All Things in Moderation

Vital Statistics:

Stocks are recovering as we end the worst month for stocks in a while. Bonds and MBS are down.

Facebook reported last night and rose despite a revenue miss. GM is up 10% pre-open on blowout earnings, while GE cut its dividend to a penny. Earnings are generally good this quarter, although if you focused only on the indices you would figure they were terrible.

Home prices rose 5.8% in August, according to the Case-Shiller home price index. Las Vegas led the way with 14% growth. San Francisco and Seattle were the other big winners. Underneath the headline number, we are starting to see some month-over-month declines if you look at the seasonally adjusted indices. Ultimately wages need to catch up with the new reality of higher interest rates and higher home prices.

Despite what is going on in housing, consumer confidence remains strong, with the consumer sentiment indices just off multi-decade highs. Historically this index has reflected gasoline prices (gas prices up, consumer confidence down), but that has broken down over the past couple of years. This confidence has allowed companies to raise prices for the first time in a decade, with a laundry list of firms from consumer staples to airlines increasing prices in reaction to increased costs, particularly fuel. Some companies are not raising prices, but cutting sizes. Wages are picking up, but they are generally lagging some of these increases in the inflation indices.

Freddie Mac sees home sales improving in 2019 despite an uptick in mortgage rates. Originations are expected to be flat at $1.65T while home price appreciation and GDP growth are expected to moderate. The 30 year fixed rate mortgage is expected to average around 5.1% for the year, and then jump an additional 50 basis points in 2020.

Janet Yellen told a conference that the current deficit track is unsustainable, and that if she had a magic wand, she would raise taxes and cut retirement spending.

Part of the inflation puzzle has always been healthcare inflation, especially in prescription drugs. Amazon looks to be entering the Rx business, and CVS is piloting a free delivery subscription program. Health care is a big part of the inflation picture and perhaps these big can take a bite out of inflation via their market strength.

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Vital Statistics:

Stocks are slightly higher this morning ahead of a big earnings day. Bonds and MBS are down small.

General Electric disappointed and cut its dividend to a nominal amount. Facebook reports after the close.

Stocks got kicked in the teeth again yesterday, with a 100 point intraday reversal in the S&P 500. Selling climaxed right around 3:30 before recovering some of the losses into the close. The S&P is officially in a correction, which is defined as a 10% retracement from the high. Tech was thrown overboard and investors are beginning to hide in consumer staples. Bonds largely ignored the action in stocks, with the 10 year stuck in a tight range right around 3.08%.

Personal Income rose 0.2% in September, which came in below consensus. Personal spending was strong at 0.4%, and the savings rate fell to the lowest level this year. Inflation remained tame however, with the PCE headline and core readings at 2.0%, spot on the Fed’s target. The December Fed Funds futures are beginning to up the probability that the Fed does nothing in its final meeting of the year. Between a global growth slowdown (Europe’s GDP numbers were terrible this morning), trade fears, and controlled inflation the Fed does have the leeway to take a wait and see approach in December.

JP Morgan was secretly prevented from growing by the Obama administration as a penance for sins during the housing bubble. The Obama Administration wouldn’t let them open any new branches in new states in a penalty that went back to 2012. The fascinating part was that it wasn’t disclosed to the markets. Surely that info was relevant to stockholders. Was Dimon hiding info from the market? Or did the Obama Admin not want people to know he was imposing double-secret probation on certain banks? Regardless, the Trump OCC has reversed the decision and JP Morgan is now free to add branches subject to the 10% deposit cap.

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Vital Statistics:

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

The 10% retracement level in the S&P 500 held on Friday and bond yields were around 3.08 when sitting at that level. As usual, MBS lagged the moves in the bond markets, waiting for confirmation.

The first estimate for third quarter GDP came in at 3.5%, which was higher than the 3.3% Street estimate. Consumption was strong, but investment growth came in weaker than previous quarters. The biggest hit to GDP came from trade, which subtracted an estimated 1.8 percentage points from the number as exports fell, while imports were largely unaffected by tariffs. As usual, housing was a weak spot.

Housing economist Robert Shiller notes that housing is weak, however he believes we aren’t looking at another huge slowdown. Housing never fully recovered from the bubble, and inventory is tight. While prices have recouped the losses from the bubble years, we are nowhere near bubble territory.

We do have some data this week, with productivity and costs, personal incomes and outlays and the jobs report on Friday. That said, bonds seem to be reacting to the movements in the stock market these days, so it is hard to say these will be market-moving reports.

Credit card companies are beginning to restrict credit, or at least pull back the reins a little. Capital One’s CEO believes “the economy is almost too good to be true,” and is beginning to lower credit limits. Credit card issuers are usually the first to react to a tightening in credit, so this bears watching.

