All Things in Moderation

Vital Statistics:

Stocks are lower this morning on Theresa May comments about Brexit. Bonds and MBS are up.

The World Economic Forum in Davos is going on this week. There may be a slight chance of market-moving data, but it is unlikely. The big subject is undoubtedly the wave of populism and anti-corporate / anti-government / anti-globalization going on throughout the world.

Corporate America seems to have read the tea leaves as well. GM just put out a headline saying they will invest $1 billion in US manufacturing operations and create 7,000 jobs. Walmart is getting into the action too. Even foreign companies are getting into the act. Of course some companies may be publicizing old plans to get the benefit of some good PR, the fact remains that big job cutting announcements are going to be out of style for a while. Don’t forget, the job market IS getting tighter, and (hopefully) the mindset of Corporate America is shifting from cost control to revenue growth.

Manufacturing in New York State slipped slightly last month according to the Empire State Manufacturing Survey. Growth is modest, however employment is still depressed.

James Bullard believes that the Fed can begin to think about shrinking its balance sheet as rates since rates are higher now than where they were. This would probably happen by not re-investing maturing assets. At the margin, this will translate into higher mortgage rates since TBAs will lose a natural buyer.

Strategist Komal-Sri Kumar is skeptical of the Fed’s forecast for interest rate hikes. His point is that the Fed cannot really raise rates in a vacuum, when all of the other central banks are going in the opposite direction. His call is for one hike this year. I am skeptical of a big fiscal stimulus out of Washington this year because Democrats will be united in opposition, and Republicans aren’t going to stick their necks out politically for a President they never wanted and don’t trust. The minutes from the Fed said explicitly that the forecast is based on expected fiscal stimulus. Note that many Fed officials are beginning to sour on the idea of additional fiscal stimulus.

In addition, if Trump manages to impose some additional tariffs (which IMO is a political non-starter) that will weaken the economy, and probably put the Fed on hold. Separately, Donald Trump just turned decades of US policy towards the dollar on its head, saying that the US currency is too strong. At the end of the day, presidents don’t really have all that much control over the economy.

Despite all the uncertainty about the government and the Fed, economic optimism remains just off a nine-year high.

The baby boomers drove housing construction through the 1970s and 1980s, yet their offspring (an even bigger generation) are not buying homes the way their parents did. What gives? Millennials earn 20% less (inflation adjusted) than their parents did at the same age. Not only that, but the consumer price inflation index deemphasizes /ignores things like college education which has going up multiples of the CPI. When you look at wealth, the numbers are even worse. That said, in 1989, mortgage rates were 10% and the principal and interest payment for a loan on the median house was 27% of median income versus around 21% today.

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Markets are higher this morning as bank earnings come in. Bonds and MBS are down.

Inflation at the wholesale level remains under the Fed’s target rate, according to the Producer Price Index. The PPI was up 0.4% MOM and 1.2% YOY. Ex-food and energy, it was up 0.3% MOM and 1.4% YOY.

Retail sales increased 0.6% in December, however if you strip out autos and gasoline, they were flat. The control group rose by 0.2%, which missed expectations. For all the post-election increase in confidence, it didn’t translate into spending.

Business Inventories rose sharply (increasing 0.7%) in November, while sales increased 0.1%. The inventory to sales ratio came in at 1.38x, which is an improvement, but is still elevated. That said, inventory build is not the driver of the business cycle that it was 20 or 30 years ago.

Consumer sentiment slipped slightly to 98.1 from 98.6. This is the preliminary January reading.

We are getting bank earnings this morning. Wells missed estimates as mortgage revenue fell 15%. Issues with hedges drove down servicing revenue 73%. JP Morgan beat estimates, while Bank of America missed.

Ben Carson testified in front of the Senate yesterday. Here are his prepared remarks. He spent the a lot of time discussing the state of government housing and the role of housing to help the poor move up the economic ladder. He addressed regulations in several instances. First, he took aim at local zoning regulations that inhibit multifamily housing. Second, he mentioned that regulations have added 24% to the cost of a new house, and finally he discussed them with respect to credit.

