All Things in Moderation

Vital Statistics:

Stocks are higher this morning on strong earnings and a good GDP report. Bonds and MBS are down.

Very slow news day.

Third quarter GDP came in at 3%, much higher than the 2.5% the Street was looking for. This is the strongest back-to-back performance since 2014. It looks like the hurricanes had a negligible effect on growth, and the Commerce Department cannot measure the effect at any rate. Consumption increased 2.4%. Housing remained a weak spot, falling 6%, as builders struggle with labor shortages and a lack of buildable land. This is the worst stretch for housing since 2010. The core inflation rate rose at 1.3%, an increase from the 0.9% from Q2, but well below the Fed’s 2% target.

Paul Ryan is confident he can sweeten tax reform to bring some of the last GOP holdouts in line. The biggest hurdle will be Republican house members in blue states, who will be affected by any changes to the state and local tax deduction. Tax reform is scheduled to be unveiled November 1.

The luxury end of the market is beginning to bifurcate, as the super high end ($5 MM plus) languishes while homes in the $1.5 million range are moving quickly. Demand for high-end homes is being driven by foreign demand as well as the stock market rally. That said, in the Northeast, particularly the pricey NYC suburbs, sellers are pulling their listings given weak demand.

Janet Yellen is reportedly out of the running now for Fed Chairman. It will come down to John Taylor (the conservative choice) versus Jerome Powell (the Professional Economist’s choice). Her term ends February 1.

Ben Carson says that HUD will work with DOJ to pull back on fines for mortgage lending errors. Aggressive prosecution during the Obama Administration pushed J.P. Morgan to get out of the FHA business altogether. “Innocent errors should not create chaos and fear and make people less likely to get involved in the first place,” he said.

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Vital Statistics:

Stocks are up this morning after yesterday’s sell-off. Bonds and MBS are up on the ECB’s decision to start tapering QE.

Initial Jobless Claims rose 10k to hit 233k last week. We are still at historically low levels.

Pending home sales were flat in September, according to NAR. The hurricanes in Florida and Texas did depress the number somewhat, but the same old story of low inventory is the real culprit. The Pending Home Sale Index is the lowest since early 2015.

The House will vote on a budget for next year, which will set the stage for tax reform scheduled to be announced on November 1. As expected, the state and local tax deduction is the biggest bone of contention, with Northeast Republicans dead set against ending it. They are hoping to use the budget vote as leverage to keep the deduction in the tax plan, but they may end up having to wait to see what comes out of the Committee.

Rising rents are becoming a burden for one in five renters, as the number of people looking to rent exceeds the supply of rentals out there. For people earning under 30,000, 28% were unable to make a full rental payment in the last 3 months. Affordable housing advocates will undoubtedly seize upon this number in order to push HUD to do more.

The MBA is forecasting about a 5% drop in origination volume from 2017 to 2018 based on higher interest rates depressing refinancing opportunities. Refis will probably be driven by two effects going forward: home price appreciation and the flattening yield curve. As home prices appreciate, those that have FHA loans with MI may now have enough equity in their homes to refinance into a conventional loan with no MI, thus saving a lot of money. Second, 30 year fixed rate mortgages will become more attractive relative to ARMS as the yield curve flattens. These two effects will create refinance opportunities in a rising interest rate environment. That said, purchase activity will be driving things going forward.

The financial services industry had a small victory yesterday as the Senate overturned a rule from the CFPB allowing class-action suits for banks. The argument in favor of class action lawsuits say it is necessary to prevent bad behavior from the banks, while those against class action suits say that wronged customers make more in arbitration, since they save on legal fees. While the big banks are probably able to absorb the massive penalties from a class-action suit, the smaller ones probably cannot. This is a highly divisive issue, pitting two giant funding sources for both parties: the trial lawyer bar for Democrats, and the financial services industry for Republicans. The vote was 50-50 and Mike Pence had to cast the tiebreaking vote.

