All Things in Moderation

Stocks are lower as we await Jerome Powell’s speech in Sweden. Bonds and MBS are up.

Small Business Optimism declined in December, according to the NFIB Small Business Optimism Index. “Overall, small business owners are not optimistic about 2023 as sales and business conditions are expected to deteriorate,” said NFIB Chief Economist Bill Dunkelberg. “Owners are managing several economic uncertainties and persistent inflation and they continue to make business and operational changes to compensate.” You can see in the chart below, we are at the lowest levels in nearly a decade.

Despite the overall gloom, there were some positive points in the survey. Inventories are back in balance, which means the supply chain issues of the post-pandemic period are largely in the rear view mirror. The number of companies raising prices also fell, and employers continue to plan to hire more workers.

Generally speaking companies do expect a recession in 2023 and are taking steps to prepare themselves for it.

Minneapolis Fed President Neel Kashkari wrote an article on inflation which discusses what the Fed missed in 2021 and lays out what it might do going forward. His point is that when prices rise, both supply and demand should adjust. Rising prices should decrease demand and increase supply. The problem is that supply hasn’t increased.

He likens it to surge pricing on ride sharing apps. When it rains more people would rather ride than walk. Prices rise. However what happens when every available driver is already working? Supply doesn’t increase. And that is where we are now. In economics terms, the supply curve is vertical. Increased demand just increases prices.

If this sounds familiar to old-timers, they might recognize the term “supply-side economics” from the late 1970s and the Reagan Administration. We had this problem during the 70s, when US manufacturing capacity was more or less maxxed out, and rising demand simply meant higher prices.

Supply side economics incentivized producers to increase capacity, which would address the lack of incremental supply (hence the name “supply-side)” The government cut taxes, which made it more likely that new projects would be profitable (or NPV-positive in B-school jargon) and it also changed the rules on depreciation which allowed companies to recoup capital expenditures quicker through bigger up-front tax deductions. While the term “supply side” has become a pejorative on the left, that was the logic of it.

It is interesting to see guys like Neel Kashkari who were too young to remember the 1970s inflation issues start to think about supply side economics. Global economies have done the Keynesian pump-priming thing for the past 15 years, which was more or less what we did from 1965 – 1980. Similar results. So perhaps a new, re-branded supply-side economics will become in vogue again.

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Stocks are higher this morning on follow-through from the jobs report on Friday. Bonds and MBS are up.

The week ahead will have some important economic data with the consumer price index on Thursday and the University of Michigan Consumer Sentiment survey on Friday. The Michigan number will focus on inflation expectations, which is something the Fed is laser-focused on. Jerome Powell will speak on Tuesday.

Earnings season kicks off this week with the big banks reporting. The Street is looking for weak numbers and a string of layoffs. Goldman will be laying off about 3,200 employees this week, and we have seen plenty of layoffs in tech-land. The Fed wants to see a weaker labor market, so they might get what they are looking for.

Rate lock volumes declined 19.4% in December, according to Black Knight’s Mortgage Monitor. Purchase locks were down 20.5%, while rate / term were down 11.2% and cash-outs were down 14%. “Mortgage rates declined through the first half of December but reversed course as the Fed doubled down on their stance of additional tightening in 2023,” said Kevin McMahon, president of Optimal Blue, a division of Black Knight. “The spread between mortgage rates and the 10-year Treasury yield narrowed another 22 basis points during the month to 264 basis points, which is 40 basis points off the recent high, but is still up 81 basis points for the year.”

“Using Black Knight’s McDash mortgage performance data to provide comparative history, December saw the fewest purchase locks in a single month since early 2014, and the fewest overall rate locks on record dating back to January 2000 when Black Knight began reporting origination metrics,” McMahon continued. “The number of mortgage holders locking in a rate to refinance their existing mortgage also set a new record low for the fourth consecutive month.”

Given the absence of refi activity, seasonality is a big driver these days. We will probably continue to report lousy volumes until the Spring Selling Season starts in a month or so.

Another positive for inflation. Ocean shipping rates are down 80% from their peak in September. It may not have a massive effect of prices for consumers, but it certainly helps.

