| 3rd Qtr.
| 12 Mo.
|10-yr Treas. yield||4.57%||3.82%||+0.75%||3.80%||+0.77%||+0.69%|
|Fed funds rate||5.25-5.5%||5.0-5.25%||+0.25%||3.0-3.25%||+2.25%||+1.00%|
Higher interest rates and signs of a slowing economy hit stock markets, and the S&P closed with its worst month of the year in September. The US dollar regained strength, hitting its second-highest level against a basket of currencies in 21 years. The yield curve remains inverted (two-year Treasury rates higher than 10-year rates) and the benchmark 10-year Treasury is at 12-year highs. Oil prices rose as Russia and Saudi Arabia announced production cuts, and the UAW initiated strikes at Ford, GM and Stellantis at the same time for the first time ever. Second quarter GDP growth was decent, at 2.1%, and hopes of avoiding a recession are still alive. And there was yet another potential government shutdown that was averted at the very last moment, although it only buys 45 days until the next shutdown deadline and cost the House speaker his job in an historic ouster by rebellion in his own party.
China’s long-running, debt-fueled economic growth slowed dramatically and may have hit a wall. Its currency fell to its lowest level since 2007. So far, China has cut interest rates to spur growth, lifted a trading tax to encourage trading and limited initial public offerings to bolster the stock market. Another of China’s largest property developers is on the brink of default, a large player in China’s “shadow banking” system missed debt payments and the government has restricted unemployment data because of very high unemployment rates for younger workers. China’s share of US imports is at a 20-year low and an executive order by President Biden banned US private equity and venture investment in semiconductor, quantum computing and artificial intelligence Chinese firms.
The Fed, as expected, did not raise interest rates in its September meeting, although the vote was not unanimous. They “penciled in” one more hike for this year and announced that rates will be kept higher for longer than previously anticipated, with only two cuts expected in 2024 compared to four projected in June. Other central banks are mixed, with the Bank of England and the European Central Bank also pausing after steady increases, but Russia raised rates dramatically to combat inflation and support a crumbling currency, Japan is on the cusp of raising its rates out of negative territory and China cut rates.
Consumer spending was revised downward in the final GDP report and also slowed in August, but business investment was revised upward. Consumer confidence slipped and future expectations were particularly weak. Inflation did not decrease much in September but since housing costs currently make up most of recent inflation increases, there is hope that both housing costs and inflation will moderate. EU and UK inflation remain higher than in the US but both have come down dramatically from their highs as those economies are slowing and have had time to adjust to the shocks of the war in Ukraine.
US manufacturing contracted for its 11th month and services grew for the ninth month. Household debt grew but is still less than 10% of disposable income but inflation-adjusted household income fell in 2022 and remains almost 5% below the 2019 peak, raising concerns about how long the consumer can keep spending. Employment stayed resilient, with over 3 million jobs added in the year ended in August, but recent months were revised downward. Unemployment increased to 3.8% due to more people entering the workforce. Still, nearly 20% of jobs created in 2023 were in the public sector and there are conflicting data on employment prospects, with an estimate of only 89,000 jobs added in September offset by a surge in job openings.
The economic slowdown in China could have significant global impact, and it is unclear how Chinese leadership will deal with it. But let’s stay with domestic issues.
What will happen to loosen the US housing market?
The problem, simply put, is a lack of supply of existing homes for sale, and the data are not encouraging. Existing home sales for August were down 15% from a year earlier, and despite the increase in mortgage rates the median sales price was up 4% to $407,100. Worse yet, the inventory of existing homes for sale is down 14% from a year earlier and is at the lowest levels since the data began in 1999. With such low inventory, the common strategy of downsizing a home purchase to manage costs becomes very difficult. Pending home sales, or sales that are scheduled to close in the coming month or two, were down nearly 19% in August from the prior year.
