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Bill Roller, CFA, CFP®
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Mortgage Rates
Sam Khater, Freddie Mac’s chief economist, says, “The response to the recent decline in mortgage rates is already being felt in the housing market. After declining for six consecutive months, existing home sales finally rose in October and November and are essentially at the same level as during the summer months. This modest rebound in sales indicates that homebuyers are very sensitive to mortgage rate changes – and given the further drop in rates we’ve seen this month, we expect to see a modest rebound in home sales as well.”
The 30-year fixed-rate mortgage (FRM) averaged 4.62% with an average 0.4 point for the week ending December 20, 2018, down from last week when it averaged 4.63%. A year ago at this time, the 30-year FRM averaged 3.94%.
The 15-year FRM this week averaged 4.07% with an average 0.4 point, unchanged from last week. A year ago at this time, the 15-year FRM averaged 3.38%.
The 5-year Treasury-indexed hybrid adjustable-rate mortgage (ARM) averaged 3.98% with an average 0.3 point, down from last week when it averaged 4.04%. A year ago at this time, the 5-year ARM averaged 3.39%.
Average commitment rates should be reported along with average fees and points to reflect the total upfront cost of obtaining the mortgage. Borrowers may still pay closing costs which are not included in the survey.
Summary
In a busy week for economic data to nearly wrap up 2018, the Federal Reserve raised interest rates by another quarter-percent. In other economic data, sentiment, leading economic indicators and jobless claims remained strong; durable goods orders and several manufacturing surveys, were positive but lackluster; and housing data was mixed.
U.S. equity markets suffered mightily again last week, with a variety of concerns weighing on investors’ minds. Foreign stocks lost ground as well, although emerging markets held up better than developed markets. Government bonds fared decently due to the movement away from risk and lower long-term yields. Commodities struggled due to a double-digit decline in the price for crude oil.
Economic Notes
(0) The FOMC decided to raise the fed funds rate target by 0.25% to a new level of 2.25-2.50%, as widely anticipated. Following the meeting and press conference, market optimism changed to pessimism, with some confusion as to whether the message from the Fed was ‘dovish’ (alluding to a possible upcoming pause during 2019) or a continued ‘hawkish’ trend, where the current perceived strength of the economy will not warrant straying from the current course, despite the recent soft patch. The tendency of the Fed to offer a financial market ‘put’, or, in other words, to offer accommodative support in response to weaker prices, is perhaps moving on to a new, more standoffish regime.
In the Summary of Economic Projections, the ‘dot plot’, which specifies various fed member estimates for the appropriate funds rate, showed a decline of roughly a quarter-percent across the board for the next few years. This in keeping with similar declines in the average Fed estimates for growth and inflation.
The appropriate neutral fed funds rate, based on a variety of sources, currently lies in a band from 2.5-3.0%—implying the current rate could be getting close to the finish line for this cycle. (This again reiterates the importance of the inclusion of the word ‘some’ into the Fed’s formal statement, in describing the pace of further rate increases.) It’s important to remember that reacting to short-term volatility in financial markets is not part of the Fed’s mandate (with the only exception being if underlying financial system stability is threatened, as in 2008), but tighter financial conditions brought about by weaker asset prices could play into considerations indirectly if the tightness is persistent enough to spread throughout the economy eventually.
(0) The third and final estimate of third quarter GDP came in a tenth lower than the 2nd estimate, at an annualized 3.4%. Changes were seen in the business fixed investment area, which fell -0.3%, as well as personal consumption, the latter which ticked down a tenth of a percent as well, to 3.5%. Core PCE inflation, used directly by the Fed, was revised up slightly to an annualized pace of 1.6%.
Estimates for Q4 GDP from a variety of sources, including several Federal Reserve banks that provide formal tracking, appear to be in the 2.5-3.0% range. This was largely expected this year, as the initial impacts from tax cuts last year begin to fade; however, the impact of the stronger dollar appears to be a more significant influence, based on comments from corporate executives during recent earnings calls.
(0) Personal income for November rose by 0.2%, a tenth below expectations, while personal spending rose by 0.4%, a tenth faster than expected. The combined result brought the personal savings rate down a tenth to 6.0% for the month. The PCE price index rose 0.1% on a headline and 0.2% core level, which brought the year-over-year inflation measures to 1.8% and 1.9%, respectively—under the Fed target.