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Vital Statistics:

Stocks are lower again this morning as overseas markets remain under pressure. Bonds and MBS are up, with the 10 year trading below 3.1%.

Initial Jobless Claims ticked up slightly to 215,000 last week. The labor market remains strong and employers are hanging on to their employees.

Durable Goods orders rose 0.8% last month (a strong reading) however that was driven largely by aircraft orders which can be lumpy. Ex-transportation they rose 0.1%. Capital Goods orders (a proxy for capital investment / business expansion) were down 0.1%.

Retail inventories rose 0.1% while wholesale inventories rose 0.3%. We will get a read on the back-to-school shopping season when the retailers begin reporting earnings next month. Note Amazon reported last night and their earnings beat expectations, but their guidance (and revenues) was terrible. The stock is down about 9% pre-open. Part of the miss in guidance is due to the decision Amazon made to raise warehouse worker wages, but the revenue guidance is something to worry about.

Two of the other sled-dogs in the FAANG index are down this morning – Google and Netflix. While it is probably too early to start reaching for defensives like PG or MO, the leaders are hitting a rough patch.

Pending home sales rose 0.5% in September, according to NAR. Don’t get too excited; they were down 1% YOY, but these days any positive reading in the housing sector is a win.

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Vital Statistics:

Stocks are higher this morning despite a huge sell-off in Asian shares last night. Bonds and MBS are flat.

Stocks got walloped yesterday yet again, making this month the worst since the bad days of the financial crisis. There really isn’t much of a catalyst to hang your hat on – just general overseas selling and the risk-off trade. I think part of this is a rotation back into the short term interest rate market. CDs are now paying over 2%, after having paid nothing for years. A moribund asset class is coming back, and stocks are going to feel the brunt of it.

With the NASDAQ officially down 10% from the high, and the S&P 500 pushing close to it, where do you think the VIX is? Just over 25, which isn’t even the high for the year. If you are hoping we have hit capitulation, we haven’t.

Home price appreciation decelerated in August, according to the FHFA House Price index. Prices rose 0.3% MOM and 6.1% YOY. The red-hot Pacific and Mountain MSAs have decelerated, while many of the laggards (Mid-Atlantic) are seeing improved performance.

New Home Sales fell dramatically in September on both a month-over-month and annual basis. They fell to a seasonally-adjusted annual rate of 553,000, which is down 5.5% MOM and over 13% YOY. With current inventory at 327,000 units, we have over 7 month’s worth of inventory, which would be characterized as a buyer’s market (6 – 6.5 months is considered “balanced.”). Note that new home sales can be extremely volatile but it confirms what we have been seeing in the homebuilder ETF – affordability is beginning to deter buyers.

“Modest to moderate.” was how the Fed’s Beige Book characterized economic growth. “Modest to moderate” was pretty much how the Fed characterized everything from 2010 to 2016. This is a downgrade from “brisk,” “solid” or “strong” – words the Fed has been using recently to characterize the economy.  The Beige Book is a more qualitative assessment of the economy, so parsing the language is about the only thing you have to work with.  The Fed has been expecting the economy to slow due to trade wars. If the economy is beginning to slow, the Fed might want to take a breather and let the recent rate hikes take effect before making any further moves. The Fed also noted that housing continues to underperform.

The sell off has affected the Fed Funds futures market. A week ago, the markets were handicapping a 80% chance for a hike. It is now down to 74%. A March 2019 hike is now a coin toss.

Delinquencies spiked in September, rising 13% for the biggest jump since November 2008. Hurricane Florence hit areas saw DQs rise by 38%, although there is a seasonal aspect to DQs – they typically rise during September and January.

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Vital Statistics:

US stock index futures are lower despite a rally overnight in Asia and Europe. Bonds and MBS are up.

We have a lot of Fed-speak today, which could translate into some volatility in the bond market, but I suspect bonds are just going to be driven by stocks and the risk on / risk off trade.

The 10 year bond touched 3.11% yesterday around noon, and then sold off as stocks recouped some of their losses. One thing to keep in mind, especially during overseas-led sell offs: First, the European markets close around 11:30 EST. Often times, the best prices (ie lowest rates) can be found right around / after the European close. Second, TBAs (which determine mortgage rates) are slow to react to big moves in the 10 year. So even though the 10 year bond might be up a half a point, it doesn’t mean the scenario you just ran will be half a point better than yesterday.

Mortgage Applications rebounded 5% last week as purchases rose 2% and refis rose 10%. Rates increased by a basis point to 5.11% – the highest since Feb 2011.

The MBA sent a letter to the CFPB asking them to address LO comp, and in particular the inflexibility of it. During the crisis, loan officers were accused of steering consumers into the loans that paid LOs the most and weren’t often the best for the consumer. In response, Dodd Frank made LO comp insensitive to product – in other words the LO makes the same on every product. While this sounds great in theory, it ignores competitive realities, the fact that LOs sometimes screw up on an application, and that state housing programs can become unprofitable for the lender if the LO makes a full commission. The MBA is asking for clearer, bright line rules from the CFPB.