The difference in the 30-year mortgage payment for that median-priced home, with a 20% down payment, would be $780/month, or 48%, between a 3% mortgage and a 7% mortgage. Normally, higher mortgage rates would put downward pressure on house prices, because of higher payments, and that is happening in some markets (14 of the 50 biggest markets), but not yet nationwide. And the nationwide median price had dropped slightly for five months (the longest period of decline in 11 years) before resuming its climb in July.
Institutional home buyers (owners of 1,000 or more houses) have also been slowed by high borrowing costs and lack of supply. Their purchases accounted for only 0.4% of sales in the second quarter, down from a peak of 2.4% in late 2021, and more of these organizations are selling some properties, sitting on cash or building their own houses rather than buying existing houses. New home sales to individuals, despite being down for the month of August, are up 6% year-over-year. But home builder confidence is down and while new homes for sale are now around 30% of all available homes, the historical range is 10% to 20% and the supply of new homes cannot increase fast enough to ease the market pressure.
Most current homeowners have mortgages at rates they literally cannot afford to give up, making them reluctant to put their house on the market and buy another house at current prices and rates. Nearly three-quarters of primary mortgages have fixed rates for 30 years, and two-thirds of primary mortgages have a rate below 4%. Mortgage rates have risen faster than Treasury rates (hitting 22-years highs), partly because there are fewer buyers of mortgage-backed bonds as the Fed is trying to shrink its balance sheet and banks are more cautious in their investment practices. People without a mortgage, around 38% of homeowners, are certainly able to sell and purchase another house, and a quarter of sales are for cash, but this group is also insufficient to loosen the market.
The only way to balance the overall market between buyers and sellers is to moderate the cost of buying a home, which is driven by price and mortgage rate. It seems likely prices will fall before rates.
While we are the sole decision makers on our portfolios and do not subscribe to any external investment guidance, we are among the many fans of Warren Buffet. At this year’s annual meeting of Berkshire Hathaway (known as “Woodstock for Capitalists”), Buffet commented on topics ranging from the banking crisis (“fear is contagious, always”), to the debt ceiling (politicians, government agencies and the media have made people needlessly afraid), to the economy (the US economy is poised to suffer a downturn this year, despite strong employment).
Buffet is also a quote machine for investing. Here are a few of his well-known quotes, and how they are reflected in our portfolios.
“Our favorite holding period is forever” – Our philosophy is that there will be long-term growth in the global economy, and we want to participate in it. That requires taking the long view and looking past the inherent volatility of markets and maintaining a steady allocation.
“Lethargy bordering on sloth should remain the cornerstone of an investment style.” – Our steady approach is not because we are lazy, or not smart enough to do something else, or too busy with other tasks. In fact, we spend a lot of time monitoring the markets and knowing what is going on, even if it does not show up in changes to the portfolio. It is our obligation to our clients and their financial well-being.
“Unless you can watch your stock holdings decline by 50% without becoming panic-stricken, you should not be in the stock market”. While it is not foolproof (2022 was the worst market year ever for bonds), the bond and cash allocation in our portfolios serves as a cushion for those stock market declines. Not only do our clients understand this, but they also appreciate that good years in the stock market have greatly benefited them and increased their likelihood of success.
“The business schools reward difficult, complex behavior more than simple behavior, but simple behavior is more effective.” – The investment world is packed with the newest tool or technique or the hot investment given current events. These shiny objects get in the way of a sound investing strategy and serve to enrich the investment sponsors and confuse the investors. (As a graduate of Harvard Business School, Dave can personally attest to the validity of this quote.)
Warren Buffett has regularly been dismissed as being out of touch or not understanding how the world has changed. He has always proved the critics wrong as the economy and markets have gone through longer cycles, and we think being consistent with his philosophy is a good thing for our clients.
All Talk, All the Time
(This article was written by Dave in November 2014 but is still relevant, even more so with the addition of social media to the mix)
We have often said that the avalanche of financial information and media leads to further confusion and poor decisions rather than real education or deeper understanding. We are also big fans of college football, and since sports is another area that is blanketed with coverage and commentary, the media parallels are many. So, here is a guide to digesting both sports and financial media, and if you are among those with a mental block regarding finance, just think football.
