Morning Report: Homes are still affordable, but for how much longer?

Vital Statistics:

 

Last Change
S&P futures 2732.75 -6.85
Eurostoxx index 362.55 -0.95
Oil (WTI) 62.68 -0.42
10 year government bond yield 3.20%
30 year fixed rate mortgage 4.96%

 

Stocks are lower as voters head to the polls for Midterm elections. Bonds and MBS are flat.

 

Regardless of what your politics are, I think everyone will agree that it will be refreshing to not get spammed everywhere with political ads, starting tomorrow.

 

The Midterm elections will hold the press’s attention today, however they won’t have much (if any) of an impact on markets. Expect Democrats to take the House and a few governorships and Republicans to hold the Senate. This means gridlock for the next two years, which is good news for stocks and bonds.

 

The ISM Non-Manufacturing Index slowed a touch in September, but was still pretty strong. New Orders rose while employment was a drag on the index. Employment issues referred to the labor supply, with comments like: “Low unemployment causing team members to leave for higher wages in other businesses and industries” and “Challenging to replace vacant positions.” Expect to see more wage inflation ahead. Tariffs are still worrying some respondents and construction is experiencing cost push inflation. Retailers are reporting strong traffic and expect it to continue through the rest of the year. All of this adds up to a probable hike in December.

 

Rising mortgage rates have cut the size of the refinanceable pool of mortgages to 1.85 million, a 56% drop from the beginning of the year. Overall, there apparently were 6.5 million borrowers in total who had the opportunity to refinance during the ZIRP years that missed the boat. Despite the concerns about affordability, it takes 23.6% of median income to make the monthly payment on the average house which is lower than the pre-bubble benchmark of 25.1%. (Note: I did a deep dive into that metric earlier this year in the Scotsman Guide: Homes are Not Overpriced.) Black Knight estimates that an additional 50 basis points rise in the mortgage rate will push the monthly payment metric above the historical average, even if home prices don’t rise further.

 

refinance candidates

 

The residential homebuilding sector has had a lot of headwinds to deal with, from labor shortages, to rising materials prices and also the lack of buildable lots. The issue is that in the areas where demand is highest (places like Seattle and SF) there are geographical issues that make building out hard. On the other hand, in places like the Midwest, where there is less demand, there is plenty of land available.

Morning Report: October was hard on MBS investors

Vital Statistics:

 

Last Change
S&P futures 2728 4
Eurostoxx index 364.84 0.76
Oil (WTI) 62.92 -0.35
10 year government bond yield 3.21%
30 year fixed rate mortgage 4.96%

 

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

 

The highlight of this week will be the FOMC meeting on Wednesday and Thursday. Typically they fall on Tuesday and Wednesday, but I guess they moved it for election day this year. No changes in monetary policy are expected and the Fed Funds futures market is assigning a 93% probability of no change in rates. Aside from the FOMC meeting, the only other market moving news will be PPI on Friday. Whatever happens Tuesday is probably not going to be market-moving. Best bet: Ds narrowly take the House, Rs retain the Senate, gridlock rules Washington.

 

October was a rough month for MBS investors, the kind folks who set our rate sheets. MBS underperformed Treasuries by 37 basis points, the worst since immediately after the election. Yes, the Fed is reducing the size of its MBS holdings, but that isn’t what makes MBS outperform and underperform. Volatility in the Treasury markets can be great for bond investors, but is is toxic for MBS investors.  You can see we October was a period of high volatility in the bond market (shown below with a “VIX” for Treasuries). Volatility causes losses losses for MBS investors and makes them less likely to “bid up” securities, which translates into a phenomenon where rates don’t improve as much as you would think when rates fall, and negative reprices happen frequently.  The Fed’s reduction of its balance sheet has been going on for years, and it isn’t all of a sudden going to manifest itself in rates.

TYVIX

 

Fannie and Freddie reported strong numbers and paid about $6.6 billion to Treasury between them. Fannie Mae has paid in total about $172 billion to Treasury since the bailout.

 

Jerome Powell thinks the current period of low inflation and low unemployment could last “indefinitely.” Historically, inflation usually increased as unemployment fell (which was measured by the Phillips Curve). He thinks that relationship has broken down over time. He notes that the last two booms were not ended by goods and services inflation, they were ended by burst asset bubbles. Since we don’t seem to have any asset bubbles brewing at the moment, this set of affairs could last a while. I wonder how much of the historical unemployment / inflation was due to union contracts which included explicit inflation cost of living increases. Regardless, he is correct that we don’t have anything resembling a stock market bubble or real estate bubble, and changes in inventory management have probably done a lot to get rid of the historical cause of recessions, which is an inventory glut.

 

Isn’t this a perfect encapsulation of the cognitive dissonance in the business press right now? They don’t like the guy in office, so they constantly feel like the economy is awful (Consumer confidence is definitely a partisan phenomenon). Classic example of why you always have to take consumer confidence numbers (and the business press) with a grain of salt….

Cognitive DIssonance

 

Morning Report: Blowout jobs report

Vital Statistics:

 

Last Change
S&P futures 2752 12.25
Eurostoxx index 364.42 2.24
Oil (WTI) 63.42 -0.46
10 year government bond yield 3.18%
30 year fixed rate mortgage 4.89%

 

Stocks are higher this morning after a strong employment report. Bonds and MBS are down.

 

Jobs report data dump:

  • Nonfarm payrolls up 250,000
  • Unemployment rate 3.7%
  • Average hourly earnings up 3.1%
  • Labor force participation rate 62.9%
  • Employment-Population ratio 60.6%

 

Overall, an exceptionally strong report, with nothing to dislike. Strong wage growth, increasing labor utilization rates, low unemployment. Simply  put, this is a blowout jobs report, the best we have seen in years.