Here are his comments with respect to origination: “Loans are now bifurcated: the well-off have their pick of loans and lenders while many others without solid credit or stable incomes are locked out – one of the reasons the economic recovery was slower than many would have liked. Homeownership rates have fallen on a year-over-year basis in every quarter for the last 10 years, and a surge in renting has dropped the homeownership rate to a 50-year low. Banks are loath to participate in low-down payment programs through FHA for fear of getting sued if the borrowers default. (emphasis mine) So we need to make sure HUD and FHA are fulfilling their missions to help people build up an asset, like a home, which will help them climb up the rungs of the economic ladder.”

On the subject of private capital, he supported more private capital in the mortgage market to displace government capital (which is a completely non-controversial sentiment). He also thinks that a government backstop is not necessary to keep a 30 year fixed rate mortgage, however he supports government involvement to keep it. Note that while the typical American considers a 30 year fixed rate mortgage to be their birthright, they are largely a US phenomenon. Everyone else has some sort of adjustable rate. Of course you could still have a 30 year fixed rate mortgage without the government backstop, however the rate will reflect the added risk.

Finally, he was asked about the recent decrease in FHA annual MIP and only said he would look at it. So, it looks like we aren’t going to see a wholesale change from the Obama administration, although GNMA may become a little more forgiving, at least at the margin. For the mortgage origination business, HUD isn’t the big driver – it is Treasury via the GSEs and the CFPB with enforcement.

NAR has a good wrap-up of the testimony. Here are the objections from the left.

Overall, Trump’s nominees have come across as relatively mainstream, so much so that Dick Durban (D-IL) commented on it. Trump’s response was that he wanted them to be themselves and to say what they thought, not what he thinks. Interestingly, the biggest difference between Trump’s cabinet and Obama’s is his lack of lawyers. Obama’s cabinet was dominated by them.

Builders are encouraged that a new administration will ease the shortage of buildable land caused by increased environmental regulations. They may be overoptimistic about what can be done, however. Many of these laws are local, which the Federal Government can’t do much about. Changing regulations takes a long time, with comment periods, and environmental groups have lawsuits at the ready if they sense the administration is no longer enforcing existing laws.

Finally, perspective is everything:

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Markets are lower after Trump’s press conference yesterday. Bonds and MBS are up

We saw stocks sell off (and bond rally) after Donald Trump’s press conference yesterday. He did not address any sort of fiscal stimulus, which the markets were hoping to see. IMO the market may be realizing the huge stock market rally (and bond sell-off) post election was overdone. Trump also fired a shot across the bow of the pharmaceutical industry (which sent the S&P 500 downward), and got into it with a CNN reporter. He also will not divest his business operations. The pivot to a more presidential demeanor doesn’t look like it is going to happen. He is also introducing the dreaded “U” word – uncertainty – into the conversation with his tweets directed at specific companies. The markets are in a risk-off mood.

The first act of Congress was to set the stage to repeal Obamacare on a simple majority basis. The Senate passed it yesterday 51-48 and the measure goes to the House today. IMO, if the first legislative act is to repeal Obamacare on a party-line basis without any sort of replacement plan, any sort of bipartisan cooperation of tax reform and infrastructure spending is going to be almost impossible. Given the Fed’s forecast of 3 Fed Funds hikes this year was based on the assumption that we will have more fiscal stimulus, we could see a March hike taken off the table rather quickly, and I wouldn’t be surprised to see a further decline in overall interest rates. As Morgan Stanley said: Buy the election, sell the inauguration.”

St. Louis Fed Head James Bullard said that any of Trump’s proposed fiscal stimulus would be a 2018 and 2019 story, not a 2018 story. Infrastructure spending has a long lead time – the idea of “shovel ready” jobs is more or less a myth. Tax cuts would affect things sooner, but even then will be a 2018 story. The best chance for immediate results will be in regulatory reform.

