customer base doesn’t reflect the demographics of the relevant market, then it is assumed the lender is guilty of discrimination. While a Texas court upheld the concept, it did institute some guardrails to prevent abuse. HUD’s new guidance was intended to reflect that decision.

 

The relief for lenders turns on the use of algorithms to make lending decisions. Since most lenders use DU or LP automated underwriting systems, the big question is whether this insulates them from discrimination charges. Ballard Spahr believes it does. “However, if the use of the model is an “industry standard,” the defendant is relieved from liability if it uses the model “as intended by the third party” that created it.  It appears that the second defense could apply in a variety of situations, including when a mortgage lender uses the automated underwriting systems of Fannie Mae or Freddie Mac.”

 

The Business Roundtable officially ended the era of shareholder value yesterday and declared that it would focus on “all stakeholders.” Though this document is largely symbolic, it is an attempt by business to play along with the new populism emerging in the Democratic Party. “The American dream is alive, but fraying,” said Jamie Dimon, Chairman and CEO of JPMorgan Chase & Co. and Chairman of Business Roundtable. “Major employers are investing in their workers and communities because they know it is the only way to be successful over the long term. These modernized principles reflect the business community’s unwavering commitment to continue to push for an economy that serves all Americans.

 

To me, this document is indicative of several trends: first the emerging populism in both political parties, second a tight labor market, and third the emergence of indexing as the primary long-term investing vehicle. We are seeing the left become more comfortable in their historic role of being a check on big business, while the right is talking about antitrust and Big Tech. Neither party seems particularly hospitable and the “third way” Democrats are battling an increasingly mobilized left. The tight labor market is also playing a part, as companies need to attract employees and this might be the second-to-last resort to try and attract them. Of course the last resort is to raise wages and hire the long-term unemployed, and that may be on the horizon.

 

The indexing angle is probably the most significant. When most of the largest shareholders in the S&P 500 are index funds and ETFs, you have take into account they don’t have the motivations that money managers had a couple decades ago. 20 years ago, money managers were paid to beat the market and pick good stocks. Those that did so were rewarded with inflows and their managers were paid big bonuses. That was the Peter Lynch model. Today, the biggest money managers aren’t interested in beating the market. They aren’t paid to do that. They are paid for minimizing tracking error and fees, which means they aren’t paid much since the skill set is completely different. They couldn’t care less if XYZ Inc’s CEO is a bum who makes bad decisions – as long as their fund holds the requisite 2.49856% of net asset value in XYZ, they have done their job. Indexers largely vote the way Institutional Shareholder Services (ISS) recommends, and ISS has its own set of priorities. Punch line: companies can get away with this because their largest shareholders don’t have any skin in the game.

Morning Report: The Fed is at Jackson Hole this week

Vital Statistics:

 

Last Change
S&P futures 2923 32.5
Oil (WTI) 55.32 0.44
10 year government bond yield 1.61%
30 year fixed rate mortgage 3.78%

 

Stocks are higher on optimism of a trade deal with China. Bonds and MBS are down.

 

The upcoming week will be dominated by Fed-speak as they head to Jackson Hole. Economic data will be sparse, with leading economic indicators, and new home sales the only potential market-moving numbers. Jerome Powell is scheduled to speak on Friday where he is pretty much expected to hint at another rate cut at the September meeting. Note the Fed funds futures are pricing in a 93% chance of a 25 basis point cut, and a 7% chance of a 50 basis point cut.

 

fed funds futures

 

Homebuilder KB Home notes that consumer confidence took a hit in August, and this translates into lower home sales more than interest rates do. “I’ve always maintained over the years that consumer confidence means more than rates to the home buying decision,” said Jeff Mezger, CEO of Los Angeles, CA-based KB Home. “We’ve had some great years where interest rates were 8, 9,10%—because people find a way when they feel confident about the future.” Of course interest rates were way higher during the 80s and 90s and people still bought homes. Nominal wage growth was higher too. Further, he talks about why housing starts are weak: “Frankly, as an industry, that’s what is holding us back from getting to normalized levels,” said Mezger. “We’re only going to invest and build if we can get a return, and it’s difficult to find the combination of land, the cost to produce, the fee structure in that city and then what you can sell a home for based on the incomes in that submarket. So that is the challenge.” So, it is land, labor, and regulations that are the issue. Income growth might be what ends up squaring the circle.

