Morning Report: FOMC minutes and homebuilder earnings

Vital Statistics:

 

Last Change
S&P futures 2569 -13.5
Eurostoxx index 346.51 -1.2
Oil (WTI) 51.94 -0.24
10 year government bond yield 2.70%
30 year fixed rate mortgage 4.48%

 

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

 

The FOMC minutes didn’t really contain much interesting information – the committee noted that financial conditions were tightening slightly and that the stock market was falling (we bottomed on Christmas Eve), but still decided unanimously to hike the Fed Funds rate 25 basis points. Despite fears in the market that the Fed has overshot, that possibility was not entertained by either the members or the staff. Incidentally, we will have a lot of Fed speakers throughout the day.

 

Homebuilder Lennar reported strong earnings for the fourth quarter, however it decided to hold off giving guidance on 2019 due to opaque market conditions. That said, new orders were up big, and margins were strong. Lennar is transitioning into a pure-play homebuilder and has been exiting businesses like asset management and real estate brokerage. This quarter should be the last with any CalAtlantic integration noise in the numbers. The Street was happy with the numbers, sending the stock up about 8%.

 

KB Home also reported numbers, although they saw a decrease in revenues, margins and a fall in average selling prices. KB is more of a turnaround story, however and the whole sector is so out of favor that it seems any non-disaster is taken as positive. KB was up 4% on its numbers.

 

Canary in the coal mine? No high-yield debt has been issued since November, according to DealLogic. This is the first December without junk issuance since 2008. This could have simply been due to the gyrations in the stock market, but this bears watching. Despite a spike at the end of 2018, credit spreads are still at historically normal levels, so it is too early to sound any alarms yet. The Fed noted tightening credit conditions in its FOMC minutes as well.

 

Donald Trump met with Democratic Congressional leaders yesterday on the subject of border security and the government shutdown. He characterized the meeting as a “waste of time” after being told there is basically no way Democrats will allocate funds for the wall. The government shutdown is almost 3 weeks old, and Federal workers are not getting paid. That said, unlike the Obama-era shutdowns, the Trump Administration is trying to make the shutdown as invisible as possible to the average citizen. The IRS is back issuing refunds and 4506-Ts, so for the most part there isn’t much of an effect on real estate with the exception of flood insurance. 75% of all realtors noticed no impact on buyers.

 

Michael Bright, who has been the interim president of Ginnie Mae for a year and a half, has resigned and will return to the private sector. 

 

The drop in interest rates means that another half a million borrowers (total of 43 million) will find it attractive to refinance, according to Black Knight Financial Services. This is up 29% from the bottom, but still down 50% from last year.

“As recently as last month, the size of the refinanceable population fell to a 10-year low as interest rates hit multi-year highs,” said Graboske. “Rates have since pulled back, with the 30-year fixed rate falling to 4.55 percent as of the end of December. As a result, some 550,000 homeowners with mortgages who would not benefit from refinancing have now seen their interest rate incentive to refinance return. Even so, at 2.43 million, the refinanceable population is still down nearly 50 percent from last year. Still, the increase does represent a 29 percent rise from that 10-year low, which may provide some solace to a refinance market still reeling from multiple quarters of historically low – and declining – volumes.

“In fact, through the third quarter of 2018, refinances made up just 36 percent of mortgage originations, an 18-year low. And of course, as refinances decline, the purchase share of the market rises correspondingly. So now, in the most purchase-dominant market we’ve seen this century, we need to ask whether the shift in originations will have any impact on mortgage performance. The short answer, based on historical trends, is that it certainly bears close watching.  Refinances have tended to perform significantly better than purchase mortgages in recent years. When we take a look back and apply today’s blend of originations to prior vintages, the impact becomes clear. A market blend matching today’s would have resulted in an increase in the number of non-current mortgages by anywhere from two percent in 2017 to more than a 30 percent rise in 2012, when refinances made up more than 70 percent of all lending. As today’s market shifts to a purchase-heavy blend of lending, Black Knight will continue to keep a close eye on the data for signs of how – or if – this impacts mortgage performance moving forward.”