The BLS released its projection of the job market for the next 10 years. Suffice it to say, the trends we have been seeing over the past decades (decreased emphasis on manufacturing, increased emphasis on services, higher education requirements) will continue. Heath care employment is the growth area, while many manufacturing jobs are becoming obsolete.

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Vital Statistics:

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

Stocks are in the middle of earnings season. Companies that beat their numbers are seeing a slight bump, while companies that miss are being taken to the woodshed. AMD is down 8% this morning, and Chipotle is down 14%. This has been a historical warning sign for stocks, along with declining breadth.

New Home Sales shocked to the upside, rising 19% MOM and 17% YOY to an annualized pace of 667,000. FWIW, the margin of error on these estimates out of Census is gargantuan, and building permits / housing starts have not really confirmed this data. Regardless, it is great news, if it holds up. The biggest growth was in the South, although we saw increases everywhere.

Mortgage Applications fell 4.6% last week as purchases fell 6% and refis fell 3%. Rising rates affected the numbers as well as the comparison to the holiday-shortened week previously. Overall, mortgage rates increased about 4 basis points to 4.18%. The purchase index is up 10% YOY.

Durable goods orders came in better than expected, increasing 2.2%, a touch better than expectations. Ex-transportation, they rose 0.7%. Core capital goods expenditures rose 1.3%.

Home prices rose 0.7% MOM and 6.6% YOY, according to the FHFA House Price Index.

The 10 year bond yield is trading above 2.4% – a key technical level over the past year. If it holds, it means the bond bears might have their day at last. Much of this will depend on whether we get tax reform, and what shape it takes. Republicans are supposedly releasing their tax bill on November 1.

Machinations in DC are not the only thing influencing bonds, though. Overseas strength is also playing a role here: the UK economy grew faster than expected, and German business confidence is at a high. Despite the differences between economies, sovereign debt does trade as an asset class and therefore strength and weakness overseas will flow through to our bond market.

One thing to keep in mind is that mortgage rates generally lag Treasuries. In other words, if the 10 year bond yield spikes, mortgage rates will generally take a few days to adjust. So, if you are floating and wondering whether to lock, mortgage rates will probably move up over the course of the next few days if this level holds in the 10 year. It pays to check the movements in the 10 year and the mortgage market to get an idea of where mortgage rates are headed over a day or two.

Arizona Senator Jeff Flake announced yesterday that he will not run for re-election. Republicans have a huge advantage in the Senate midterms as they are defending only a few seats while Democrats are defending a lot. There was always a rift in the Republican Party between Trump and Establishment Republicans, who were never comfortable with each other. Establishment Republicans like Corker and Flake were going to be primaried, and it appears that their constituents are further to the right than they are. Despite all the media spin, Jeff Flake was going to have a tough re-election anyway. This is nothing new: In 2010, Republicans hoped to re-take the Senate, however they ran some Tea Party types who ended up losing. The entire US electorate is becoming more polarized, which makes legislation all that more difficult, and shows the importance of controlling the regulatory agencies.

Fannie Mae is collaborating with fintech companies to launch Single Source Validation, part of its Day 1 Certainty program. Single Source Validation will augment a borrower’s credit report with data from other sources. The program is being piloted right now with Quicken. They are also working with companies to improve security and to allow lenders to get info directly from the borrower’s bank without having to scan and email statements.

What jobs are most likely to not be replaced by robots and AI? Many in healthcare.

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Vital Statistics:

Stocks are up this morning on strong earnings, especially from CAT. Bonds and MBS are down small.

Manufacturing continues to be strong, according to the Markit Flash PMI which came in stronger than expected.

Whoever Trump nominates to replace Janet Yellen will have a more hawkish bent than she had, and the Street is making a bet on a flatter yield curve. This means that people are betting that short term rates will increase more than long term rates as the Fed hikes, which should translate into at least stable mortgage rates despite a rising Fed Funds rate. The yield curve flattened during the last 3 tightening cycles and even inverted in one of them.

The Fed Funds futures are now pricing in a 97% chance for a December hike.