They have to fill the time – Even finding worthwhile topics for a monthly article is hard enough, but there are multiple sports and financial channels that broadcast all day, every day. Aside from games and daily market developments, there is still plenty of time left to fill. Unless your kid is playing, does anyone really need to watch a high school game on national TV? Just because something is on TV does not give it any greater significance nor does it make it worth your time.
They make a mountain out of a mole hill (and a mole hill out of a pebble) – Every obscure injury, recruiting development and legal infraction involving college and professional athletes is reported and dissected. This goes far beyond the recent high-profile rash of domestic violence incidents in the NFL, which is a real problem. Likewise, while a company’s quarterly earnings are of interest to competitors, employees and a small group of analysts who follow that company, for everyone else it is just not relevant.
They abuse the language – While there is plenty of drama and excitement in sports, there are just not that many things that are “unbelievable”, “epic, “legendary” or “iconic”. For some traders, every market move can have substantial financial implications, but for the rest of us, markets don’t really “soar”, “crash”, “plummet” or “collapse” that often. Sports run on passion (“fan” is short for fanatic, after all) while markets run on fear and greed, so the fires must be stoked.
They have a ridiculously short attention span – Whatever happened in the last five minutes draws a disproportionate amount of attention and is analyzed to death until the next thing comes along. Even unsubstantiated rumors can result in team disruptions or quick spikes in markets.
And they like to project far into the future – This (2014) is the first year of the four-team college football playoffs and the possible teams have been exhaustively projected every week, even before the playoff rankings began. Of course, every week the actual games reshuffle those projections, and the talk is about what happened as well as what might happen next. As the saying goes, that’s why they play the games, so just enjoy the games and let the playoffs work themselves out. In markets, traders will try to gain any advantage they can, but acting on some conjecture is as likely to result in a loss as a gain. The greatest chance at success is to look long-term and let the markets fluctuate as they may.
They repackage the same information – Having eight people comment on the same minor issue adds little value and often as not just ends up being annoying. And sometimes there is no effort to even add a new perspective, just different people saying nearly the exact same thing. In the meantime, what seem like obvious and legitimate questions go unaddressed.
They are as much entertainment as information – There are occasionally successful and worthwhile explanations in terms the average or even uninitiated person can understand and appreciate. For the most part, attempts at being clever or theatrical are confusing and seldom funny. Seeing ex-players and coaches re-enact a play is interesting once, but that’s about it. The yelling and props that have bled over from sports to financial reporting are even worse.
The experts aren’t necessarily good commentators – Experts by definition know their stuff, but that same depth of knowledge sometimes gets in the way of communicating clearly. It’s a sports cliché that players at all levels fondly remember their coach’s confused sayings (“line up in a circle by height”) and financial experts are not immune to the same dilemma. Actually, these situations are unintentionally more charming and entertaining than the more explicit attempts noted above.
And the good commentators aren’t necessarily experts – As the saying goes, beware the articulate incompetent. They look good, they sound good, they keep your attention, and when they’re done you’re left with the feeling there was nothing really there. If there was no new information or perspective presented, you’ll know your time was just wasted.
Despite all the shortcomings, there is still plenty of good stuff – In sports, the good stuff is thrilling finishes, exceptional effort or true talent, and memorable displays of the human spirit. The recent story of Lauren Hill, the terminally ill basketball player who only wanted to play in her first, and last, college game is a wonderful example. In financial issues, the good stuff is thoughtfully presented basic information that creates or enhances a solid foundation on which to build a financial approach that fits an individual’s needs and goals. The rest is mostly noise.
Given the various media shortcomings, what is the layman to do? It is certainly okay to simply view media coverage as entertainment, and to gain personal knowledge through other means. It is also helpful to maintain a critical eye and to question what you are being told, especially regarding finances. In the end, making financial decisions based on a media report will provide little consolation when things go bad.