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9 charts and themes from the past week that tell an interesting story in markets and investing…
1) Rising Supply + Falling Demand = Lower Prices
The supply of new homes in the US crossed above 10 months in July, its highest level since January 2009. Every time it’s been over 10 months in the past, the US has been in a recession.
The combination of rising supply and lower demand is leading to falling prices. The median sales price of a US home is now down 6% from its all-time high in mid-June. Is this just typical seasonal weakness? No. During the same period last year home prices rose 0.4%.
For the first time since March 2021 (18 months), the average home is selling below its list price.
2) Higher Rents vs. Much Higher Mortgage Payments
US rents hit another record high in August, rising 10% over the last year. The rate of change in rents is slowing, however, as the 10% YoY increase is the smallest we’ve seen since June 2021.
While rents have surged over the last year, mortgage payments have surged even more. The ratio of median mortgage payments to median rents is approaching 1.5x, at its highest level on record with data going back to 2009 (WSJ).
Why have mortgage payments skyrocketed?
The combination of higher home prices and higher mortgage rates…
–Higher home prices: US home prices have risen 18% over the last year and 40% over the last 2 years (note: national Case-Shiller Index data through June).
–Higher Mortgage Rates: The 15-year mortgage rate in the US has risen to 4.98%, its highest level since 2009. A year ago it hit an all-time low of 2.10%.
3) The Job is Not Done
At Jackson Hole, Jerome Powell made it clear to anyone who was thinking otherwise that the Fed still has work to do on the inflation front, saying “we must keep at it until the job is done.”
Translation: there are more rate hikes and balance sheet unwinding to come.
The reduction in the Fed’s balance sheet has been slow thus far, only decreasing by $139 billion with assets still higher than where they started the year. The expectation is that the unwind will accelerate from here at a pace of $95 billion per month.
As for interest rates, the market is pricing in continued hikes in the Fed Funds Rate to around 4% by early 2023 before a pause and move in the opposite direction.
What would cause the Fed to shift back to easing next year?
A sharp move down in inflation due to a recession, which most people feel has already begun…
As Powell acknowledged in his speech, further tightening is going to be painful in the short run, but it’s a pain we must bear if we want to avoid a more painful outcome in the long run: “While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses. These are the unfortunate costs of reducing inflation. But a failure to restore price stability would mean far greater pain.”
4) Is a Soft Landing Possible?
Notably absent from Powell’s speech was the concept of a “soft landing,” where the economic growth would slow but an outright recession would be averted.
Is this a likely outcome?
Not based on recent history.
The last 5 times US Inflation peaked above 5% it took a higher Fed Funds Rate and a recession to bring it back down.
5) It’s All Relative
Given how far the Fed remains behind the inflation curve (2.33% Fed Funds Rate vs. 8.52% Inflation Rate) it would probably come as a surprise to learn that the US Dollar Index is at its highest level in 20 years.
But currencies are all relative, and the largest component of the Dollar Index by far is the Euro, which has been plummeting. Why is it going down so hard?
One reason: the differential between the ECB’s interest rate and inflation is even wider than the Fed’s. Eurozone inflation has moved up to 9.1%, its highest level ever. Meanwhile, the ECB only recently abandoned their negative rate policy by moving back to 0%.
6) A Volatile Year
The only years with higher volatility in stocks at this point than 2022 (169 trading days):
-1930s (Great Depression, World War II)
-2002 (Dot-Com Crash)
-2009 (Global Financial Crisis)
-2020 (Covid Crash)
The S&P 500 has declined 3% or more 7 times this year. In the last 70 years, the only ones with more 3+% down days than we’ve already seen in 2022?
2008, 2009 and 2020.
7) Why Many Fear the Bear is Not Over
This has been the 4th worst start to a year for the S&P 500 in history, and the worst we’ve seen since 2002.
With data going back to 1976, we’ve never seen a worse start to a year for a US 60/40 portfolio of stocks and bonds.
Why are many fearing that the bear market is not over yet?
There’s no shortage of reasons, but these three seem to be the most popular…
a) Earnings
S&P 500 GAAP earnings are down 12% year-over-year, the largest YoY decline we’ve seen since Q2 2020. Earnings during the quarter were down 21% from their peak in Q4 2021.
b) Recession
The last 10 times the US had 2 or more consecutive quarters of negative Real GDP growth, the economy was in a recession. You have to go back to 1947 to find an exception.
c) Fed Policy
During the previous 8 bear markets, the Fed responded with easy money (rate cuts, QE, etc.). This year they’re doing the opposite, hiking rates and expected to continue hiking for the rest of the year.
8) The Solution to the Problem?
In the last 30 years, College Tuition and Fees have more than quadrupled while overall Consumer Prices (US CPI) have doubled.
This is clearly a big problem, but is the recently announced student loan forgiveness ($10-$20k per borrower for incomes less than $125k for individuals and $250k for couples) the solution?
If your goal is lower tuition prices, unfortunately no, and it is likely to have the opposite effect.
Why? Because when you subsidize a good, you artificially increase demand for it while decreasing the incentive for buyers (students) and sellers (colleges) to lower costs.
What impact will the plan have on national debt and inflation?
-Debt: The non-partisan Penn Wharton Budget Model estimates that the Student Debt Forgiveness plan will cost $605 billion and depending on the details of the Income-Driven Repayment (IDR) program could raise the total cost to over $1 trillion…
-Inflation: The non-partisan Committee for a Responsible Federal Budget estimates that the Student Debt Forgiveness plan will boost inflation by 15 to 27 basis points over the next year as it will lead to an increase in consumption and put “upward pressure on tuition costs.”
9) Moving in the Right Direction
The Prices Paid component of the ISM Manufacturing Index is moving sharply lower, a good sign. During the inflationary spikes in the 1970s/80s, a downturn in Prices Paid was a leading indicator of lower inflation rates to come.
Gas prices in the US have moved down to $3.80/gallon (national average), a decline of 24% from their all-time high in mid-June and at their lowest levels in 6 months.
Global container freight rates have hit a 16-month low, down 52% from their peak. This is still 4x higher than pre-pandemic levels but moving in the right direction.
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And that’s it for this week.
Have a great weekend everyone and Happy Labor Day!
-Charlie
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