We have a lot of Fed-speak today, with 3 speakers, so expect some volatility in rates during the day.

Import prices rose 0.4% last month, however if you strip out energy, they fell 0.2% and the YOY rate was flat. The strong dollar is helping keep inflation in check.

Initial Jobless Claims rose to 247,000 last week. We are still at exceptionally low numbers: employers are hanging on to their employees.

Ben Carson travels to Capitol Hill today to answer questions about his plans for HUD. Expect Republicans to focus on GSE reform and Democrats to focus on fair lending and affordable housing. There will undoubtedly be questions on his lack of experience in housing.

KB Home reported fourth quarter numbers yesterday. Revenues increased 21%, while average selling prices increased only 2%. We have been seeing a decline in ASP inflation from most of the builders. Backlog was the highest in 10 years. Deliveries were up 19%, while gross margins decreased to 16.5%. The stock is down about 4% on the open.

The fall in gross margins is a reflection of (a) increasing inflation and (b) an inability to pass on higher costs through price increases. Inflation is most prominent in increasing raw land costs, higher regulation, and also a tight market for skilled labor.

Foreclosures are at a 10 year low, and we are seeing better performance in many states. 379k people lost their homes to the bank last year. At the height of the crisis over a million people did. Home price appreciation helps as it takes the strategic defaulters off the table. The worst state for foreclosures? New Jersey.

The night of the election, Carl Icahn left the party early to buy S&P 500 futures down 100 points. He ended up taking a $1 billion position overnight and profited handsomely in the subsequent rally. Know who was short the whole time? Soros. Trading and politics are a dangerous mix. Politics is almost pure emotion.

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Markets are flat ahead of Donald Trump’s news conference. Bonds and MBS are flat.

Mortgage Applications rose 5.8% last week as purchases rose 6% and refis rose 4%.

Secretary of State nominee Rex Tillerson will face Congress today. Jeff Sessions had his time in the box yesterday.

Home sales are falling through at a faster pace than last year, according to Trulia, and it is the starter home price points that are seeing it the most. 4.3% of all sales failed in the fourth quarter, compared to 1.4% two years ago. This may have to do with the increase in the number of first time homebuyers and the drop in professional investors which makes this probably a credit story. We are also seeing people who had foreclosures and bankruptcies during the bubble years re-approach the housing market as those events fall off their credit reports.

Part of this phenomenon could in fact be the divergence between the opinions of buyers / sellers and appraisers. According to Quicken loans, appraised values came in about 1.3% lower than owner expectations in November. Interestingly, appraised values fell in November, while house prices (at least according to the home price indices) have been rising. That said, appraisal values did increase almost 4% YOY, however that is much lower than the 6% or so home price appreciation we have been seeing in the other indices. That said, since appraisals use historical comparisons, some lag is to be expected.

Bob Shiller says the animal spirits are stirring in the housing market. Of course tight credit for both buyers and builders as well as increasing interest rates will offset that somewhat, but confidence plays a huge role in economic growth. That said, demographic headwinds are going to be an issue.

In keeping with the demographic headwinds issue, the Bipartisan Policy Center Senior Health and Housing Task Force has some advice for Ben Carson and helping the Baby Boom generation age in their homes.

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

Job openings increased to 5.5 million, according to the JOLTS report. This is at levels not seen since 2000. The quits rate has been steady at 2.1%, and that is the ultimate measure of labor market strength and a leading indicator for wage growth and inflation. As long as that number is steady, the Fed can be reasonably comfortable that inflation is going to stay low.

Small business optimism rocketed in December, according to the NFIB. The index rose 7.4 points to 105.8, the highest level since December 2004. The lion’s share of the gain was due to improving expectations, so it probably will be given back if big changes in the regulatory and tax environment don’t materialize. Job creation plans did hit a 9 year high, and capital expenditure plans jumped as well. That said, actual hiring in December was virtually unchanged from a month ago. That said, competition remains tight for skilled workers and a net 26% of respondents reported increasing compensation.