(+) Durable goods orders for November rose by 0.8%, which disappointed compared to the 1.7% gain expected. However, revisions to the prior month were positive. Removing a positive from the more volatile components (aircraft equipment/parts in this case), the metric ended up with even more disappointing results—with the core capital goods orders figure declining -0.6%, versus the expected increase of 0.2%. Core capital goods shipments also fell, by -0.1%, compared to an expected 0.2% increase. This measure has taken on a more flattish trend as of late.
(-/0) The New York Fed Empire state manufacturing survey for December fell by -12.4 points to 10.9, far below the forecasted 20.0 reading, but remained solidly in expansion. The significant drop was largely focused on weakness in new orders and shipments. However, employment increased sharply, further into expansionary territory. Business conditions for the coming six months also declined by a few points to a still positive 30. While still expanding, this survey does suggest some manufacturing slowing.
(-/0) The Philadelphia Fed manufacturing survey for December fell by -3.5 points to a still-expansionary 9.4, but below expectations of a 15.0 reading. The underlying metrics were a mixed bag, with new orders and employment a few points higher, but shipments fell by over -10 points. Prices paid also ticked downward, but continued to expand at a fast pace. Importantly, six-month-ahead business activity indicators rose by several points to remain at a solid expansionary pace.
(+) Existing home sales rose 1.9% in November, to a seasonally-adjusted level of 5.32 mil. units, surpassing expectations calling for a -0.4% decline, and representing the second straight month of gains. Both single-family units and condos/co-ops gained at roughly the same rate for the month. Regionally, sales in the Northeast and Midwest gained at rates over 5%, while the West experienced the sole decline at -6%, which may have been due to the influence of pervasive wildfires in parts of California. On a year-over-year basis, however, the metric remains down -7%, with days on the market ticking up a few days to 42 from 40 last year at this time nationally.
(+)Housing starts for December rose by 3.2%, to a seasonally-adjusted annualized level of 1.256 mil., which surpassed expectations for no change. Under the hood, however, the usually-volatile multi-family group rose over 22%, while the larger and typically more stable single-family component fell by -5%—although up 3% over a year ago. Regionally, the Northeast and South saw strong double-digit gains, while the Midwest and West experienced declines in the double-digits. It appears that the wildfires in Calif. may have played a significant role in the data, depressing activity. Building permits rose 5.0% on the month, which also beat consensus estimates calling for a decline of -0.4% on the month. Here, also, multi-family permits led the way, with gains of 15%, while single-family permit activity was flat on net. Regionally, the South and West saw gains, while the Midwest declined slightly. Interestingly, on a relative level, single family homes under construction remain at the same level they were 25 years ago, while multi-family building is back to peak levels.
(-) The NAHB homebuilder sentiment index for December fell -4 points to the 56 level, below the unchanged 60 expected by consensus, and representing the second straight month of a substantial decline. In fact, the index has now reached its lowest level in nearly four years. Current sales fell by -6 points, future sales by -4 points, and prospective buyer traffic by -2. Regionally, the West was unchanged, but the other three areas fell by at least a few points, with the Northeast dropping by -15. Overall financial markets appeared to react negatively in part this this data being released last week, although it’s typically a minor report. The key importance is its role in being a decent predictor of upcoming housing start numbers, which do tend to be considered a bit more important. Housing activity continues to show weakness, which could be due to a combination of higher interest rates, unaffordable housing in certain key areas, as well as a lack of supply.
(+) The Conference Board’s index of leading economic indicators for November increased by 0.2%, continuing a string of several straight positive months, albeit at a less robust rate. The single month results benefitted from positive contributions from building permits, ISM new orders and the yield spread, while these were somewhat offset by negative influences of unemployment insurance, stock prices and average workweek length. For the last six months, the indicator rose at an annualized rate of 4.4%, which was slower than the 5.9% rate of the prior six months. The November coincident indicator rose at an identical 0.2%, while the lagging indicator increased by 0.4%. While the robust rate of several prior months has tempered (in keeping with other data already tracked), the overall trajectory is still upward—which should translate to positive GDP and corporate earnings figures.
(+) The final edition of consumer sentiment for December showed a rise of 0.8 of a point to 98.3, which surpassed the 97.4 reading expected. The sub-indexes for current conditions and expectations for the future both increased to roughly the same degree. Inflation expectations for the coming 5-10 years ticked up by a tenth of a percent to 2.5%.
(-) Initial jobless claims for the Dec. 15 ending week rose by 8k to 214k, which was just under the 215k level expected. Continuing claims for the Dec. 8 week rose by 27k to 1.688 mil., which surpassed the consensus estimate of 1.663 mil. Claims rose in the largest states, as usual, with no anomalies reported. However, seasonal adjustment factors can play a role toward year-end due shutdowns and a flurry of temporary employment in some areas, such as retail.