 

Speaking of sentiment, the University of Michigan preliminary survey showed that confidence has dropped. Trade concerns and Fed policy increased fears of a recession, which translated into the numbers.

 

The Administration is set to introduce a new rule to codify lending discrimination and move away from the disparate impact standard that began during the Obama Administration. It appears that lenders will have protection if they use ” – third party systems” – i.e. algorithms – to make lending decisions. The actual guidance (from a leaked memo) is supposedly here.  While they don’t mention any algorithms by name, they are probably proposing that if you use DU or LP for lending decisions, you will have safe harbor from lending discrimination charges. If it turns out that DU or LP are biased, that is on the provider of these algorithms, not the lender. All of this is in response to a disparate impact lawsuit (Texas vs. Inclusive Communities), which allowed disparate impact theory to be used, however it did institute some restrictions on its use. The updated guidance from HUD will be to align current policy with that decision.

Morning Report: Why we aren’t headed for a recession

Vital Statistics:

 

Last Change
S&P futures 2874 24.5
Oil (WTI) 54.62 -0.14
10 year government bond yield 1.55%
30 year fixed rate mortgage 3.78%

 

Stocks are higher on no real news this morning. There is a risk-on feel to the tape after a tumultuous week. Bonds and MBS are down.

 

Housing starts disappointed (again!) coming in at 1.19 million, lower than the 1.26MM street estimate. This is down 4% on a MOM basis, and up about 0.6% on a YOY basis. On the bright side, building permits surprised to the upside, coming in at 1.34 million versus the 1.27 million street estimate. Still, new home construction remains depressed due to labor shortages and lack of buildable lots.

 

Despite these issues, homebuilders remain optimistic. The NAHB / Wells Fargo Builder Sentiment Index rose in August to 66. Current sales conditions improved, while expectations for the next six months moderated. “While 30-year mortgage rates have dropped from 4.1 percent down to 3.6 percent during the past four months, we have not seen an equivalent higher pace of building activity because the rate declines occurred due to economic uncertainty stemming largely from growing trade concerns,” said NAHB Chief Economist Robert Dietz. “Although affordability headwinds remain a challenge, demand is good and growing at lower price points and for smaller homes.” Interesting about the tariff issue – building materials prices are down quite substantially. If tariffs were really that big of a deal, you would expect to see shortages and increases. We aren’t.

 

Given all the chatter about the yield curve and a possible recession, it is worthwhile to step back and take a look at the facts on the ground. The business press is awash with stories about the yield curve and how it is possibly signalling a recession. The yield curve shows interest rates along the spread of maturities, and short term rates are usually lower than long term rates. However, we are flirting with a situation where long term rates are lower than short term rates. That is a yield curve inversion, and historically a yield curve inversion has been a decent (but not perfect) predictor of an imminent recession. The reason for this is that it implies that businesses are taking less risk, which means they must see something wrong in the economy.

 

The problem with the inverted yield curve model is that it gives off a lot of false positives – an old market saw is that an inverted yield curve has predicted “15 of the last 10 recessions.” Many times an inverted yield curve is the result of technical issues in the bond markets, which are temporary and don’t really spill through to the overall economy. This current period is probably one of those cases, and the technical issue is central bank behavior. The Fed, ECB, Bank of Japan have been pushing down long term rates in order to stimulate the economy for years, and now we have negative interest rates in much of the world. Negative interest rates in Germany and Japan (two huge bond markets) is drawing down US bond yields as overseas investors sell things that pay less than nothing (German Bunds and Japanese Government bonds) to buy things that pay something (US Treasuries).

 

The business press is emphasizing the recession angle here because (1) it is a much simpler story to tell, (2) the partisans can blame it on Trump, and (3) many strategists are too reluctant to stick their necks out and discuss the implications of negative rates worldwide – this is a completely new phenomenon and quite simply people don’t know.  We have a bubble in sovereign debt that has been engineered by global central banks – unlike stock and real estate bubbles, and we don’t have any historical analogy. We know that bubbles end eventually, and how this resolves is anyone’s guess.