Despite the improvement for small business, some in Corporate America (the automakers) are not sure what to think. Trump’s jawboning over outsourcing has caused automakers general uncertainty, as the industry recovers from the worst slump since the Great Depression. The ultimate trade may in fact turn out that Trump will let Obama’s new fuel efficiency standards die in return for more production in the US.

Rising rates are hurting buyer sentiment, according to Fannie Mae. Their Home Purchase Sentiment Index fell for the fifth month in a row. The survey predicts that home prices will increase 2.1% next year, however the survey has been consistently lower than the professional forecasts, let alone actual price appreciation. Respondents also believe it is easier to get a mortgage than it was two years ago. Their view of the economy has improved dramatically, with roughly the same percentage of people thinking the economy is on the right track versus the wrong track. Note this optimism was reflected in the Gallup data as well.

There were 26,000 completed foreclosures in November, according to CoreLogic. The seriously delinquent rate was 2.5%, which is the lowest since August 2007. Foreclosure inventory remains concentrated in the judicial states of New York, New Jersey, and Florida. The seriously delinquent rate remains highest in NY and NJ as well, with rates of 5% and 5.6% on average.

Yesterday’s change in FHA MIP caused some strange activity in the TBA market which affected pricing. Bonds were up yesterday and pricing was generally better for most products, except for higher-coupon FHA and VA loans. That pricing actually worsened. Why? Because the change in annual MIP caused investors to bump up their prepayment assumptions for higher coupon Ginnie securities (generally those with 4% coupons and up). This makes those higher coupon mortgage backed securities worth less than last week, all things being equal. So if you priced out a FHA loan on Friday expecting to see better pricing, only to get an unpleasant surprise, the MIP change was the reason. On the bright side, refinancing just got more attractive.

Quicken CEO Dan Gilbert accused the Department of Justice of conducting a shakedown operation.

Goldman’s Dan Hatzius is handicapping a 35% of a March hike this year, while the Fed Funds futures are handicapping a 25% chance. Goldman is much more hawkish than the Fed in general, and they foresee a more linear hiking of rates while the Fed (and the futures markets) are forecasting a more gentle increase.

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Stocks are lower this morning on overseas worries. Bonds and MBS are up.

The week after the jobs report is typically data-light, however we will have a lot of Fed-speak this week, especially today, Thursday, and Friday.

The labor market conditions index slipped in December to -.3 from 1.2 in November. Note this is a meta-index of many leading and lagging indicators, so it is possible to have a so-so number just after a decent jobs report.

HUD announced they are cutting the annual insurance premium for most FHA loans by 25 basis points, which should save the typical homeowner about $500 annually. This will affect mortgages with a disbursement date after Jan 27. The reduction is due to the improving health of the housing market and the FHA’s insurance fund. Since the crisis, FHA has increased premiums by 150% to restore capital reserves. This reduction reverses that move and brings annual premiums back down to close to pre-crisis levels.

The current HUD Chairman, Julian Castro is worried that Ben Carson will roll back some of the HUD initiatives over the past several years. The one most likely to be on the chopping block is a controversial policy in which HUD sues local governments in order to force them to change their zoning laws in order to accommodate more multi-family housing. Westchester County in New York has been fighting this for the entire Obama administration.

Notwithstanding the jump in wage inflation last month, overall wage inflation has been hard to come by, not only in the US, but globally. The relationship between unemployment and wages seems to have broken down. What is going on? First, the most likely explanation is that the new jobs being created pay less than the jobs that were lost. This is the most plausible explanation, as many of the construction jobs that were lost in the bubble never came back, and most of the employment growth is coming in lower-paying health care jobs. Second, workers lost so much bargaining power in the recession that they don’t feel comfortable asking for more. A third explanation could be that the cost to employers has risen, but these costs are largely regulatory and don’t flow through to wages. Regardless of the reason, wage growth is an imperfect representation of labor market strength.