Finally, some news from me. I launched my Substack over the weekend, where I took went over the market’s reaction to the jobs report and the main drivers. The Weekly Tearsheet will take a deeper dive into some of the happenings in the prior week, along with economic commentary. I hope you enjoy it and consider subscribing. If you use this professionally and can expense it, I hope you consider becoming a paid subscriber.

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Vital Statistics:

Stocks are lower after stronger-than-expected labor market data. Bonds and MBS are down.

The economy added 235,000 jobs in December, according to ADP. This was above the 145,000 Street estimate, and is also above the forecast for tomorrow’s jobs report. Initial Jobless claims fell to 204,000 which signals the labor market remains tight. Finally, outplacement firm Challenger, Gray and Christmas noted 43,651 announced job cuts in in December.

The minutes from the FOMC meeting were released yesterday and they poured cold water on people hoping for a Fed pivot.

What about the dovish CPI reports in November and December? “Participants concurred that the inflation data received for October and November showed welcome reductions in the monthly pace of price increases, but they stressed that it would take substantially more evidence of progress to be confident that inflation was on a sustained downward path. Participants noted that core goods prices declined in the October and November CPI data, consistent with easing supply bottlenecks…. Participants noted that, in the latest inflation data, the pace of increase for prices of core services excluding shelter—which represents the largest component of core PCE price inflation—was high. They also remarked that this component of inflation has tended to be closely linked to nominal wage growth and therefore would likely remain persistently elevated if the labor market remained very tight.”

In other words, the reduction in inflation is being driven primarily by easing supply chain issues which is old news. They see inflation as being driven by supply chain issues, housing, and wages. The supply chain issues are largely resolved. Housing-driven inflation will disappear by summer. The battle they are fighting is based on wages. As long as wage growth remains high, they are going to keep tightening. Below is a chart of average hourly earnings. We are in the low 5% range. They probably want to see that number closer to 3%. BTW the spikes up and down in the early days of COVID are lockdown-related noise.

The FOMC also noted that the Fed Funds futures were at odds with the FOMC, and that no members thought it would make sense for the Fed to start easing in 2023. Take a look below at the Fed Funds futures – the disconnect is pretty substantial:

The Fed also noted that financial conditions have eased, and that they don’t want a further easing. “Participants noted that, because monetary policy worked importantly through financial markets, an unwarranted easing in financial conditions, especially if driven by a misperception by the public of the Committee’s reaction function, would complicate the Committee’s effort to restore price stability.”

Home prices declined 3.2% on a QOQ basis, according to the Clear Capital Home Data Index. We are beginning to see big declines out West, and MSAs like San Francisco are now flat on a YOY basis. Florida remains one of the best markets.

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Vital Statistics:

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

The FOMC minutes will be released at 2:00 pm. This release could be market-moving as a lot of investors will be looking for the Fed’s rationale to raise its inflation target when the data were showing a slowdown.

Mortgage applications fell 13.2% over the past couple of weeks, according to the MBA. Purchases were down 12.2% while refis fell 16.3%. Refi activity is down 87% compared to a year ago. “The end of the year is typically a slower time for the housing market, and with mortgage rates still well above 6 percent and the threat of a recession looming, mortgage applications continued to decline over the past two weeks to the lowest level since 1996,” said Joel Kan, MBA’s Vice President and Deputy Chief Economist. “Purchase applications have been impacted by slowing home sales in both the new and existing segments of the market. Even as home-price growth slows in many parts of the country, elevated mortgage rates continue to put a strain on affordability and are keeping prospective homebuyers out of the market. Refinance applications remain less than a third of the market and were 87 percent lower than a year ago as rates remained close to double what they were in 2021. Mortgage rates are lower than October 2022 highs, but would have to decline substantially to generate additional refinance activity.” 

Construction spending rose 0.2% MOM and 8.5% YOY in November, according to the Census Bureau. Residential construction spending fell 0.5% MOM and rose 5.3% on a YOY basis.

The manufacturing economy contracted in December, according to the ISM Manufacturing Index. The index came in at 48.4, the lowest since the early days of the pandemic. If the index comes in above 50, it is expanding, while below it is contracting. The prices index fell to 39.4, which is good news on the inflation front, while employment remained in expansion territory.