In the sea of red yesterday, the homebuilders were a bright spot after Pulte released earnings pre-open.  Revenues were up 74%, but new orders and backlog were up only single digits. Gross margins increased to 24%. The homebuilder ETF (which hasn’t been able to get out of its own way lately) was up smartly.

Donald Trump escalated his attacks on Jerome Powell, the Fed Chairman yesterday in an interview with the Wall Street Journal. “Every time we do something great, he raises the interest rates,” Mr. Trump said, adding that Mr. Powell “almost looks like he’s happy raising interest rates.” While Trump acknowledged the independence of the Fed, he would prefer low rates (as would every politician on the planet). BTW, I think Powell is happy the economy is in a strong enough state that he can put some distance between the Fed Funds rate and the zero bound. Monetary policy can become completely ineffective when rates are around zero.

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Vital Statistics:

US stock index futures are down this morning as a sell-off that started in Asia has spread to Europe. Bonds and MBS are up on the risk-off trade.

Chinese markets are the catalyst behind the sell-off, and it appears that non state-owned firms are having financing difficulties. The Chinese government addressed the issue on Friday, and while it soothed fears for a couple of days, investors are still worried. Financing difficulties invariably accompany bursting real estate bubbles and China’s bubble has been going on for years.

If China’s real estate bubble is bursting, the effect on US interest rates could go a couple of ways. The most likely event will be a drop in inflationary pressures as China’s currency drops and they attempt to export their way out of the problem. They could sell Treasuries to repatriate cash (in crises, you sell what you can, not necessarily what you want to) which would temporarily put upward pressure on US rates. The most likely scenario would be a risk-off one, where Chinese money withdraws out of risky assets in favor of Treasuries. It might cause the Fed to take a break.

Speaking of the Fed, the December Fed Funds futures are handicapping a 82% chance of a hike at the December meeting.

Economic growth moderated a bit in September, according to the Chicago Fed National Activity Index.

Fair Issac, the creator of the FICO score is going to re-work their model in 2019, which may bump up the scores of the more marginal borrower. Borrowers with some dings on their scores could get a boost if they maintain a few hundred dollars in their checking accounts and don’t overdraw them.

Jim Cramer warned that a 5% mortgage rate is a “line in the sand” for the economy.  “We’re going to see more and more bad earnings because [a] 5 percent mortgage is the end, that is the line in the sand,” Cramer said Monday on “Squawk on the Street. ” “The mortgage rate is very high in this country.” Cramer has become critical of the Fed’s tightening regime, saying that the Fed is ignoring signals of a slowdown in the economy (particularly in housing). The thing to keep in mind is that rate changes act with a lag of about a year. This year’s moves have yet to be felt in the economy.

Note we will get the first estimate of third quarter GDP this Friday. The consensus estimate is for 3.3% growth, a slowdown from the second quarter pace of 4.2%.

Donald Trump proposed 10% middle class tax cut, which will be voted on after the election. This is an attempt to rally Republicans to the polls in order to maintain Congress. As of now, it looks like the GOP will probably increase their seats in the Senate, while Democrats are looking to possibly take over the House.

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Vital Statistics:

Stocks are higher this morning after Chinese and Italian markets rallied on benign political comments. Bonds and MBS are flat.

Existing home sales fell 3.4% in September, according to NAR. Pretty much every part of the country saw a decline. Rising rates are affecting affordability and this is dampening sales. That said, the median home price did still rise 4.2% to 258k. Inventory improved a hair, increasing to 4.4 months’ worth from 4.2 months worth in August. Lawrence Yun, NAR chief economist, says rising interest rates have led to a decline in sales across all regions of the country. “This is the lowest existing home sales level since November 2015,” he said. “A decade’s high mortgage rates are preventing consumers from making quick decisions on home purchases. All the while, affordable home listings remain low, continuing to spur underperforming sales activity across the country.” Days on market rose to 32 days, and the first time homebuyer accounted for 32% of sales. Historically that number has been closer to 40%.

Refis dipped to 29% of all originations in September, according to the Ellie Mae Origination Insight report. As rates rise, you are seeing an increase in ARM origination, which rose to 7.2%. Credit quality also ticked up, with the average FICO rising to 727.

Bank of America is teaming up with the Neighborhood Assistance Corporation of America (NACA) to offer no-downpayment, no MI, below market rate mortgage loans to people with bad credit. BOA has promised to allocate $10 billion in mortgage credit to the program. The only requirements are the home has to be owner-occupied, and the borrower has to go through a counseling process where they learn about budgeting and getting the required documents in. The company is betting that borrowers will act like they have skin in the game, even if they don’t have any equity in the home. So far, no foreclosures in the past 6 years (which corresponds to the bottom of the real estate market. Not sure why Bank of America is hot to lend money at below market rates to uninsured low FICO borrowers without a down payment, but I suspect they are doing it for the PR or to keep the fair lending types off their back.