The Treasury Department has weighed in on the CFPB’s proposed arbitration rule, and concluded that it “failed to meaningfully evaluate whether prohibiting mandatory arbitration clauses in consumer financial contracts would serve either consumer protection or the public interest — its two statutory mandates.” They conclude that the CFPB’s rule will do more for trial lawyers than it ever will for consumers of businesses – it is basically a $300 million transfer of wealth to the Plaintiff’s Bar, coming from consumers and business.

The MBA National Conference is going on right now in Denver. Dave Stevens warned that the heads of the FHFA and CFPB will be replaced in the future, and that could mean big changes for the industry. Mortgage bankers have a false sense of security at the moment, with the current FHFA Chairman advocating for a strong role of government in housing finance. That could change. Making the current changes permanent will require legislation, however and housing finance reform always seems to be something down on the priority list.

76% of people renting believe it is more affordable than home ownership, and that could help explain why the homeownership rate is so low, particularly among the young. Certainly the housing indices show prices back to the heady days of 2006, however remember these indices aren’t indexed for inflation. If you make the inflation adjustment, we still have not recouped those losses. When you take into account the tax effects and interest rates, affordability hit a record in 2012 and buying is still extremely cheap compared to historical numbers.

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Vital Statistics:

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

Economic activity picked up in September, according to the Chicago Fed National Activity Index. Production, consumption, and employment indicators all improved. August and July were both weak, so the 3 month moving average is still negative, but within the range that shows the economy growing on trend.

Congress continues to work on tax reform. Over the weekend, a trial balloon was floated that concerned limiting 401k contributions. This morning, Donald Trump tweeted that no changes in 401ks are being contemplated. Here is going to be the rub for tax reform. While the elderly were historically considered the “third rail” of American politics, in fact the real third rail is the upper middle class. Things like the mortgage interest deduction, 401k contributions, 529 college savings plans, etc are going to be almost impossible to eliminate. Obama tried to tinker with 529 plans and got nowhere. The state and local tax deduction is probably going to tough to eliminate as well, given that there is uniform Democratic opposition to any sort of tax reform, and there are enough blue state Republicans in the House who will see their constituents hit with higher tax bills. Donald Trump is so eager for a win, he will probably sign anything, and that “anything” will probably consist of a few marginal cosmetic things that won’t amount to much of a change. It will allow everyone to claim victory and move on to the midterms.

The prospect for tax reform is affecting interest rates. As we increase the probability of tax reform, rates are going to go up on the expected economic growth. If we end up getting some sort of symbolic tax reform, I wouldn’t be surprised to see a “buy the rumor, sell the fact” effect. In other words, an increase in rates leading up to it, and then a drop as people digest the fact that it probably won’t make much of a difference in growth.

Trump said he will decide on the new Fed Head “very shortly.” It is between Jerome Powell (the economists’ choice), John Taylor (the conservative choice) and Janet Yellen (the liberal choice). This decision will be relatively apolitical, and will be nothing like when Obama was leaning towards Larry Summers and Elizabeth Warren led a vanguard from the left to nominate Janet Yellen.

Ray Dalio of Bridgewater warns the Fed to not pay too close of attention to national statistics that are simply averages. As the economy bifurcates and the top 40% pull away from the bottom 60%, the effects of a recession will be borne more by those in the lower part. The punch line: the 4.2% unemployment rate probably overstates the strength of the labor market, and GDP growth overstates the growth of the economy. While he is correct on both points, the Fed doesn’t seem to be in danger of overshooting and sending the economy into a recession. They are stepping very gingerly, and are de-emphasizing the unemployment rate in favor of wage inflation. Inflation is coming back in commodity prices (especially food), but that is almost invariably a temporary phenomenon.

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Vital Statistics:

Stocks are higher after the Senate passed a budget resolution which allows tax reform to go forward. Bonds and MBS are down.

Existing Home Sales increased 0.7% in September, according to the National Association of Realtors. This is down 1.5% YOY. September’s number was only slightly higher than August, which was the lowest reading in a year. The median home price rose 4.2% to 245,100. Inventory is still a big problem, down YOY at 4.2 month’s worth from 4.5 a year ago. The first time homebuyer was 29% of sales, which was a drop. There is a complete dearth of listings at the low end of the market.