 

That said, what is the current economic state of play? Europe is doing its same-old Euro-sclerosis thing, which it has been doing for decades. Germany had a flat GDP quarter and most of the Eurozone is slowing down in sympathy. Japan has been in the throes of a sclerotic economy since the New Kids on the Block ruled the charts. China is also tempering its growth. On the other side of the coin, the US has the lowest unemployment rate in 50 years, initial jobless claims are the lowest since we had a military draft, wages are rising, inflation is under control, and the consumer is increasing spending. This simply is not a recipe for a recession. And to take this a step further, tariff income has been about $60 billion since they have been implemented. In the context of a $21 trillion economy, this is insignificant – about 1/3 of 1%. It is a humorous state of affairs with partisan talking heads accusing Trump of destroying the economy over small-beer tariffs, while Trump accuses partisan journalists of sabotaging the economy with negative stories – as if the press had the power to do that.

 

Here is the big picture: The US economy has been strong enough to withstand a tightening cycle from the Fed, and has had 2.6% GDP growth in the immediate aftermath of a tightening cycle. Inflation is low, and is probably going to go lower as Europe and China begin exporting deflation to the US. Oh, and by the way the Fed is now cutting interest rates, which is the equivalent of giving a can of Red Bull to your kid at 9:00 pm on Halloween night. Don’t buy the recession narrative. None of the required pieces are in place.

Morning Report: Strong retail sales

Vital Statistics:

 

Last Change
S&P futures 2857 14.5
Oil (WTI) 54.92 -0.64
10 year government bond yield 1.59%
30 year fixed rate mortgage 3.84%

 

Stocks are up after strong retail sales numbers. Bonds and MBS are flat. The German Bund hit a new low this morning, trading at negative 66 basis points.

 

Strong retail sales numbers out this morning. The headline number was up 0.7%, well above the Street expectations of 0.4%. The control group, which strips out volatile gas and autos, was up 1.0% MOM, exceeding the Street estimate by 0.7%. Note that Trump’s delay of Chinese tariffs means they won’t hit until mid-December, or after the holiday shopping season. These numbers bode well for the back-to-school shopping season, which is the second most important of the year. Note that Walmart also reported strong numbers this morning, another bellwether for the retail sector. Expect strategists to take up their GDP estimates on these figures.

 

In other economic news, initial jobless claims rose to 220,000 last week, while industrial production fell 0.2% MOM and rose half a percent YOY. Capacity Utilization fell to 77.5%. The industrial and manufacturing numbers are probably influenced by trade.

 

Productivity rose 2.3% in the second quarter, way more than expectations as output rose 1.9%, hours worked fell 0.4% and compensation rose 4.8%. The biggest surprise however came in the revisions, where compensation in the first quarter was revised upward from -1.5% to +5.5%! These are inflation-adjusted numbers, so we had real compensation growth of 5.2% in the first half of the year. Where was the growth strongest? Manufacturing.

 

With the inversion of the yield curve, the business press is chattering about an imminent recession. Don’t buy it. Most of them are talking their partisan book and are sticking with their preferred narrative: (Trump’s trade war is causing a recession!). It helps that it is the most convenient and easy to explain scenario, and let’s face it: it is hard to talk about overseas interest rates when most journalists wouldn’t know a Bund if it bit them in the begonias. Reality check: you generally don’t get recessions with a dovish Fed, unemployment at 50 year lows, strong consumer spending and accelerating wage growth. In fact, the bullish case is that with strong wage growth, overseas deflation keeping inflation in check, and a dovish Fed, you could see a scenario similar to the mid / late 90s. Food for thought.

 

The new FHA guidance for condos is available in its unpublished form here. The new rule will become effective 60 days after publication in the Federal Register (which should be any day now) and will make more condos eligible for FHA insurance.

 

Home prices rose 3% in July, according to Redfin. “July home prices and sales were weaker than I had expected, especially given that falling mortgage rates have been luring homebuyers back to the market since early spring,” said Redfin chief economist Daryl Fairweather. “Even though we’ve seen increased interest from homebuyers—especially compared to a year ago when mortgage rates were climbing—uncertainties in the overall economy and talk of a looming recession have people feeling jittery about making a huge purchase and investment. But I think the odds are that we won’t see a recession within the next year. If rates stay low and the economy continues to grow, we’ll see more homebuyers come back in a serious way in 2020, and the market will be much more competitive.” Home sales were down 3.4%, while supply fell by the same amount. In terms of price, the previously hot markets of San Jose and Seattle fell, while many of the laggards (like Cleveland and Rochester) rose.

 

Redfin price chart

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