All Things in Moderation

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Markets are flattish on no real news. Most of Asia was closed overnight for the lunar new year.  The G7 is expected to make a statement against competitive devaluation.  There is no economic data this morning, but many will be looking at tomorrow’s retail sales report to get a gauge on how much consumers have been affected by the increase in taxes.  Bonds and MBS are flat.

The internal debate at the Fed concerns how to start extricating itself from the market. As QE winds down, the Fed wants to prevent the market from getting ahead of it and prematurely slowing down the economy. The fear is that the market will interpret the end of QE as a signal that the end of ZIRP is imminent. Since the Fed has given numerical targets for the end of ZIRP, this fear is probably overblown, but targets can be changed. That said, if you look at the float numbers, the Fed has effectively cornered the market in 10 to 20 year bonds. And they have the buying power to maintain it.  The exit may involve simply holding the paper and letting it mature.

HUD just made it easier to prove discrimination cases.  Under the disparate impact rule, statistical proof that your lending mix is different that the population as a whole means you are guilty of discrimination, no matter what your policy or intention is.  Period. Obviously this is a huge victory for affordable housing advocates. The Mortgage Bankers Association is unhappy. IMO, this whole debate of FICO explaining everything misses the point that collateral valuation volatility in some neighborhoods is higher than in others.  Since the borrower is effectively long a put (if the house drops below the loan amount, they can toss the keys to the bank), and the value of a put is a function of volatility, then that has to be priced in the loan. And if house prices are more volatile in Detroit, or Harrisburg, or Newark then loans there should cost more to reflect that.  Which means FICO is not the whole story, contrary to what housing advocates insist.

45 Democrats sent a letter calling on President Obama to permanently replace Acting FHFA Director Ed DeMarco with someone more “willing to implement all of Congress’ directives to meet the critical challenges still facing our nation’s housing finance markets.”  This statement means willing to forgive principal on Freddie and Fannie loans. The mandate to put taxpayers first is at loggerheads with the desire to ease the financial burden on consumers. 

Separately, the White House is considering more mortgage relief for homeowners through executive order. The plan would allow underwater homeowners who are current on their mortgage to refinance at today’s rates, even if their loans are private label.   

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Another slow news day.  Markets are flat after the ECB maintained interest rates.  Initial Jobless Claims rose to 366k last week, while productivity fell.  Bonds and MBS are down small.

Jimmy Rogers is getting short Treasuries. He has been saying bonds have been in a bubble since 2009, though he has only started shorting them recently.  He plans to increase his position. Guys like Jimmy Rogers can’t affect bond prices (they are too small), but the Fed can, and will once it ends QE and begins to unwind its balance sheet.  The bond vigilante has been dormant for 20 years, but is about to make a re-appearance.

The National Association of Homebuilders Improving Markets Index expanded to 259 in February, with all 50 states represented. Roughly 70% of the metros covered were listed as improving. 

Even though the financial crisis ended long ago, the scars still linger.

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Slow news day. Stock index futures are lower after yesterday’s strong rally.  MBA mortgage applications rose 3.4% in the week ended Feb 1. The ECB meets later today.  Bonds and MBS are up.

Earnings season is starting to wind down.  Roughly 3/4 of all the companies in the S&P 500 have released earnings so far.  2/3 have beaten forecasts.

Pension funds and endowments are getting out of the commodities markets after returns have disappointed. When commodities started rallying about 6-7 years ago, big pension funds began buying commodities as a way to increase exposure to assets uncorrelated with stocks and bonds.  The problem is that these markets are relatively tiny compared to stocks and bonds (the dollar value of the entire open interest in the March WTI crude oil contract is about the same dollar value of Exxon Mobil stock traded daily). This meant that pension funds were driving up prices of commodities as they bought them.  And it wasn’t just oil – it was copper, lumber, wheat as well.  Unlike traditional speculators who buy and sell, the big institutions were making a long-term investment, which is more or less unheard-of in the commodities market, at least on a large scale.  Large OTC derivatives contracts allowed them to get around position limits, and those will be restricted in Dodd Frank. The punch line is that their exit will put pressure on commodity prices and keep inflation in check. It will also be a good thing for cash-strapped consumers. Where is the money going?  TIPS.