The Senate passed a budget resolution last night on party lines (with Rand Paul voting against) which allows tax reform to go forward on a simple majority. There are still a couple of differences between what the House and Senate are willing to accept. The House wants to see revenue-neutral tax reform, while the Senate is willing to accept an increase in the deficit. The House version includes spending cuts to offset the tax cuts, while the Senate version envisions additional revenue from allowing more oil production in Alaska. They hope to have a deal by the end of the year.

General Electric missed earnings badly this morning, however this appears to be a bit of a kitchen sink release for the new CEO. Regardless, the stock is down 6% this morning. GE historically has been a bellwether for the entire stock market, but today the FAANGs run the show.

The next Fed nominee is reportedly a horse race between Jerome Powell and John Taylor. Trump is expected to make his announcement in the next couple of weeks. Insiders say that Powell is the favorite of the two. Both nominees are more hawkish than Janet Yellen, which means rates will go up faster and higher, at least at the margin. In all honesty, the practical differences between Yellen and these nominees is not all that large. It probably won’t make any difference to the economy.

The increasing digitization of real estate transactions has increased the risk of fraud. Scammers are issuing emailed instructions to change wire transfer destinations on closing day. The best step buyers can take is simply to be aware of the potential for fraud and to verify everything, especially changes in wiring instructions.

The latest CoreLogic Market Pulse takes a look at the effects of the hurricanes on local real estate markets. They estimate that 70% of the flood damage in the Houston area is uninsured. This will be a nightmare for loan servicers. Separately, Black Knight Financial Services is seeing about a 9% jump in past-due mortgages due to the hurricanes. In fact, September had the first year-on-year increase in delinquencies since 2010.

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Vital Statistics:

Stocks are lower this morning on overseas weakness. Bonds and MBS are down small.

Initial Jobless Claims fell to 220,000 last week which was the lowest since we still had a military draft. If you correct for population growth, the number is even more impressive. Note that last week included the Columbus Day holiday, so the number should be taken with a grain of salt.

The Conference Board Index of Leading Economic Indicators slipped in September for the first time in a year as hurricanes depressed activity. The main source of weakness was in the labor market and residential construction.

The Fed’s Beige Book summary of economic conditions reported that activity was between “modest” and “moderate” for all of the 12 districts in September. Hurricane-related disruptions were reported as a drag on the economy. The labor market remains tight, with shortages in many industries, including construction, health care, and transportation. While wage growth overall remains soft, we are seeing some evidence of wage pressure increasing in these areas, as firms are adding signing bonuses, overtime, and other non-wage benefits.

The trend of larger houses and smaller outdoor spaces is being reversed, as materials costs are making larger homes unaffordable for many buyers. The average square footage of outdoor space has increased 7,048 square feet. Yard sizes peaked in the mid 70s, at around 12,000 feet before bigger and bigger houses became the norm. Since 1973, the average size of a single family home increased 62% to 2,467 square feet.

For an example of rising materials costs (aka sticks and bricks) here is a chart of lumber futures going back to the mid 80s. We are at prices not seen since the bubble.

You see some of this in the suburbs of Manhattan, where luxury homes languish. This home was first listed at $17.35 million in 2 years ago, cut to $11.5 million and still hasn’t sold. It was taken off the market in September. All real estate is local, and the Northeast is pretty much the opposite of the West Coast, where demand is overwhelming supply.

Brian Montgomery, Donald Trump’s nominee to run the FHA, represented banks for years, helping them fight penalties imposed by the agency. Many on the left are worried that he will be unable to think solely from the perspective of the public interest. The government wants to see more FHA lending, but the Obama Administration’s use of the False Claims Act (which awards treble damages) has driven the business to smaller non-bank lenders. HUD Chairman Ben Carson recognizes the issues with FHA lending, and wants to see a more balanced approach.