Job openings were more or less unchanged in November, according to the JOLTS job openings report. The quits rate (which tends to predict wage increases) ticked up as well.

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Vital Statistics:

Stocks are higher as we start the new year. Bonds and MBS are up.

The week ahead will contain some important economic data, with the ISM data and the jobs report on Friday. Given that Jerome Powell’s focus has been the surprisingly strong jobs report, I could see a situation where bad news is good news – i.e. a weak report would trigger a rally in stocks and bond as it would increase the chances that the Fed will pivot from a tight monetary policy to a neutral one.

Jerome Powell discussed the three basic inputs to inflation. First, there are the supply chain issues, which manifested themselves early on in the pandemic. Second, there is housing which had its biggest impact beginning in 2022. Finally, there is services ex-housing, which basically means service sector wage growth. The supply chain issues have largely been fixed, and housing will probably fade by summer. The final component – services ex housing – is the focus of the Fed. Which means any negative news in the labor market will perversely be positive for the markets.

Manufacturing exhibited the fastest decline since May of 2020, according to the S&P Global Purchasing Managers Index. “The manufacturing sector posted a weak performance as 2022 was brought to a close, as output and new orders contracted at sharper rates. Demand for goods dwindled as domestic orders and export sales dropped. Muted demand conditions also led to downward adjustments of stock holdings, as excess inventories built earlier in the year were depleted in lieu of further spending on inputs. With the exception of the initial pandemic period, stocks of purchases fell at the steepest rate since 2009. Sinking demand for inputs and greater availability of materials at suppliers led to a further easing of inflationary pressures. In fact, the rate of input price inflation fell below the series trend. Selling price hikes also eased, albeit still rising steeply. Slower upticks in inflation signal the impact of Fed policy on prices, but growing uncertainty and tumbling dem

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The 11th Circuit issued an opinion the other day on another trans case coming out of Florida, in which a trans person sued a school district for restricting access to bathrooms in schools on the basis of biological sex rather than self-declared gender. Most of the headlines focused on the fact that, contrary to similar cases in other circuits, the 11th Circuit ruled in favor of the school district, which makes it highly likely that the issue will finally have to be resolved by SCOTUS. But for me the most notable thing was one of the dissents, and how it substantiates the concerns that the ultimate goal of trans ideology is the elimination of the very concept of biological sex. There were 5 opinions issued apart from the majority ruling, including 1 concurrence and 4 separate dissents.

The most troubling dissent was by Judge Jill Pryor (joined in parts by Judge Rosenbaum).

Recall that at the beginning of the whole trans craze, less than 10 years ago, it was repeatedly asserted that gender as a concept was wholly distinct from sex. The two terms it was claimed, referred to two separate things. The simplistic explanation that was routinely trotted out was that sex is what is between your legs, and gender is what is between your ears. This claimed distinction had its own coherency problems, but at the very least it implicitly acknowledged the reality of the binary biological categories of male and female. There was a semantic game being played in attempting to divorce the concepts of “man” and “woman” from their biological underpinnings in “male” and “female”, but the biological notions of “male” and “female” were not themselves being challenged or changed. As trans ideology takes its next reality-obscuring step forward, it appears that is no longer true.

In her dissent, Pryor argues not that bathrooms separated by biological sex are unlawful, but rather that biological sex itself is determined by one’s “gender identity”, which means that when a transgender boy (ie a female who is claiming to be a boy) is denied the use of the boys bathroom, it can only be a result of “his” transgender status, because “he” is, in fact, a biological male. You may think I am joking, or misunderstanding, or making this up. I am not.

From Pryor’s opinion:

“To start, the majority opinion simply declares—without any basis—that a person’s “biological sex” is comprised solely of chro- mosomal structure and birth-assigned sex. So, the majority opinion concludes, a person’s gender identity has no bearing on this case about equal protection for a transgender boy. The majority opinion does so in disregard of the record evidence—evidence the majority does not contest—which demonstrates that gender identity is an immutable, biological component of a person’s sex.