The Justice Department is suing S&P over ratings for subprime mortgages.  The complaint is here. The government is going to focus on conflict-of-interest issues (the issuer pays the ratings agency, not the investor) and supposedly not go after them for failing to predict the bursting of the housing bubble. Some of the damning emails are here. Sure, maybe ratings agencies may have suspected the housing bubble was bursting.  Does that mean that professional investors who relied solely on S&P’s rating get a pass?  A professional investor’s claim that “I bought this security because S&P said it was okay” ranks up there with “The dog ate my homework.” They do have a fiduciary duty, after all…

GOP Senators Bob Corker and David Vitter have introduced a bill to remove the dual mandate and direct the Fed to focus on inflation only.  Needless to say the bill is going nowhere in the Democratically-controlled Senate, but is should hopefully spark some debate.  Does the dual mandate compel the Fed to keep interest rates too low and does that fuel speculative bubbles?  

Separately, Senate Republicans have sent the President a letter suggesting that there be a bipartisan board of directors to oversee the CFPB and that its budget be subject to the annual appropriation process.  Actually, the 5 member board was part of the original proposal.  Again, this will probably end up going nowhere.

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Markets have a better tone this morning after yesterday’s sell-off.  Euro sovereign yields are down.  Bond yields are at the 2% level.

Stock index futures back up.  Dell doing a $23B LBO. Retail Investors Returning. Bonds can’t get out of their own way. Is the risk-on trade happening?  Feels like it. That said, the S&P 500 is nearing the top of its trading range since 2000. The 1970s bear market was a rangebound market where people would start to pile in at the top, only to have a crisis or inflation push the market back down.  The final cri de coeur was Business Week’s late 1979 piece The Death of Equities. That is what secular bear markets feel like when they end. The article even quotes a very happy diamond dealer in NY after ERISA changed the laws to let institutions buy hard assets, as if CALPERS was going to start burying gemstones in the back yard. 

Chart:  1970s Bear Market in Stocks.

The CoreLogic Home Price Index rose 8.3% in December, the biggest jump since May 2006. Excluding distressed sales, prices increased 7.5%.  They are forecasting a 7.9% YOY jump in January. The states with the biggest growth were AZ, NV, ID, CA, and HI.  The worst were DE, IL, NJ, and PA. It does feel like the secular bear in real estate is over. 

Listings of new homes has dropped to a 12-year low. For all of the fears of the shadow inventory, the problem seems to be a lack of merchandise. Many potential sellers are holding out for better prices, while professional investors are buying properties before they even hit the market.  Mark Zandi of Moody’s estimates that inventories might remain tight for a year or two. Sellers are worried that they may not be able to find a replacement home if they sell. This means the homebuilders are going to have a very good year.

Senate Democrats are trying to figure out a way to delay the sequestration cuts scheduled to take effect March 1. They are looking to replace the spending cuts with a surtax on oil companies and an end to the carried interest loophole. Meanwhile, House Republicans are considering a stopgap measure that would fund the government through Sep 30, which is $974 billion, well below the current level of $1.043T. Implicit in that measure is the assumption that the sequestration cuts happen. Republicans are resigned to having to accept the sequestration cuts and don’t have the appetite to try an negotiate a deal with the WH, which is going to delay releasing its budget until late March. While it has zero prospect of getting enacted as-is, it will be a clue as to whether the President is interested in some sort of long-term solution to the budget or is content to fiddle at the margins with what is currently out there.

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Markets are weaker on the back of big declines in the Italian and Spanish bourses. Euro sovereign yields are starting to tick back up. There doesn’t seem to be a story out there driving it. 