Today is the 30 year anniversary of the Crash of 1987, where markets fell 23% in one day. Many people blamed program trading and wonder if the same thing could happen today as high frequency traders dominate the market. That is certainly a possibility, however high frequency traders usually step away from the markets once volatility kicks up, so they probably wouldn’t force stocks down, the way portfolio insurance did in the mid 80s. The biggest risk today is that liquidity will vanish at the worst possible time. Technology and regulation have reduced stock trading commissions and bid / ask spreads to almost nothing, and have driven the market-maker and stock specialist (the “traffic cops” who helped maintain an orderly market) out of business.  IMO, flash crashes we have seen will probably be the model this time around, where volume becomes so light that a few market sell orders can drive stocks down to nothing. We saw this happen before, where well-known, profitable and solvent companies were driven to a penny a share. The next crash will be an interesting test whether exchange traded funds are all they are cracked up to be as well, especially if we see a big divergence between NAV and trading prices.

The Crash of 87 also ushered in the Greenspan Put, which got its name after Fed Chairman Alan Greenspan assured the markets that the Fed stood by ready to provide liquidity as needed in the aftermath of the crash. This probably prevented the crash from turning into a wholesale financial crisis, however that policy became more or less codified to where the Fed began to ease whenever asset markets had a hiccup. It prevented a recession in the mid-90s, which could have occurred after any one of financial hiccups, whether the MBS implosion in 1994, Long Term Capital Management, or the Asian Financial Crisis. The idea that the Fed would save the day with interest rate cuts or more liquidity whenever asset prices fell became known as the Greenspan Put, which had the effect of lowering risk premiums and making investors more willing to pay high multiples or earnings. Stocks became a “can’t miss” proposition. (Remember the talking heads on CNBC? Don’t worry about P/E ratios – just buy “quality” companies.) The poster child of this theory was Cisco Systems, which hit a high of over $77 a share in early 2000 and is less than half that today, over 17 years later.

The Greenspan Put also set the stage for the residential real estate bubble of the mid 00s. Years of easy money found its way into different asset classes, especially the residential real estate market. Nobody wanted to talk about Cisco any more, they were too busy flipping condos in Las Vegas. Rock bottom interest rates had investors reaching for yield, which made for an insatiable appetite for mortgage backed securities. We all know how that ended. And even today, people are willing to tie up their money for 30 years lending to the US government at 2.8% while we have a Federal reserve hell-bent on creating inflation. Or they are invested in auto asset backed securities, lending for 8 years at 3.2% for an asset that depreciates like sushi. It is strange to think how this state of affairs was largely the unintended consequence of well-intentioned Fed policy in the aftermath of the Crash of 1987.

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Vital Statistics:

Stocks are lower on no major news. Bonds and MBS are down small.

Housing starts fell in September, as hurricane effects probably had an effect. Starts fell 4.7% from August, but are up 6.1% on an annual basis. Weather probably doesn’t explain all of it, however as building permits were also down on month-over-month basis. Permits were also down on year-over-year basis. Housing starts fell in the North, South, and Midwest, but rose in the West. Permits rose in the Northeast and Midwest and fell in the South and West. We should probably see some improvement in these numbers as the flood waters recede and people rebuild.

Mortgage applications rose 3.6% on an adjusted basis for the holiday-shortened week. Purchases rose 4% while refis rose 3%. The MBA said that mortgage rates decreased by 2 basis points overall last week. This was the first increase in the applications index in over a month.

Treasury Secretary Steve Mnuchin predicts the stock market will slump if tax reform isn’t passed this year. Since Democrats are uniformly against tax reform, it will have to be modest in order to pass it under a straight majority in the Senate. “There is no question that the rally in the stock market has baked into it reasonably high expectations of us getting tax cuts and tax reform done,” Mnuchin said in the “Politico Money” podcast interview. “To the extent we get the tax deal done, the stock market will go up higher. But there’s no question in my mind that if we don’t get it done you’re going to see a reversal of a significant amount of these gains.” Note that there are some procedural hurdles to get this done. It all comes down to earnings. If there are no changes in taxes at the corporate level, then the forward earnings estimates are too high, which means the multiple is higher than people think.

