The Eye of the Storm
The Eye of the Storm
Today I discuss the current state of the US housing market, which is experiencing turmoil due to high yields.
The US housing market is experiencing turmoil due to high yields. Currently, both sides of the market are affected — builder and buyer confidence took a big hit post-2020, and although we are seeing a small bounce, I doubt the pain is over yet, especially for builders.
In 2020, to help contain the economic damage caused by the pandemic and to support the government stimulus packages, the Fed cut rates from 1.75% to 0.25% between January and April 2020.
The swift intervention stimulated a market frenzy and gave rise to numerous unintended outcomes.
#1 – US bond yields collapsed.
The US bond yield (10 and 30) went to all-time lows and stayed in that range for nearly one year, making borrowing cost standards very low.
#2 – Debt rose with reduced lending standards.
Household mortgage debt went up 17% in two years. To put this increase into perspective, it went up only 12% between 2015 and 2020…
Ditto for household debt (which includes mortgages)...
In the last two years, the US government added as much debt as it had over the previous five years…
#3 – Asset bubbles popped up everywhere.
The US stock market cap went up 130%!!!
Commodities went up 85%!!!
Risk assets went on a tear…
Bitcoin went up 1660%!!!
Ethereum went up 3620%!!!
#4 – The dollar weakened.
The US dollar lost 13% before starting a huge rally at the beginning of 2021.
#5 – Inflation surged out of control.
Inflation went up to 8.3% (the highest in 40 years!) before the Fed started to raise interest rates to tackle it.
Note: Inflation rising so fast was a mix of supply chain disruption, debt growth, and free money available.
This drop in yield created the perfect opportunity to refinance homes or finance home purchases at low-interest rates. It created an unprecedented move in home prices across the US, with prices up 20% annually (on average at peak).
The price of used cars skyrocketed (partly due to supply chain constraints)…
Food price growth went ballistic…
All this was always going to happen this way; that was the risk the Fed faced by cutting rates so deeply and quickly.
Zooming in on the US housing market
While it doesn't represent a systemic risk this time (like in 2008), the US housing market is clearly at risk. Financing a house purchase right now is as expensive as in 2000.
The lasting repercussions in the housing market will take time to digest.
Since 2000, declining mortgage rates have pushed US home average prices higher…
The problem is that now, with such high average prices and high financing costs, many people are priced out. Currently, purchasing a $400,000 house (current average price) will cost $811,000. Two years ago, buying a home at an average price would have cost $484,000, including financing, which is an increase of $326,000 on a $400,000 house.
Good luck to new buyers!
These are by far the worst financing conditions recorded, and they may get worse…
No wonder we see the housing market in turmoil.
Inventories are growing due to market conditions.
Building permits growth is collapsing and is the lowest since the GFC…
Homebuyer demand has vanished. MBA Purchase Index growth is at its lowest since 1991 and already lower than in 2008!
Pending home sales have collapsed…
New one-family house sales are logically contracting…
I suspect that more families will have to delay building their dream home…
Withering demand will drive the growth of houses sold under construction further down, most likely to an all-time low…
Unless US houses become affordable again — and rapidly!
For home financing to become affordable, the Fed would have to cut rates faster than they raise them, which is not on the table.
Therefore, high home financing costs will impact the housing market until the Fed changes course.
To make “US housing great again” (similar to pre-Covid), home prices would have to fall 10% and the interest rate be around 3%.
This would be the first price contraction in fourteen years…
The decline in the S&P real estate sector is already pricing the average home below $350,000 (down $50,000 from the all-time high).
On the corporate side, Prologis (the biggest US REIT) doesn’t look great…
Ditto for American Tower Corp. (the 2nd largest US REIT)...
and ditto for Realty Income Corp. (the third largest US REIT)...
The Bloomberg REIT index looks awful…
The only solution to fix the real estate market is for the US 30-Yr bond yields to correct fast enough, which will only happen once the Fed cuts rates.
To be back to “business as usual” means that fed fund rates should be just below 2% (this is what the housing market is telling us right now) and we know this is not happening anytime soon.
The US 30-Yr yield is about to break out. Due to the current Fed course, a breakout in the near future is inevitable...
Shorting the US real estate sector is the obvious play for the next six to twelve months. If you are interested in opening a short position, here are a few companies to look at:
Prologis - American Tower Corp - Realty Income Corp - D.R. Horton - Lennar - Pulte Group - NVR (Ryan Homes) - Taylor Morrison
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At the beginning of 2020, the Fed had to cut rates to contain the economic impact of the covid crisis.
The swift intervention stimulated a market frenzy and gave rise to numerous unintended outcomes.
Inflation became a real issue; we saw many asset bubbles popping up, the dollar depreciated, and lending standards loosened.
During that time, as US bond yields collapsed, mortgage rates reached an all-time low and stayed within this range for about a year. Many people accelerated their home purchase process to take advantage of the low borrowing costs. As a result, home prices in the US spiked like never before, pricing many people out of the market.
The only way to reverse the coming storm would be for the Fed to cut rates rapidly, but we know this is not an option. They have made it clear that, if anything, they might raise rates even more, making things very bad indeed.
Let’s not forget that with a recession coming, this could get uglier…
The US real estate industry is about to enter the trouble zone.
The good thing is that this time around, unlike in 2008, the real estate market’s collapsing doesn't represent a systemic threat. Nevertheless, shorting the real estate sector is the obvious play until the Fed changes course.
US thirty year mortgages are priced off the ten year, not the thirty year. Their duration is similar to the ten year due the annuity structure of fixed rate mortgages. American Tower owns cell phone towers, at least they did when I last looked at them. Not sure why AMT would be affected by the housing market.