Our recap of the week in numbers from equities to bonds to commodities and housing to the many indices and measures of the economy and the for-sale and rental housing markets.
The best opportunities are often ones where you’re being contrarian. That doesn’t mean being contrarian for contrarian’s sake, but it means you’re thoughtful about the risks of following the crowd.
David Sze (Greylock Partners)
The Big No News
Following its two-day meeting, the Federal Reserve Bank’s Open Markets Committee raised the Bank’s Federal Funds Rate by 75 basis points to between 3.75% and 4.00%
Home Sales, Starts, and Financing
- Black Knight released an early look at September 2022 mortgage performance data. The bottom line is that delinquencies and foreclosures remain at historically very low levels far from the flood that occurred from 2008 to 2012.
- In defiance of a weakening U.S. economy, the U.S. 10-year treasury note yield has climbed steadily in 2022, dragging with it the interest rate on mortgages. A good primer can be found here on the relationship of the 10-year yield to the economy and also to mortgage rates.
- As charted from St. Louis Federal Reserve Bank data by The Balance, the 10-year yield and mortgage rates rise and fall almost in lock step.
- Zonda chief economist Ali Wolf tweeted that the firm's data is measuring a 70% cancellation rate for home purchase contracts in Phoenix.
- The notable feature of the recent pattern, however, is the broadening spread between the 10-year yield and the 30-year mortgage rate.
- In January 2022, the 10-year stood at 1.79%, and the 30-year mortgage was at 3.55% -- a spread of 176 basis points.
- In August, the 10-year had risen to 3.15%, but the 30-year was at 5.55% -- a spread of 240 basis points, translating to an increase in the spread of 37.9%!
- As of October 28, the 10-year had climbed to 4.016%, and the Mortgage News Daily 30-year fixed rate mortgage survey measured a rate of 7.08% -- a spread of 306 basis points.
- Fully 130 bps of the 7.08% 30-year mortgage rate is attributable to the dramatic increase in the spread over the 10-year treasury note. Had the spread not increased, the 30-year mortgage rate would be below 6.0%.
- We wrote this post before the WSJ decided to cover the topic, but the WSJ made one good additional point. The Federal Reserve Bank was a major purchaser of mortgage-backed securities until earlier this year when it announced an intention to shrink its portfolio. The Fed's decision has reduced demand substantially for MBS, which drives up the interest rate that must be paid to attract investors.
- Investors who purchase the mortgage-backed securities backed by 30-year mortgages have concerns that are reflected in the mortgage rate premium:
- Will the deteriorating economy and possibility of recession increase the delinquency rate for mortgages, especially those at the highest interest rates?
- Is the Federal Reserve likely to reverse interest rates in the relatively near term and so drive refinancing / prepayment of today's high rate mortgages?
- When investor confidence recovers in the safety and stability of 30-year mortgage backed securities watch for the spread to shrink and mortgage rates to decline meaningfully.
- Despite a confusing presentation and explanation, realtor.com made some useful and enlightening calculations of the relationship between housing starts and new job creation across 174 metropolitan areas. The website suggests that tracking job growth can identify areas with a current or looming housing shortage.
- Zonda compared September / October single-family home sales unit volume against historical volumes for some of the largest U.S. markets.
- Baltimore and Miami have shown little decline, keeping their volumes comparable to 2021.
- Raleigh, Orlando, Jacksonville, and Indianapolis are at their 2020 volumes.
- Nashville is at its 2018 volume.
- The U.S. Department of Labor Bureau of Labor Statistics cranks out an enormous volume of detailed data. This week's data included the median weekly income for all wage and salaried workers, which came in at $1,003 for workers 25 to 34 years of age and $1,197 for the next 10-year group up to 44 years, up an average of 6.9% over the past year. Now, let's do a little math.
- Assume a household with one worker in the upper age group and one in the lower age group. The total household income per week is $2,200 (a conveniently round number), which translates to $9,533 per month.
- Following the often cited but probably outdated "rule" that a household can afford to spend 30% of household income on housing, our imaginary household has $2,860 to spend on housing, which includes utilities, maintenance, insurance, taxes, and mortgage or rent.
- At today's 7.10% 30-year mortgage rate, the monthly principal and interest payment on a $400,000 home with 10% down would be $2,419, leaving just $441 for insurance, taxes, utilities, and maintenance. The numbers do not work.
- Reduce the mortgage rate to 5.5%, and the monthly payment drops by $375, leaving a viable $816 for other housing expenses.
- Over the next year or more, we will watch the volume of home sales in proportion to the 30-year mortgage. Maybe a housing market recovery will be imminent as the 30-year rate descends to the mid-5% range.
- Rocket Mortgage was the king (or queen) of refinancing in 2021. In 2022 Q2, Rocket's originations dropped to $34.5 billion from $53.8 billion in the prior year.
- Looking for new sources of originations, Rocket now offers a conventional chattel loan to manufactured home buyers.
- The buy-to-flip strategy of companies like OpenDoor (NASDAQ:OPEN) is showing signs of extreme sensitivity to interest rates and greater buyer power.
- The company lost money on 42% of its transactions in August.
- On November 2, 2022, OpenDoor announced a layoff of 18% of its employees.
- The Mortgage Bankers Association weekly survey revealed a consistent decline in volume.
- Purchase mortgage volume dropped 41% from the last week of October 2021.
- Refinance value was down 85%
Residential Rents and Construction
- The National Multifamily Housing Council (an industry trade group) released the results of its quarterly survey that purports to measure various conditions in the apartment industry.