As the bond market has backed up, there is a lot of talk about whether this is the big rotation out of bonds and into stocks. Within the bond market, there is a rotation out of Treasuries and into high yield. Overall, the “risk on” trade seems to be gaining steam, which means we have seen the low point for mortgage rates. It also means that the private label market might come back.

Obama wants more revenue, specifically through reducing loopholes and deductions. I don’t know if this is posturing for the sequestration cuts or something else. Liberals are using the negative Q4 GDP report to argue that we can’t cut spending. That is simplistic – Q3 government spending was higher than normal due to the government’s “use it or lose it” budgeting. The government’s fiscal year ends in September, and there is always a push to spend your budget, even if you don’t really need it, to ensure your budget doesn’t get cut. Which means that Q4’s government spending was borrowed in Q3. Obama is being a little disingenuous when he says things like “The big problem was defense spending was cut 22 percent, the biggest drop in 40 years.” which implies we are already cutting to the bone. He is in favor of “smart spending reductions,” whatever that means, to bring down the deficit.  I suspect the only smart spending reductions he favors are the Orwellian-named “tax expenditures” and oil subsidies.  And don’t forget, the definition of what is considered a spending cut depends greatly on what the baseline is when you start counting. Many in Washington prefer to use the baseline from when spending was the highest (late 2010) as the baseline, project spending out 10 years from there, and count any difference between the old projection and the new projection as a “spending cut.”

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Futures are higher this morning after Jan payroll data.  157k jobs were added in January and the unemployment rate ticked up .1% to 7.9%.  Separately, there is a slew of economic data this morning. The University of Michigan consumer confidence rose to 73.8, construction spending rose .9% in Dec, and the ISM manufacturing survey rose to 53.1 from 50.7, a big upside surprise.  Both bonds and stock have found something to like in the data and are rallying.

The internals of the job report show that construction employment has been accelerating during what should be a seasonally slow period.  Weekly hours dropped. The labor force participation rate was unchanged at 63.6%. The BLS also made some revisions and adjustments to the historical numbers, which had the effect of increasing job creation during the past year and increasing the size of the labor force. It also means that some historical comparisons are not “apples to apples.” The market is focusing on the 7.9% unemployment number because that is what is driving the Fed at the moment. Overall, it was a mixed report, showing the labor market is improving, albeit slowly.

Chart:  US Unemployment Rate:

St Louis Fed President James Bullard says that unemployment in the “low 7s” could cause the Fed to end QE. 

Lender Processing Services has put out its January Mortgage Monitor. They show that foreclosure sales are at the lowest level since March of 2009, although starts are beginning to tick up again. Speaking of foreclosures, CoreLogic reported 56,000 foreclosures in November (a 3% YOY drop).  Pre-bubble run rates are closer to 21k.  Approximately 1.2 million homes were in the national foreclosure inventory at the end of 2012, which is a 20% decrease from the prior year. 

As home prices increase, more and more previously underwater homeowners are becoming eligible to refinance – LPS estimates the number could be 4 million.  Which means that in spite of rising interest rates, the refi boom may still have some legs.

Is cheap energy the answer to the problem of offshoring?  Nucor is building a new plant in Louisiana, after sending production to Trinidad.  The reason?  Cheap natural gas as a result of fracking.  Will it make much of a dent in unemployment?  Probably not, as it will only employ 150 people who will make on average $75k. Manufacturing is increasingly hiring highly paid skilled workers and not the unskilled. That said, the oil and gas industry does have a need for unskilled labor. 

Bill Gross says the rise in unemployment is giving the bond market a “period of rest”, meaning there is room for a bond market rally. He is recommending the 5 year and is avoiding duration as he believes that QE has made the bond market “bubbly.” It will be interesting to see what the bursting of that bubble will do to the economy. 