Question of the Week–Are we in an equity bear market?
Technically, we are right on the cusp. By definition, a ‘bear market’ in stocks occurs at the point of a -20% price drop from a recent peak—we’re within a percent or two from that threshold.
Although this recent movement seems sudden and severe, and is, relative to the last few years of unusually low volatility, deeper corrections of at least -15% have occurred about once every two years, with -20% bear markets appearing once every 3-4 years, historically. Based on statistics, we’ve been overdue. The unique part is that such downturns usually happen over the course of 10-15 months, as opposed to the rapidity of this decline, measured from the peak in the S&P on Sept. 21.
What is going on? The panic is not based on any new information. Many investors look for a simple explanation when stocks move through a stretch of negatively. Often, it’s not a single reason, but a collection of various fears and uncertainties, that simply cause investors to begin shedding ‘risk assets’ in a sell-first-ask-questions-later approach. This has also affected other assets related to global demand, such as crude oil.
Bear markets have often surfaced prior to upcoming recessions, due to fears about how severe an economic downturn would be, they don’t appear as frequently in isolation (although there are exceptions, which have occurred about three times in the last thirty years, the worst of which being in 1987 and 1998). This appears to be the primary reason in this case—the risk of recession appears to have increased due to slowing in some aspects of the economy. In addition, the lack of dovish tone by the Federal Reserve in recent weeks (including the FOMC statement last week, which was not supportive enough for markets) raised fears that the quarterly rate hike pace could be too much for the economy to handle. In fact, the Fed raising rates too far and too fast has been a catalyst for recessions in the past, so this fear is not unfounded.
Along the lines of these fears of economic slowing, the ongoing U.S-China trade tensions have remained in the market consciousness, with no resolution in sight. Although the estimated effects of new tariffs won’t appear to have a catastrophic effect on GDP, they certainty don’t help matters, and could dampen sentiment that may ultimately affect global economic growth. Adding a unique holiday trading environment of lower liquidity and staffing can also exacerbate declines.
Last week, these items were coupled with fears over a politically-driven government shutdown, which drove market sentiment from bad to worse. The President was also apparently consulting with advisers about the possibility of and process for firing Fed Chair Powell due to unhappiness over the path of interest rate hikes. (Obviously, this threatens the long-standing independent and apolitical nature of the Fed, harkening back to political pressure placed on it during the late 1960’s, thought to be a partial cause of the nasty inflation of the 1970’s.) If this weren’t enough, Defense Secretary Mattis resigned, which raised more questions about the future composition of the Cabinet, and willingness of members to stay on. While not major news from a financial standpoint, each of these items add to lack of certainty about future policy direction.
Now that markets have assumed the worst—seemingly pricing in an imminent recession—what’s the upside?
Firstly, and importantly, deep corrections and bear markets bring valuations down. This may seem obvious, but removing froth from asset valuations following a bull market run can ‘refresh’ the attractiveness of stocks. While always a moving target, and not as meaningful for the short-term, returns over the long-term have been lower from more expensive starting points, higher from cheaper starting points, and ‘about average’ when assuming ‘average’ starting valuations. Per FactSet, the 12-month forward P/E for the S&P as of Friday was 14.2x (long-term averages tend to be 15-16x).
Another positive aspect is that earnings growth remains positive. This is another straightforward observation, but recessionary fears have tended to rise when either GDP or earnings growth has been at the crux of flattening or declining outright. This year was extraordinary, with earnings growth exceeding 20% based on the impact of prior year tax cuts, which is the highest level since 2010. While this effect is expected to temper in 2019, it is not falling off a cliff completely, with FactSet projecting earnings growth of 8%. Using back-of-the-envelope expected return calculations of dividend yield plus earnings growth plus/minus valuation adjustments, forward-looking metrics don’t look far off from historical averages.
Interestingly, in the midst of all of the current negative market sentiment, the outlook and commentary on equities from a variety of sources is more constructive than is has been in some time, due to lowered valuations, continued positive earnings growth and lack of immediate recession red flags on the horizon, such as in credit markets. Assuming the U.S. avoids a recession in the next few quarters, it is possible that a bear market could be shorter-lived. However, with the economy showing more signs of later cycle behavior, the risk of these types of market events (both due to poor investor sentiment and those backed up by deteriorating fundamentals) goes up.