With the bankruptcy of Sears, and the latest housing starts data, it is interesting to look back on the company’s involvement in homebuilding. Yes, you could order a house via the Sears catalog. The heyday of the movement was the early 20th century – between 1908 and 1940, Sears sold about 75,000 kit homes. Prices were anywhere from $1,200 to $5,000 for 10 room quasi-mansions.

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Vital Statistics:

Stocks are flattish on no real news. Bonds and MBS are flat.

Initial Jobless Claims fell to 210k last week, which means there is little (if any) evidence of the hurricanes affecting the employment numbers.

The index of leading economic indicators rose 0.5% in September, which is a strong reading. It points to economic strength through the end of the year and into 2019. The report noted capacity constraints, which is surprising given the capacity utilization numbers, which are still historically average at best. Note the high capacity utilization numbers in the 1970s – this was a big driver of inflation. Production generally goes from most efficient to least efficient (you use the best equipment first, and then go to more and more marginal equipment as you continue to expand). The less efficient equipment means higher costs and those get passed on to the consumer. The current capacity utilization levels are nowhere near what they were in the 70s.

The Conference Board sees growth coming in at 3.5% for the second half of 2018, however we will need more help from housing to put up those types of numbers in 2019.

The CFPB is taking a closer look at the disparate impact theory of fair lending, presumably with an eye to limiting the more expansive use of the theory under the previous administration. The CFPB is looking to possibly codify this in a rule, which would be much more permanent than a more informal statement. The Obama Administration took an aggressive stance towards the use of disparate impact, which is a controversial idea – it basically means that intent is irrelevant. If your numbers don’t match the population, you are guilty of discrimination, no questions asked. Since discriminatory intent is notoriously hard to prove, this rule amounts to a waiver for the government from having to prove it. It is a plaintiff’s dream.

The MBA sees mortgage rates topping out soon. Their latest forecast has mortgage rates leveling out at 5.1% over the long term. In other word, regardless of what the Fed intends to do going forward, the Great Post Crisis Mortgage Rate Hike is largely done. Note the MBA sees even less volume in 2019 than 2018, although at a much shallower drop than 2017-2018.

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Vital Statistics:

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

The minutes from the September FOMC meeting were released yesterday, and may have caused a delayed sell-off in stocks and bonds. Nothing was all that surprising in the document, although some in the business press attributed the sell-off to a surprising consensus that more tightening is needed. There was talk that rates might have to go into restrictive territory as opposed to just neutral territory. That apparently freaked out the bond market, although it didn’t really make a move until closer to the closing bell. FWIW, the dot plot envisions perhaps 2 or 3 hikes in 2019, which probably wouldn’t be characterized as “restrictive” given they just took out the term “accomodative” to characterize current policy. There was also talk about becoming more opaque, and spoon-feeding the markets a little less about what they are going to do. The economic textbooks talk about managing inflationary expectations, and part of that management means keeping markets on their toes. If the markets correctly anticipate what the Fed is going to do, their moves have less of an effect. Sort of like a monetary Heisenberg principle.

Regardless, the Fed was surprised to see how much economic strength there was in the economy (interestingly, they always overshot in their growth forecasts in 2008-2016, but now they are undershooting). Regardless, they are worried about the global economy, and the growth difference between the US and the Eurozone. The strength in the labor market is starting to bring out some cost-push inflation as well. Overall the minutes didn’t tell us anything we didn’t already know – growth is strong, inflationary pressures are building, trade wars are bad, and the Fed is going to keep raising rates.

Housing starts disappointed in September, falling 5.3% MOM to a seasonally-adjusted annual rate of 1.2 million. This number is up on a YOY basis however. Weather-related issues probably played a part in the disappointing number, however building permits were anemic as well. Most of the decline was in the volatile multi-family segment, while single family was generally up small.

Over 3/4 of Americans view renting as cheaper than owning, according to a survey from Freddie Mac. Blame higher home prices and mortgage rates. Note that 58% of renters don’t intend to buy a home, which is an increase from 54% earlier in the year. Rental supply is also a factor – it recently hit a 3 decade high. In the aftermath of the housing crisis, builders focused on urban rental properties targeted towards 20-something Millennials –  which has created a glut, particularly at the higher price points. In addition, we have a shortage of starter homes, as builders concentrated on the only sector that was working at the time – luxury.

China’s stock market is down 30% this year, in stark contrast to the rest of the world. China has always marched to its own drummer, but they have a serious real estate bubble. If that is unwinding, it will reverberate in the high end West Coast markets.

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