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Markets are down small as the earnings reports continue to stream in.  Economic bellwether UPS missed analyst estimates. Initial Jobless Claims came in at 368k.  Incomes and spending rose.  Bonds and MBS are continuing to rally after the FOMC statement yesterday.

The FOMC statement broke little new ground with the exception that they may have walked back their plan to end QE this year.  Recall from the minutes of the Dec meeting, the consensus seemed to be that purchases of Treasuries and MBS would end sometime in 2013, probably towards the end of the year. That was unexpected and caused a sell-off in bonds.  Yesterday, they said that if the outlook for the labor market does not improve substantially, they will continue to purchase Treasury and agency MBS.  That caused a rally in bonds yesterday.  Aside from that, the minutes contained nothing new.

As the sequestration approaches, defense contractors are relatively sanguine. Typical corporate optimism or do they know something the rest of us don’t?  Regarding the sequestration the latest amount for spending reduction is $85 billion.  The requested increase in spending from 2012 to 2013 is $74 billion.  So we are really talking about flat YOY spending (it really is a drop of $9 billion in the context of a $15.8 trillion economy).  The most likely outcome is that the sequester happens and no one notices.

Another underwater refi program is in the works, which would allow underwater borrowers in private label securitizations to refi into a government loan.  Another pilot program would have Treasury buy mortgages out of private label pools and mod the rates.  A backup plan would have Treasury cut the rates and pass on the difference between the old and new rate to the investor for 5 years.  If Washington comes up with a robust plan, the refi boom (which was thought to be over) could still have some legs.  

Opposition to Obamacare is coming from an unlikely source:  unions.

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Markets are lower on a surprisingly weak 4Q GDP number, which showed the economy contracted by .1%.    The ADP employment change report showed the economy added 192k jobs in January.  Mortgage Applications fell 8% last week.  Later today, we will get the FOMC rate decision. The 10 year, which was above 2% earlier is back down below.  MBS are up small.

The Q4 GDP number was surprisingly weak (the Street was at + 1.1%) and will undoubtedly be revised upward as it does not jive with the other data points out there.  Certainly the earnings reports we are seeing out of Corporate America do not indicate a recession.  This is the “advance” report (the first of three) and is based on incomplete data.  The next estimate will be released at the end of Feb.  

NAR has a good piece on the home ownership rate and household formation. The latest homeownership rate of 65.3% is the lowest since 1996.  Renters have been increasing.  They estimate that household formation broke out of its doldrums in 2012 and will be close to normalcy – around 1.1 million.  Note that this represents pent-up demand for housing as the Great Recession drove the low numbers, not demographics.  Of course some of these new households will go to rentals, but many will start purchasing starter homes, and they are the key to get transactions flowing again. This would also help ease the burden on the sandwich generation.

Chart:  Household Formation:

Looks like the sequester is going to happen, though the recent GDP report may give lawmakers a push to do something about it.  

When the FOMC statement is released, people will be focusing on the end of QE. Aside from the effect on interest rates, there is also the question about the size of the Fed’s balance sheet.  A recent paper projects the Fed’s balance sheet to start contracting in 2015, with a return to a more normal size in early 2018.  The Fed has been highly profitable during QE, since its own buying influences prices and makes its holdings of MBS and Treasuries more valuable. But what happens when they begin to sell?  The Fed may in fact lose money over the next few years, which will undoubtedly bring a political angle into the future role of the Fed.  Whoever succeeds Ben Bernake will, like Paul Volcker, preside over a Fed that will be unpopular, to say the least. 

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Stock index futures are weaker as the Fed kicks off its January FOMC meeting. The markets will be parsing the press release looking for clues regarding the end of QE, specifically the timing and the economic variables that influence the decision. Today is a very heavy earnings day, with Danaher, Ford, EMC, International Paper, and Pfizer reporting. Bonds and MBS are up a tick or two.