Market Notes
| Period ending 12/21/2018 | 1 Week (%) | YTD (%) |
| DJIA | -6.87 | -7.13 |
| S&P 500 | -7.03 | -7.87 |
| Russell 2000 | -8.39 | -14.81 |
| MSCI-EAFE | -2.64 | -14.54 |
| MSCI-EM | -1.50 | -17.36 |
| BlmbgBarcl U.S. Aggregate | 0.45 | -0.45 |
| U.S. Treasury Yields | 3 Mo. | 2 Yr. | 5 Yr. | 10 Yr. | 30 Yr. |
| 12/31/2017 | 1.39 | 1.89 | 2.20 | 2.40 | 2.74 |
| 12/14/2018 | 2.42 | 2.73 | 2.73 | 2.89 | 3.14 |
| 12/21/2018 | 2.39 | 2.63 | 2.64 | 2.79 | 3.03 |
U.S. stocks suffered one of the worst weeks in some time, due to the confluence of a variety of factors discussed above. Toward the end of the week, political wrangling about the potential government shutdown cast an overall negative shadow on markets. From a sector standpoint, utilities and materials fared ‘best’, with declines just under -5%, while energy stocks fared worst, with declines of nearly -9% on the week, although consumer discretionary stocks were just behind.
An area that has experienced an especially severe price decline has been U.S. small cap stocks. Traditional valuation discounts of small caps to large caps have been reduced in recent years—perhaps due to an overallocation to the asset class based on historical long-term outperformance tendencies—and it appears some investors could be tilting towards the group as a ‘safe haven’ from global tariff concerns. Of course, the flip side is that the higher beta of small cap reflects their higher economic sensitivity, and explains their recent poor performance.
Foreign stocks declined as well, but not to the same degree as domestic equities, helped by a half-percent decline in the dollar. The U.K. fared best, while Japan underperformed to the greatest degree in developed markets. Economic slowness and possible implications of Brexit continue to weigh on European equities, but it remains to be seen whether current valuations have finally priced in these various scenarios. Emerging markets fared best of all, with minimal losses—India and Turkey were significantly positive performers, with lower energy prices helping lower import costs and removing significant headwinds.
U.S. bonds rallied, as expected, due to cash flows moving away from risky assets and into cash and fixed income. Yields fell across the treasury yield curve by about 10 basis points, benefitting long-term treasuries, while wider credit spreads punished high yield bonds especially, which lost several percent on the week. Foreign developed market bonds were slightly higher in local terms, but benefitted sharply from the weaker dollar. Emerging market debt had largely the same effect, albeit to a lesser degree.
Real estate in the U.S. suffered largely in line with broader equities, with the more economically-sensitive groups, such as regional malls, suffering far more than residential. Foreign REITs outperformed due to the weaker dollar effect.
Commodities declined in most areas, despite the normal tailwind of dollar weakness. Precious metals gained, with positive flows to gold, but were overwhelmed by a sharp decline in the energy sector. The price of crude oil experienced its worst week in nearly two years, falling by another -11% to an 18-month low at just under $46/barrel. As with equities, fears of a slowing pace of global growth in 2019 and corresponding negative impacts on energy demand, in addition to the larger-than-expected supply conditions, have created another perfect storm for prices on the downside. A negative for the commodity asset class and energy stocks, lower oil prices are no doubt a positive for users.
Sources: Ryan M. Long, CFA, FocusPoint Solutions, American Association for Individual Investors (AAII), Associated Press, Barclays Capital, Bloomberg, Citigroup, Deutsche Bank, FactSet, Financial Times, FRED Economic Research, Freddie Mac, Goldman Sachs, JPMorgan Asset Management, Marketfield Asset Management, Morgan Stanley, MSCI, Morningstar, Northern Trust, Oppenheimer Funds, PIMCO, Standard & Poor’s, StockCharts.com, The Conference Board, Thomson Reuters, U.S. Bureau of Economic Analysis, U.S. Federal Reserve, Wall Street Journal, The Washington Post. Index performance is shown as total return, which includes dividends, with the exception of MSCI-EM, which is quoted as price return/excluding dividends. Performance for the MSCI-EAFE and MSCI-EM indexes is quoted in U.S. Dollar investor terms.
The information above has been obtained from sources considered reliable, but no representation is made as to its completeness, accuracy or timeliness. All information and opinions expressed are subject to change without notice. Information provided in this report is not intended to be, and should not be construed as, investment, legal or tax advice; and does not constitute an offer, or a solicitation of any offer, to buy or sell any security, investment or other product. Residential and reverse mortgages are offered through Prestige Home Mortgage in Vancouver, WA.
Notes key: (+) positive/encouraging development, (0) neutral/inconclusive/no net effect, (-) negative/discouraging development.