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: Why we haven’t seen much wage growth (yet) and what the left gets wrong about labor markets

Vital Statistics:

Last Change
S&P futures 2743 9.7
Eurostoxx index 388.45 1.55
Oil (WTI) 65.49 -0.32
10 Year Government Bond Yield 2.91%
30 Year fixed rate mortgage 4.54%

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

We should have a relatively quiet week coming up, with not much in the way of data and no Fed-speak.

Friday’s jobs report was pretty much a Goldilocks report as far as the markets are concerned. Strong job growth, with respectable (but controlled) wage growth is exactly what the Fed wants to see. Tomorrow, we will get the JOLTS job openings report, which should show job openings of around 6.5 million.

Academics are scratching their heads trying to figure out why wage growth is so slow with unemployment below 4%. With the economy at “full employment” at least according to the unemployment numbers, how can so many jobs still be created? And if unemployment is below 4% and we are at a record number of job openings, where is the wage growth?

First of all, the jobs report had wage growth at 2.7%, and the core PCE inflation rate is 2%. So, we do have inflation-adjusted (i.e. real) wage growth. Second, productivity is a puzzle. It has been low for a decade, and part of the issue is that productivity is notoriously hard to measure, especially when valuable goods are “free” or hard to measure. Think of social media, which has all sorts of entertainment value and productivity enhancing value, yet is supposedly free. Yes, you are paying with your data, but what is your data worth? Productivity calculations need a dollar value. Productivity has been low, but there is a huge uncertainty range around that number.

I think a huge part of the issue is the fact that the unemployment rate excludes anyone who has been unemployed over 6 months, and there is a huge reservoir of workers on the sidelines who want to return to the labor force. Companies know this, and all they have to do is relax their standards (i.e. hire people who have been out of the labor force for a while) and they will fill their positions. At the end of the day, this is a numbers game. The employment-population ratio has been steadily increasing since 1970 as women have entered the workforce. It peaked in 2000, bottomed after the Great Recession, and has been steadily working its way upward. The demographic factor (retiring baby boomers) is probably getting overplayed here, as most people no longer can retire at 65 (and there really is no reason why most can’t continue to work).

Leftist economics are arguing that employers are somehow colluding to keep wages low, and therefore are suggesting a panoply of policy levers designed to artificially force up wages and increase unionization. Aside from non-competes in the rarefied air of Silicon Valley engineers, generally this doesn’t happen – cartels are almost impossible to make work (witness OPEC) and there are simply too many employers who don’t compete with each other to coordinate it, even if they wanted to.

Instead of jumping to the “market failure” conclusion, the answer is that there is more slack in the labor market than the numbers suggest. There may be a mismatch of skills, where there is high demand in areas where there aren’t a lot of available workers (skilled trades, data scientists) but overall the employment population ratio doesn’t lie. The last time we saw decent wage growth was the 90s, where the employment-population ratio was around 63%. The latest number was 60.4%. That difference in a population of 326 million is about 8.5 million jobs. That is about 3 year’s worth of job growth, without population growth which is still measurable at 0.7% a year. Even if you take into account the 6.5 million job openings, you still have probably 2 million extra workers on the sidelines. IMO, that is your answer about wage growth, not monopsony of collusion, which is just a specious argument for more government intervention in the labor markets.

Chart: Employment-population ratio.

employment population ratio

House price appreciation continues apace, and between rising price and interest rates, the monthly house payment on the median house with 20% down has increased by $150 a month, according to Black Knight Financial Services. Income growth at 2.7% is not going to keep up with home price appreciation, which is running at around 6% a year. When rates were falling, we were able to paper over that issue with lower mortgage payments, but that game is over. Housing starts are still way too low, and that question is even more perplexing than wage growth.

Note that private equity is now building homes for rent, which should alleviate some of the supply problem. It was only a matter of time until new entrants saw the opportunity that the big builders have been sitting on. Politicians are getting sick and tired of the lack of housing supply (especially at the lower price points).

Friday’s jobs report reversed the Euro-driven drop in the June Fed Funds futures. At one point, they were predicting a 81% chance of a hike. Now it is back up to a near certainty. The December futures are predicting a 40% chance of 4 or more hikes this year and a 60% chance of 3 or less.