- The four indices (market tightness, sales volume, equity financing, and debt financing) measure trends in these four categories. All four indices show that conditions are deteriorating for landlords.
- Vacancies are rising. Sales of properties are slowing. Equity and debt financing are becoming less available.
- Apartmentlist.com also released its most recent monthly report over the Halloween weekend.
- Nationwide rent fell 0.7% in October for the second monthly decline, and the biggest drop in five years. The decline was broad with rents falling in 89 of the 100 largest cities in the U.S.
- Despite the rapidly cooling rent environment, rent still rose 5.9% over the prior year.
- Over the past six months, rent rose 5% in Raleigh, putting the metro tenth nationwide in rent growth.
- Rent growth is slowing most quickly in the markets that not surprisingly had the highest rates of rent increase in 2020 and 2021.
- A quick glance at the five-year chart of rent growth rate shows something quite unremarkable -- rents rise and rents fall. Six such cycles have occurred since the beginning of 2018.
- Turning to the single-family rental market, CoreLogic released its monthly report for August 2022.
- Rent continued to rise annually at a double-digit rate but more slowly than in 2021 and early 2022. The rate has declined for four straight months.
- The pace of rent growth was slowest among detached single-family homes at the highest end of the price range.
- For the first time since before 2021, the growth in attached single-family rents outpaced detached -- 11.8% to 10.6%.
- The Phoenix market has seen a dramatic increase in development of pure build-to-rent communities. Features vary, but the communities are intended to be rental in perpetuity.
Construction Costs and Supply Chain
- The lumber industry is slowly migrating south, reports Quartz. Climate change, environmental regulations, insects, and diminishing stands of Douglas fir are closing lumber mills in the northwest and driving mill operators to the American South.
- Steel prices are at their lowest level in two years. Maybe the time will be near that homes can affordably be constructed from pre-fabricated steel components.
Equities and Bonds
- Despite a barely losing performance on Halloween, the Dow Jones Industrial Average had its best month in over 46 years -- up 14.1% for the month and up more than 900 basis points more than the NASDAQ.
Other News and Data
The U.S. economy has a mind of its own, at least vis-a-vis the Federal Reserve Bank. Despite the fastest increase in history of the Federal Funds rate, the economy is rolling along quite nicely. See the data below on employment, factor production, productivity, and more.
- The U.S. Bureau of Labor Statistics reported on non-farm employment for the year ended September 2022. Employment rose in 49 out of the 50 states and also rose in the District of Columbia. Strong employment is good news for families but bad news for the Federal Reserve's efforts to suppress inflation.
- And, also from the BLS, "Employer costs for total compensation in private industry rose 5.2 percent from September 2021 to September 2022. After adjusting for consumer price inflation, constant-dollar total compensation declined 2.8 percent in the private sector from September 2021 to September 2022."
- The October new jobs report from BLS bested expectations at 261,000 new jobs. Unemployment rose from 3.5% to 3.7%. The data may suggest that the Federal Reserve's interest rate policy is having a modest effect on the economy possibly without propelling the U.S. into recession. Time will tell. We make no forecast.
- Average hourly earnings rose 4.7% in the year ending October 2022, down from 5.0% in September and far below the 8.2% increase in the Consumer Price Index. In other words, real wages are declining at a brisk pace, which compounds the effect of higher mortgage rates.
- The number of job openings rose in September to 10.7 million, nearly 1.9 jobs for every unemployed job seeker. Private employers still are eager to hire, suggesting that the Fed's interest rate moves have not slowed business growth ambitions very much.
- As we discussed above, the substantially higher Federal Reserve Bank Federal Funds Rate has spiked mortgage rates but not done much to reduce inflation yet. Based on a detailed analysis by the Federal Reserve, the Wall Street Journal offered one explanation for the blunt effect of the Fed's action -- household cash savings.
- Households and small businesses made more than they spent in 2022 Q2 by about 1.1%, which is higher than any other pre-recession time since the 1950's.
- Households also have a lot more cash because of the largesse of the U.S. government during the Covid-19 pandemic and savings from reduced commuting and other employment-related expenses -- about $1.7 trillion.
- Higher interest rates cannot diminish inflation if consumers are spending from cash, not credit.
- Housing makes headlines in part because of the industry's 40% contribution to consumer spending. The next largest purchase made by most people is a car. J.D. Power published last week its monthly report on car sales and prices. Remember, the vast majority of car purchases are financed, not cash.
- J.D. Power forecast a 12.1% increase in retail car sales in October.
- Dealer profit remains at twice the pre-pandemic level, despite a small decline from the profit peak earlier this year.
- The average new car purchase price will be up 2.7% from a year ago to $45,599.
- Dealer discounting has dropped by 44.7% from a year ago.
- The average car loan will climb to $711 at an interest rate just above 6% and that is after crediting a trade-in.
- ADP estimated that the U.S. added 239,000 new private employer jobs in October, far higher than the forecast 195,000. Wages rose 7.7% year-over-year for employees who did not change jobs and 12.7% for job changers.
- New claims for unemployment benefits for last week came in below forecasts at 217,000, near the lowest levels since the pandemic began.
- Non-farm labor productivity rose 0.3% in the third quarter of 2022, a substantial improvement from 2021 Q3.
- Factory orders rose 0.3% in September, the 11th straight monthly increase.
- Ocean cargo freight carrier Maersk reported a 7.6% decline in volume in its most recent fiscal quarter.
- The cost of a shipping container from Asia to the U.S. West coast was down a huge 85%.
You might correctly conclude from the general economic data that the Federal Reserve's interest rate policy is only affecting the housing industry.