The S&P Case-Schiller index of home values rose 5.5% YOY and .6% MOM in the month of November.   The hardest hit areas (Phoenix, Detroit, Las Vegas) showed the biggest YOY increases (Phoenix was up 23%!), while the New York declined 1.2% 

DR Horton reported a 39% increase in revenues and a 26% jump in homes closed from a year ago.  Orders were up 39% and backlog was up 62%. Like the other homebuilders, DHI is reporting general strength in their housing markets.  There was a shift towards larger houses as well, as the dollar increase in the value of homes built increased 60%, while the number of units increased 39%.  They are looking forward to the spring selling season with optimism.  The stock is up about 4% pre-open. 

Is the “risk on” trade we have been waiting for since 2007 finally on?  Trim Tabs is reporting that last month was a record month for inflows for stock mutual funds and ETFs – the last time we had inflows of this magnitude was the winter of 2000, right as the tech bubble was bursting.  Time to be cautious or time to break out the champagne?  Reason for optimism:  There are no, repeat no, signs of overheating in the economy.  If anything there is a tremendous amount of pent-up demand.  That is not recessionary, and should therefore be bullish for stocks.  Reason for pessimism:  Interest rates are going up. The great secular bull market in bonds that began with Paul Volcker’s tightening in 1981 is ending. The end of QE will mean long-term rates will rise, and short-term rates will soon follow. Also, we are in a secular bear market for stocks, and those rare animals typically last a lot longer than 12 years. 

This secular bear market in stocks resembles the bear market of the 1970s. with stocks trading in a large range that oscillates over a period of years, while going nowhere.  To put the 1970s in perspective, the Dow Jones Industrial Average was at roughly the same place when I graduated from high school as it was when I was born.  

Chart:  Dow Jones Industrial Average 1965 – 1983: 

Compare to the S&P 500 since 2000: 

Similar oscillating pattern, with higher highs, and lower lows. If you believe in charts, they suggest a further run to eclipse the previous high and then a swoon lower. So, you might have another 8% – 10% left before the market heads back down again. 

Of course we have one other secular bear market to look at:  the granddaddy of them all:

23 years of a secular bear – it took until 1953 to recover the losses from the 1929 crash.  Some stock market darlings – Radio Corporation of America (aka RCA) never regained its peak from the 1920s. The economic backdrop of deleveraging has a lot more in common with the Depression bear than the 1970s bear which was driven by commodity price shocks and inflation.

Of course as Wall Street loves to say, past performance is not indicative of future performance, and charts are just that – representations of history that may or may not be relevant. The market may not follow either pattern.  But, remember the great secular bull market in stocks from 1983 – 2000 was accompanied by a secular bull market in bonds that began at roughly the same time.  That will not be the case this time around. 

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Markets are slightly higher this morning after a strong earnings report from Caterpillar and strong durable goods numbers. Bonds continue their swoon, with the 10 year approaching 2%. Is the “risk on” trade we have been waiting for since 2008 finally at hand?  MBS are down as well.

Fannie Mae is offering deed-in-lieu options for underwater borrowers who are current on their mortgage and have experienced some sort of hardship like illness, job change, or other problems.  It effectively allows these homeowners to “toss the keys to the bank” and walk away from their underwater property with the underwater portion of their mortgage debt forgiven. The program does not address mortgages, so a second-lien holder could prevent a homeowner from walking away.

The Federal Appeals Court has rejected Obama’s recess appointments, specifically his appointments to the NLRB and the CFPB. Cordray’s appointment to head the CFPB was an interim appointment, and he will have to go through the process for his 5-year term.  Will it change anything for people in the industry?  Probably not.

Since we have kicked the debt ceiling can down the road for a few months, the next item is the sequestration – which is all of the automatic spending cuts that kick in.  Half will be in defense, and half will be in non-defense discretionary spending. Paul Ryan was on Meet the Press and said that he expects the sequestration cuts will happen.  Agencies are bracing for the cuts to happen as well.

Looks like the eminent domain idea is officially dead, at least in California.

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