 

The sell-off in the stock market was beginning to push the Fed Funds futures towards the dovish direction, but this report pretty much ended that. While  we will get one more job report before the December FOMC meeting, it is looking like we are going to see another 25 basis points.

 

Productivity increased 2.2% in the third quarter, which was a deceleration from the 2.9% we saw in Q2. Unit labor costs rose 1.2%. We are seeing rising compensation costs (up 3.5%) while output is also up. Rising comp costs are much higher than the inflation rate, and while it is easy to focus solely on wages, the cost of an employee is more than just wages – it includes benefits and other regulatory costs as well.

 

Construction spending was flat in August and rose 7.2% YOY. Residential construction rose 0.5% MOM and 4.9% YOY. Office and lodging rose smartly on a YOY basis. Interestingly, education building is still going strong, just as the tail end of the Millennial generation is graduating. You would think colleges would figure out how to compete on price, but for the moment they are competing on amenities and infrastructure. Which is partly why college is so expensive. There is going to be a reckoning, IMO when a demographic dearth of students meets falling affordability driven by rising interest rates.

 

Manufacturing slowed somewhat last month according to the ISM Manufacturing Survey, however it remains robust, despite what is going on with trade.  That said, many of the comments from survey participants noted that prices are rising, partially driven by tariffs. Supply lines are stretched and more firms are running at capacity. That said, the higher anecdotal capacity utilization isn’t translating into the numbers, at least not compared to historical norms:

 

capacity utilization

 

Rising interest rates have pulled back corporate bond issuance. Corporate bond issuance is often the canary in the coal mine for the economy and therefore bears watching. Many companies tapped the markets during the ZIRP years to refinance pre-crisis debt and the fund stock buybacks, so perhaps the comparisons aren’t really all that valid. Investor appetite is waning, however that may be due to the fact that shorter duration paper is beginning to earn a return, so funds are getting defensive with the Fed in tightening mode. So far we aren’t seeing a material widening of credit spreads. Still, in the summer of 2007, a few leveraged buyouts were unable to sell the paper from M&A deals, and the buyside went on a buyer’s strike against structured products. At the time, nobody had any idea what it would turn into.

Morning Report: Lots of labor data

Vital Statistics:

 

Last Change
S&P futures 2723 12.25
Eurostoxx index 364.42 2.24
Oil (WTI) 64.81 -0.46
10 year government bond yield 3.16%
30 year fixed rate mortgage 4.89%

 

Stocks are higher this morning after yesterday’s end of month window dressing. Bonds and MBS are down again.

 

The ADP report showed the US economy added 227,000 jobs in October, which is well ahead of the Street estimate for Friday’s BLS report. There was a big (typically seasonal) increase in transportation and retail, although professional / business services was strong as well. Mark Zandi, chief economist of Moody’s Analytics, said, “The job market bounced back strongly last month despite being hit by back-to-back hurricanes. Testimonial to the robust employment picture is the broad-based gains in jobs across industries. The only blemish is the struggles small businesses are having filling open job positions.” Large and medium sized employers (50 employees +) accounted for the lion’s share of new jobs.

 

ADP jobs report

 

With added employees comes added employee cost. The Employment Cost Index rose 0.8% QOQ and 2.8% YOY. The wage component of employment costs rose 2.9% while the benefit portion rose 2.4%. The drop in healthcare costs is helping wages as higher healthcare costs of consumed a lot of employee raises. Your cost of healthcare ate your cost of living raise.

 

Mortgage Applications decreased 2.5% last week as purchases fell 2% and refis fell 4%. Rates held steady. “The 30-year fixed-rate mortgage held steady over the week, but total applications decreased overall. Purchase applications inched backward from the previous week, as well as compared to one year ago – the first year-over-year decline in purchase activity since August,” said Joel Kan, AVP of economic and industry forecasts. “Purchase applications may have been adversely impacted by the recent uptick in rates and the significant stock market volatility we have seen the past couple of weeks. Additionally, the ARM share of applications increased to its highest level since 2017, but since this is a compositional measure, it was driven by a greater decrease in applications for fixed-term loans relative to the decrease in ARM applications.”

 

The Challenger and Gray job cut report rose last month, but it is a third-tier employment data point. It focuses on job cut announcements, which may or may not happen.

 

The homeownership rate rose 64.4% according to the Census Bureau. This was up 0.1% from the second quarter and 0.4% from a year ago. The homeownership rate has been ticking up, although the big jump in homeownership from 1994 to 2005 was partially driven by aggressive social engineering out of Washington and probably was artificially high.

 

homeownership rate NAD

Morning Report: Red October ends

Vital Statistics:

 

Last Change
S&P futures 2704 19.25
Eurostoxx index 361.06 5.53
Oil (WTI) 66.46 0.28
10 year government bond yield 3.14%
30 year fixed rate mortgage 4.89%

 

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

 

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

 

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

 

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

 

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

 

freddie mac mortgage rates

 

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

 

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

Morning Report: S&P 500 enters correction territory

Vital Statistics:

 

Last Change
S&P futures 2648 4.5
Eurostoxx index 355.05 -0.48
Oil (WTI) 66.58 -0.46
10 year government bond yield 3.11%
30 year fixed rate mortgage 4.93%

 

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

 

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

 

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

 

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

 

savings rate

 

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

 

Morning Report: GDP comes in stronger than expected

Vital Statistics:

 

Last Change
S&P futures 2691 21.65
Eurostoxx index 356.69 4.38
Oil (WTI) 67.32 -0.28
10 year government bond yield 3.10%
30 year fixed rate mortgage 4.93%

 

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

 

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

 

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

 

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

 

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

 

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