With the role of gender identity in determining biological sex thus obscured, the majority opinion next focuses on the wrong question: the legality of separating bathrooms by sex. Adams has consistently agreed throughout the pendency of this case—in the district court, on appeal, and during these en banc proceedings— that sex-separated bathrooms are lawful. He has never challenged the School District’s policy of having one set of bathrooms for girls and another set of bathrooms for boys. In fact, Adams’s case logi- cally depends upon the existence of sex-separated bathrooms. He— a transgender boy—wanted to use the boys’ restrooms at Nease High School and sought an injunction that would allow him to use the boys’ restrooms.”

This is a remarkable display of sophistry in several respects. but it is not Pryor’s alone. She cites and claims to be relying on “expert” testimony at the original trial in which a Dr. Ehrensaft claims that “external genitalia alone— the typical criterion for assigning sex at birth—[was] not an accurate proxy for a person’s sex” and that:

“[M]edical understanding recognizes that a person’s sex is comprised of a number of components including: chromosomal sex, gonadal sex, fetal hormonal sex (prenatal hormones produced by the gonads), internal morphologic sex (internal genitalia, i.e., ova- ries, uterus, testes), external morphological sex (ex- ternal genitalia, i.e., penis, clitoris, vulva), hypotha- lamic sex (i.e., sexual differentiations in brain devel- opment and structure), pubertal hormonal sex, neu- rological sex, and gender identity and role….When there is a divergence between these factors, neurological sex and related gender identity are the most important and determinative factors.”

Again, there is a lot of word salad and sophistry going on here, but read that one more time. It is saying, quite explicitly, that when a person’s “gender identity” diverges from biological sex-indicators, “medical understanding” is that “gender identity” is the determinative factor in establishing a person’s biological sex. Now, I don’t know how widespread this understanding actually is in the medical community, and I suspect it isn’t at all the common medical understanding (which would make the Dr.’s testimony border on perjury). But it is an indication that we are entering the next phase of the trans ideological war on objective reality, and its attempt to impose itself simply by redefining words and concepts.

The goal here is to essentially make it impossible to even talk about (and hence to think about) the historical understanding of the biological binary. Under the previous iteration of trans ideology and language, it was laborious but at least still possible to have a coherent discussion by using the words “male” and “female” where one would have in the past used “men/boys” and “women/girls”. However, if even the words “male” and “female” are going to be re-defined as being determined by “gender identity”, it will no longer be possible to have that discussion. And again, that is surely the whole point here, to make that discussion impossible.

Watch for this to start showing up more often in these cases.

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Vital Statistics:

Stocks are lower this morning as we round out a year most market participants would love to forget. Bonds and MBS are down.

The bond market closes early today, and volumes should be light as everyone heads into the long weekend.

The Chicago PMI showed the economy contracting for the fourth consecutive month, although the rate of decline decelerated in December.

Luxury home sales fell 38% over the past 3 months – the biggest decline on record according to Redfin. The areas experiencing the biggest declines were Nassau County (think the Hamptons), San Diego, San Jose, Riverside, and Anaheim.

Luxury homes probably correlate pretty tightly with the fortunes of the stock market, and are often looked at as investments. With home prices beginning to decline potential buyers are pulling in their horns.

With the mortgage banks so battered over the past year, I am wondering if they might be good candidates for the January Effect.

Wishing everyone a happy and prosperous new year.

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Vital Statistics:

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

The FHFA reported that 30-60 day delinquencies rose 0.4 ppts YOY to 1.2% in the third quarter of 2022. This was a 0.2% increase on a QOQ basis. All buckets – enterprise, government, and other conventional – increased, however government increased the most. Government loans were 3.1% in the 30-60 day bucket which was up 1.4% YOY and 0.6% QOQ. Given that FHA loans are usually high LTV loans, we should see things get worse as home prices decline and these loans slip into negative equity.

Investor confidence turned dour in December, according to the State Street Investor Confidence Index. The index fell 14.4 points to 75.9.

We are seeing investors rotate into defensive names such as utilities and consumer non-discretionary stocks ahead of an expected recession in 2023. The bright side is the next phase will be early-stage cyclicals which includes financials and homebuilders. 2023 will start out as downright awful for housing, however the second half could be brighter, especially if we finally see a pick up in homebuilding.

