Several months ago, I said that the Federal Reserve should go all in with a big interest-rate hike. Rip the bandage off quickly, I wrote. We’ll head into a recession but it will be shorter and will help reset the economy, I predicted, while smaller increments will just prolong the pain.
Alas, Fed Chair Jerome Powell didn’t take my advice and although I like to be right most times, this time it’s a bit painful, even for me.
That’s because our economy is showing huge discrepancies between good news and bad (due in part to latent data), making for more uncertainty. And, honestly, they didn’t do a great job of reading consumer sentiment, which might have helped decision-making more so than simply using latent data.
The Wall Street Journal, June 15, 2022, 2:43 pm ET.
Interest rates: An eventual end to the pain?
As reported on Seeking Alpha, "Chairman Jerome Powell and his colleagues are walking a monetary policy tightrope hoping to avoid a recession while dampening demand," said Mark Hamrick, senior economic analyst at Bankrate. "This year's decline in stock prices and rise in bond yields are among the more obvious consequences of the Fed's actions."
The net result is that mortgage rates are predicted to edge above six percent soon – a rate we haven’t seen
since the 1990s and early 2000s. This means that an entire generation or two of home buyers haven’t seen rates this high, ever.
The thing is, demand remains high and even though inventory is increasing in most markets, listing prices are still far higher than they were a couple of years ago. In fact, in the update, “
Housing Affordability Falls as Mortgage Rates Climb in April,” the National Association of Realtors offers a whole bunch of dismal news for homebuyers:
“At the national level, housing affordability declined in April compared to the previous month according to NAR's Housing Affordability Index. Compared to the prior month, the monthly mortgage payment increased by 14.5% while the median family income increased modestly by 0.7%.
Compared to one year ago, affordability declined in April as the monthly mortgage payment climbed 45% and median family income rose by 2.5%. The effective 30-year fixed mortgage rate1 was 5.05% this April compared to 3.11% one year ago, and the median existing-home sales price rose 14.8% from one year ago.”
As I’ve said before, I think that rising interest rates will dampen further price increases in most markets and lead to listing prices being lowered more often (and more quickly) than has been the case in the last couple of years. But I don’t see a reversal, back to pre-pandemic levels. The housing market will cool, but it may also simply falter for a bit, rather than open real opportunities for those who are trying to get a foothold by buying their first homes or trading up for the first time.
Stock Markets and the Negative Correlation with Residential Real Estate
I’ve often talked about the correlations between the major indices and residential real estate – in particular, I look at correlations between the Dow and premiere markets, NASDAQ and emerging housing markets, and the S&P and tertiary markets.
What I don’t see is a total correlation in overall rises or dips – I don’t believe, for example, that a 20% dip in the stock markets will result in a 20% dip in home prices. I could, however, envision a reduction in listing prices of about 10%.
In part, individuals and institutional housing investors alike simply have less money to spend because of the nosedive in the stock markets in recent weeks. When a primary source of equity – and often, already highly leveraged equity – falls as significantly as we’ve seen lately, there’s just less liquidity to pull out and redirect, including into housing.
While this could ultimately be a healthy turn for the incredibly overheated housing market (as well as overheated stock markets), there will be a pain in the coming months.
The Lag Time Between Stocks and Housing
The Wall Street Journal reported this week on record home equity in the U.S: A staggering $27.8 trillion. But, as you know from this blog, there’s the latency between what we know from housing data (which is typically 30-90 days behind) and where things truly stand.
Given the obvious correlation, do precipitous dips in the stock markets mean that the astounding level of home equity will also dip? I don’t think as much – at least not on the surface. However, there could be a ripple effect if people leveraged too much home equity for other assets that are now getting battered.
According to the article, which cites data from Black Knight, about 60% of that home equity had been withdrawn in 2021 as cash-out refinances – and I’m willing to bet that likely, much of it was used to leverage other asset purchases, including rental properties, crypto, and NFTs.
What happens now, as borrowing will become much more expensive given the rising interest rates? Likely, according to CoreLogic (per that same WSJ article), some of that equity will go into home improvements (a good thing to keep in mind if you’re researching companies for value investments in these rocky times). Some will simply be used to cover the inflationary impacts of day-to-day life. And some will inevitably be used on investments that reflect dodgy long-term strategies.
But what we have to keep in mind is that so many predictions – so many behaviors, too – are based on trends we’ve seen over the last 2+ years, a time of incredible anomalies in every aspect of our lives.
For example, many businesses that pivoted some operations to meet Covid-related challenges have bounced back stronger than ever. But others that built (or pivoted) their models based on Covid-era behaviors are getting decimated, whether you look at crypto-related companies or those in real estate, like Compass and Redfin (both of which announced layoffs this week) or Zillow, which we covered several months ago and which continues to struggle.
What Does It All Mean?
These are uncertain times and it’s more likely than ever that we’re bordering on recession – you don’t need economic data to hear about hiring put on hold (or layoffs already in play) or companies and individuals cutting back on spending. Rather, you’re likely feeling pinched at the gas pump, at the grocery store, and at your favorite restaurant.
Recessions – whether officially declared by two successive quarters of contraction in the economy, or by consumer sentiment and behaviors, which are generally better guides – tend to cause some pain for just about everyone. But an economic reset after the red-hot wave of the last several years is needed and overall healthy.
If you’re among the fortunate people who gained home equity and are looking for ways to invest it, simply do the things that we’ve discussed here: look for value-investing opportunities, as well as investments that make sense in other asset classes.
What to avoid? In their best times, I didn’t like nebulous offerings like crypto and NFTs and I like them even less now. But a lot of self-interested people out there will be pushing exactly those kinds of assets now (‘bitcoin will be back at $40K before you know it,’ they’ll say).
Here’s what I say: Avoid the siren song of bottomed-out assets (or, at least, know what you can afford to lose, especially in recessionary times, and stick with that if you want to take on higher risk). Now’s the time to stay calm, stay strong, and stay smart.