The Senate has a tentative deal to save Obamacare and the cost reduction subsidies, however the White House is lukewarm on it, and many in the House are outright hostile to anything that props up Obamacare.

Trump is expected to name his nominee to be the next Fed Chairman by early November. The expected nominees are John Taylor, Kevin Warsh, Gary Cohn, Jerome Powell, or Janet Yellen. Trump meets with Yellen this week. Note a Reuters poll of economists think Powell will get the nod.

One puzzling aspect of the current economy is the labor market and the lack of wage growth. Theory says that if the unemployment rate is as low as it is now, we should be seeing bidding wars for workers and general wage hikes across the board. The leading indicator for wage growth – the JOLTS quit rate – has been flat for 2 years. What is going on? The first (and biggest) is that the unemployment rate is sending a false signal about how tight the labor market is. While there is some tightness in the labor force, particularly in skilled labor, most people are not in the hot sector, and are reluctant to leave. Second, many could still be trapped in homes with negative equity, unable to move to where the jobs are. And finally, many are just not willing to move, for whatever reason. I think the answer is the first one: Our unemployment rate stops counting the unemployed at 6 months, which may have been a reasonable thing to do 30 years ago, but not today. The employment to population ratio is probably a better indicator. And according to that, we still have a ways to go. Note that demographic trends will play a part here as well. The low ratios in the 50s and 60s are explained by a lack of women in the labor force. And some of the drop in recent years is due to the retirement of the baby boomers, however their kids (the Millennials) should be replacing them.

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Vital Statistics:

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

Neel Kashkari speaks at 10:00 am. The Fed funds futures are pricing in a 93% chance of a rate hike at the December meeting.

Industrial Production increased 0.3% in September as the effects of the hurricanes probably depressed the number by 0.25%. Capacity Utilization rebounded from August but is still lower than where it has been most of the year. Manufacturing capacity utilization is around 75%, which is 3% below its longer-term average.

Small business optimism fell in September, as the hurricanes in Florida and Texas took their toll. Job creation fell during the month by .17 workers per firm. We saw firms cutting workers in most census divisions, so this isn’t just a hurricane effect. That said, 19% of firms listed “difficulty in finding qualified workers” as their single most important business problem. This was the second overall issue, with the highest being taxes. Access to credit remains a non-problem as only 1% said their credit needs were not being met. Overall, sentiment declined from a historically high level.

Donald Trump met with John Taylor yesterday, and came away very impressed. Kevin Warsh had been seen as the front-runner, however he has attracted criticism from economists on the left, particularly Paul Krugman. Taylor is known for the Taylor Rule which sets the proper Fed Funds rate based on what his model tells him. He is probably more hawkish than Warsh, and certainly more than Janet Yellen, who Trump will interview this week. A Reuters poll of economists has Jerome Powell as the most likely choice.

Tax reform has the potential to make the mortgage interest deduction irrelevant for most homeowners. Note that many articles will breathlessly say the MID is “threatened,” however in reality it will just become irrelevant, as the standard deduction will increase and most people will be better off taking the standard deduction instead of itemizing. You can’t really call it “threatened.” Currently about 30% of the homes in the US are valuable enough to take the MID. Under tax reform, that number should drop to 5%, according to Zillow.

A warning? Credit card delinquencies have risen for the third month in a row, as lenders have pushed the envelope credit-wise to increase revenues. Both JP Morgan and Citi reported 14%-15% increases in DQs for the third quarter.

The Census Bureau reported that building permits for the first 8 months of the year are up 7.5% compared to the first 8 months of 2016. Where are the most expensive places to build? The Left Coast, where it costs roughly $164 a square foot to build a spec house. The national average is $101. New England is second at $147, while the cheapest is the West South Central (TX, OK, AR and LA) at $81 a square foot.

A trailer in New York City just went for $150,000.

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