Initial Jobless claims ticked up 9k to 225k last week. The labor market continues to prove resilient despite other measures of weakness.

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Vital Statistics:

Stocks are higher this morning on optimism over China’s latest bout with COVID. Bonds and MBS are down.

Pending Home Sales fell 4% in November to the lowest level in 20 years. They are down a whopping 38% on a YOY basis. “Pending home sales recorded the second-lowest monthly reading in 20 years as interest rates, which climbed at one of the fastest paces on record this year, drastically cut into the number of contract signings to buy a home,” said NAR Chief Economist Lawrence Yun. “Falling home sales and construction have hurt broader economic activity.”

Note that sales tend to lag moves in the mortgage market by a couple of months, so sales today represent rates in October and November. Mortgage rates peaked in mid-November and have been falling since. The Spring Selling Season should see a pickup in sales. Geographically, the West has seen the biggest declines.

The WSJ had an interesting article about non-traded single-family REIT funds, which have outperformed their publicly traded counterparts by a lot this year. Blackstone’s BREIT fund has reported a gain of 8.5% this year, versus the bloodbath that has been the publicly-traded REIT stocks. About half of the assets in these private REITs is residential. Compare that to the stock price of Invitation Homes, a single family rental REIT, which is down 34% so far this year.

The outperformance means that a lot of the fast money in these funds want to ring the register and pull their money out. Blackstone has been forced to freeze redemptions, as has Starwood. If these funds are similar to American Homes 4 Rent or Invitation, they have heavy exposure to Southern California and Phoenix, which is where iBuyers like Zillow and Redfin have also been slammed. End-of-year redemptions could mean some forced selling for these funds, which would certainly impact property prices in these MSAs.

Transactions in general have been slowing in commercial real estate. This is usually a sign of falling prices. As interest rates increase, cap rates have to rise as well to reflect the cost of financing. I think this is most pronounced in office properties. Manhattan’s landlord – S.L. Green just cut its dividend to conserve cash.

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Vital Statistics:

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

We should have a quiet week ahead as investors (and mortgage bankers) wrap up a year they would love to forget. We don’t have much in the way of market-moving data so any large movements in the markets should be read in the context of light holiday trading.

House prices were flat in October, according to the FHFA House Price Index. They increased 9.8% on a YOY basis. “U.S. house prices have seen two consecutive months of near-zero appreciation,” said Nataliya
Polkovnichenko, Ph.D., Supervisory Economist, in FHFA’s Division of Research and Statistics. “Higher mortgage rates continued to put downward pressure on demand, weakening house price growth. The U.S. house price index growth decelerated as it posted the first 12-month growth rate below 10 percent after 24 consecutive months of double-digit appreciation rates.” The Pacific Division had the lowest YOY home price appreciation, while New England had the highest.

The Case-Shiller Home Price Index fell 0.3% in October and was up 9.2% on a YOY basis. “October 2022 marked the fourth consecutive month of declining home prices in the U.S.,” says Craig J. Lazzara, Managing Director at S&P DJI. “For example, the National Composite Index fell -0.5% for the month, reflecting a -3.0% decline since the market peaked in June 2022. We saw comparable patterns in our 10- and 20-City Composites, both of which stand -4.6% below their June peaks after October declines of -0.7% and -0.8%, respectively. These declines, of course, came after very strong price increases in late 2021 and the first half of 2022. Despite its recent weakness, on a year-over-year basis the National Composite gained 9.2%, which is in the top quintile of historical performance levels.

Personal Incomes rose 0.4% in November, while personal consumption rose 0.1%. The Personal Consumption Expenditures Index (the Fed’s preferred measure of inflation) rose 0.1%. Excluding food and energy, it rose 0.2%. The monthly numbers are back at levels that should make the Fed happy, although the annual increases are still too high.

The drop in consumption is a worry, and I suspect the narrative is going to shift quite rapidly from fears of inflation to fears of a recession. Another signal of the change: retail. Dollar Stores are back in fashion.

New Home Sales rose 5.8% to a seasonally-adjusted annual rate of 640,000. This was down about 16% compared to a year ago. Meanwhile, Lennar is looking to sell about 5,000 homes to single-family rental funds.

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