Now that it is becoming harder to find buildable lots, many homebuilders are returning to half-finished subdivisions that were abandoned as the housing bubble burst in 2007 and 2008. The supply of developed vacant lots (go-dirt) has fallen by 20% since 2011. The buyers seem to be the big national homebuilders like Lennar. The credit markets for homebuilders remains a case of “haves and have-nots.” The big builders are able to issue corporate debt at super-low interest rates while the small guys are getting turned down by the local bank.

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Stocks are up slightly after the jobs report. Bonds and MBS are down.

Jobs report data dump:

• Nonfarm payrolls increased 156,000
• November payrolls revised up to 204,000
• Unemployment rate 4.7%
• Labor force participation rate 62.7%
• Average hourly earnings up 0.4% (up 2.9% annualized)

Overall, a good report. The payrolls number was a disappointment, however we did see an increase in the labor force participation rate and an increase in average hourly earnings. The employment to population ratio was steady at 59.7%. The job growth was primarily in health care and social assistance. Retail gained, as well as transportation. Finance grew as well.

The focus for markets in on wage growth, as that is going to be the big determinant of Fed policy. I have plotted average hourly earnings over the past 10 years. You can see that the slope of the blue line (wage inflation) has almost come back to pre-crisis levels. In fact, wage inflation is the highest since 2009.  The gap between the two red lines represents the damage done by the Great Recession. The bigger question is whether employees get their raises in the form of higher benefit costs or whether it shows up in their paychecks. That will depend (in part) on whether the young Millennials get jobs, as they will help the risk pool which should (all things being equal) help lower health insurance costs for everyone else. Universities are reporting lower enrollments, which is a tell that Millennials are finding jobs. Note that sentiment indicators show that Millennials are more bearish on the economy than most, though this could be explained by partisanship.

Bonds sold off slightly on the report, with the 10-year reaching 2.4% before dropping back down. We have had some hawkish Fed-speak with Loretta Mester suggesting more than 3 hikes might be necessary and Williams saying 3 hikes would be reasonable. Remember, just because the Fed Funds rate increases, it doesn’t automatically follow that long term rate (which determine mortgage rates) will also increase. The last few tightening cycles have seen a flattening of the yield curve.

Despite the gloom for department stores and the holiday shopping season, online retailers reported an 11% increase in sales over the holiday period. We’ll have to wait until we get retail sales to see how the season actually went.

What are the most crowded trades on Wall Street? Here is your guide.

The trade gap widened in December, while factory orders fell 2.4% in November.

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Stocks are higher this morning on some good economic news out of Europe. Bonds and MBS are up small.

The FOMC minutes are scheduled to be released at 2:00 pm EST today. The focus will be on the dot plot, which showed the Committee members predicting 3 Fed Funds rate hikes this year. At her press conference, Janet Yellen downplayed the change, so investors will be looking closely at the discussion to get some more color on what the Fed is thinking. There is a chance that rates could get volatile around 2:00 pm, so just be aware if you are looking to lock around then.

HSBC took up their estimate for world growth on better US and Chinese growth prospects.

Mortgage Applications fell 12% last week as purchases fell 2% and refis fell 22%. It was a holiday week, so the numbers aren’t as bad as they look.

The Gallup Job Creation Index was unchanged last week and is at post-crisis highs.

China recently imposed new capital controls in order to prevent outflows of their currency, which restricts Chinese companies from buying foreign real estate. You are starting to see the effect of that in the high end real estate markets. Apartment prices fell 6.3% in Manhattan and you are seeing the same thing in Central London (which has been in bubble territory for years). Though we have yet to see it, you should expect to see some of the froth come off other high flying real estate markets, particularly on the West Coast.

CoreLogic looks at the change in Administrations (and ideologies) regarding housing going forward. Think tanks like the Urban Institute will take a backseat to think tanks like Cato. Expect to see a de-emphasis on fair housing issues like zoning and more of a focus on free-market solutions. Steve Mnuchin has been out calling for a re-privatization of Fannie Mae.

“Buy the election, sell the inauguration” is Morgan Stanley’s advice to equity owners. Their call is that uncertainty about Trump’s policies and the Fed will overshadow the optimism over regulatory relief and lower taxes going forward.

Wall Street lawyer Jay Clayton is the leading candidate to run the SEC. Along with Treasury Secretary Steve Mnuchin, they will hopefully get the private label securitization market back on track.

A fascinating read on the CFPB and how it operates.

It is interesting to see Corporate America begin to tout bringing jobs back to the US post-election. You have seen Ford, GM, Sprint, etc all out with headlines about planned job creation and shifting production back to the US. This could be the beginning of a trend. IMO, Corporate America has read the tea leaves from the election and realizes that they too are in the spotlight and want to get ahead of it. Ironically, Obama would have been crucified if he took on companies directly via Twitter the way Trump has. I guess only Nixon could go to China.

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Stocks are starting the year on an up note on overseas optimism. Bonds and MBS are down.

The highlight of the week will be the jobs report on Friday and the FOMC minutes from the December meeting on Wednesday. We have no Fed-speak until Friday.

Home prices rose 7.1% YOY, according to CoreLogic. They are forecasting an increase of 4.7% for 2017, as higher rates and prices affect buyers. Home prices in 27 states are now above their pre-crisis peaks. Remember, these are nominal prices, not inflation-adjusted prices.

Delinquency rates ticked up slightly in November, from 1.21% to 1.23%. On a year-over-year basis they were down from 1.58%. The peak DQ number was in early 2010 when it hit 5.59%.

Manufacturing improved in December, according the Markit PMI Index and the ISM Manufacturing Index.  New orders and pricing drove the increase. Pricing had been an issue for years. This may simply be a blip, however it does hint at inflation beginning to stir. The current level for the PMI Manufacturing Index (54.7) historically corresponds with GDP growth of 3.6%.

Construction spending rose 0.9% in November and is up 4.1% YOY. Residential Construction rose 1% and is up 3% YOY.

Barry Ritholz has his advice for 2017. His take: the secular bond bull market is over, however inflation is the real risk to bond investors, not mark-to-market losses. He also believes that secular bull markets in stocks aren’t measured from where they bottom, but from where they break out of their bear market range. This would put the beginning of the secular bull (assuming we are in one) around early 2013, not 2009. We had a secular bear market from 1966 to 1982, a secular bull market from 1982 to 2000 and a secular bear from 2000 to 2013 (if this is in fact a change of trend).

Note that corporate tax reform is a priority for the new administration. If you cut corporate taxes, then that means earnings are increasing, and the current forward P/E ratios of the S&P 500 are overstated. Of course higher interest rates, a higher dollar, and increasing wages will offset that somewhat.

Doug Kass has his surprises for 2017. This is usually a fun read and these should be looked as improbables that the markets are assigning a too-low probability to. The punch line is that the year starts off strong, however Trump’s inexperience begins to take its toll on politics and the markets, and the Administration devolves into chaos. Stocks peak in January and end the year down 15%. The 10 year shoots through 3% before falling back to 1.5% as the Fed begins QE unlimited to hold the 10 year at a specific level. Overall, it is a pessimistic take, but remember these are all “go out on a limb” sort of predictions – they aren’t base case scenarios.

Another one of Kass’s predictions is that Trump’s security advisors finally convince him to stop Tweeting and close down his Twitter account, which causes the stock to drop 20%. Meanwhile this morning, Trump fired a shot across the bow of GM:

GM’s stock is down slightly pre-open, however tweets like this could give investors fits.

Larry Summers is skeptical that any sort of repatriation tax break for companies will find its way into re-investment. His view is that repatriated cash will be used for dividends, buybacks and M&A. Of course if companies don’t think there are opportunities for investment, they will return the money to stockholders, however that isn’t necessarily a given that there are no investment opportunities. Capital Expenditures have been moribund for a decade. You can only put that off so long. Secondly, if the psychology of CEOs changes from being worried about costs to being worried about missing out on business, then you will see more investment.

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