The US and China Trade Deal was signed last week and marks a significant first step in trade negotiations. The US will still maintain 25% tariffs on approximately 250 Billion worth of Chinese goods and 7.5% on another $120 Billion, rolled back from 15%. These tariffs could be removed in a Phase 2 deal and are being kept in place to keep China honest. As a part of the Phase 1 agreement, China will have to buy at least $200 Billion more in US products and services than it did previously and will have to reduce barriers to US farm goods like beef, pork, poultry, and rice. Probably the biggest commitment from China is one to improve protection and enforcement of intellectual property rights, where China will increase criminal penalties for copyright theft as a deterrent.
Potential Recession Indicator
The Cass Freight Index, which measures shipments in the US and is a good broad measure of economic health, was down significantly in December. Shipment volumes dropped 7.9% vs December 2018 levels, as the index posted its lowest reading since January 2018. It was also the steepest year over year decline since the Great Recession of 2008-2009.
This is an interesting index and is something that is not widely followed, but is very important. Think about it, every company must ship products, whether it’s by air, boat, train, etc., in order to deliver those products to stores and consumers. When this figure is negative, it speaks to businesses slowing down and can be an early warning sign that things are turning in the economy. Of course, there are other factors, but this is something that should be closely monitored.
Best New Construction Numbers in Nearly 20 Years
The strong housing data rolls on – Housing Starts were up 17% to a rate of 1.608M units for the month of December. Surprisingly, even Diana Olick from CNBC, who is typically very negative, was positive on housing after the report, citing some of the demographics that we have talked about for years. The level of starts is the highest number in almost 14 years. Last Month’s figure was revised higher from 1.365M units to 1.375M units and without the revision, Starts would have been even stronger and up 17.8%. Year over year Starts are up a whopping 40.8%. Single-family homes, which are really the life blood of the housing market, were up 11.2%.
Permits, which are a good forward-looking indicator of starts, were down 3.9%. Year over year permits are still up 5.8%. Single Family Permits were down 0.5%.
The NAHB (National Association of Home Builders) released their Housing Market Index, which gives a “finger on the pulse” look at Builder Confidence. The index decreased 1 point in January to 75…but this is still a very strong level and is only one point off a 20-year high.
What to Look for This Week
The focal point of this week will be more housing data. The FHFA (Federal Housing Finance Agency) will release their House Price Index, showing appreciation levels of single-family homes in the US with conforming loan limits. Typically, this report will show appreciation on homes that are closer to the median home price…and those homes are appreciating at a much faster clip than higher priced homes, as that’s where all the demand is. Look for this number to be north of 5%, which is extremely meaningful for wealth creation. After all, a 5% return on a $300,000 home would equate to a $15,000 appreciation gain in just 12 months.
Additionally, Existing Home Sales for December will be released. This is one of the most important housing reports, as existing sales account for nearly 90% of the housing market. Look for more strength in these numbers.
Technical Analysis Breakdown
Mortgage Backed Securities continue to trade in a very wide 137bp range between overhead resistance at 101.904 and support at 100.53. Support was tested last week, but as seen on the chart, it held and prices bounced higher. Because Bonds are in such a wide range, they are susceptible to big price swings and there may be volatility this week. Bonds are trying to remain in the uptrend that has been intact since December 19th. Last Friday Bonds began to break beneath this rising trend line, but there has not been a convincing break just yet. This is a level to watch closely, because if it’s broken, Bonds will likely move lower to test 101.53.
Last week was another volatile one, due to the US and Iran Conflict. Iran fired more than 20 ballistic missiles at two military bases in Iraq where US troops were stationed. Initially, the Stock market sold off significantly, down over 400 points. Once Stocks sold off, that money went into the Bond market, however once the Iranian Foreign minister made a statement regarding the attacks, everything changed. The Iranian Foreign Minister said that his country had “concluded” its attacks on American forces and did “not seek escalation or war”. This was followed by President Trumps press conference, where he said that no US citizens were injured and that he too did not want to use military action. The backing down from both sides was all the Stock market needed to hear to rally and set new all-time highs, with the Dow breaking above 29,000 at one point. Mortgage Bonds hung in there and after some turbulence, ended the week close to where they started.
The Fed Keeps Buying
The Feds balance sheet has a great correlation to the rise in the Stock Market. As covered in a previous issue, the Fed has been buying a significant amount of Treasury Bills each month to provide liquidity to the market and steepen the yield curve. Approximately $100 Billion per month in Treasury Bills is approximately how much. To give you an idea of how significant that is, during the height of the Fed’s Quantitative Easing purchasing program, the Fed was buying $85 Billion in Mortgage Backed Securities and Treasuries.
This is important because around September, when the Fed started purchasing, the correlation the Stock market has had was significant. As the Fed has continued to purchase and their balance sheet has risen, so too have Stocks. It’s unusual to see such an exact correlation. This is supposed to be a six-month operation which is setting up for turbulence down the road if they pull the plug and take away the punch bowl.
The One Piece of Jobs Data No One is Talking About
The Jobs Report is one of the most important economic reports released each month. There are many components within the report, but three of which are paramount: the overall level of job creations, the unemployment rate, and average hourly and weekly earnings.
Last week’s report was for December and it showed that there were 145,000 jobs created. This was lighter than the 158,000 expected. Additionally, there were 14,000 in negative revisions to the previous two months. While this was a slight miss, it was still a decent level of jobs.
The Unemployment Rate remained stable at 3.5%. There are two different surveys within the Jobs Report – The Business Survey, where the headline jobs figure is derived from, and the Household Survey, where the Unemployment Rate comes from. The Household Survey also has a job creation component, which said that there were 267,000 job creations. Additionally, there were 209,000 additional individuals that came into the labor force. Since the figures were close to one another, the unemployment rate remained unchanged.
Interestingly, the all in U6 Unemployment Rate, which includes total unemployed, plus all persons marginally attached to the labor force, plus total employed part time for economic reasons, moved lower from 6.9% to 6.7%….which is the lowest level on record.
But the one piece of data that seemed to fly under the radar was average weekly earnings. There are two measures of earnings in the Jobs Report, average hourly and average weekly earnings. Average hourly earnings decreased from 3.1% year over year to 2.9%. But the more important figure and the real story here is Average Weekly earnings, which decreased sharply from 3.1% to 2.3% year over year. We pay closer attention to weekly earnings because it shows what an employee is taking home each week. Think about it, you may make a certain amount per hour, if you are working less, you are earning less. While average weekly earnings are still going up 2.3% year over year, this was a significant drop. This is something to watch to see if it’s just a one off or a trend.
More Good Housing News
The housing market has been incredibly strong, and the good data keeps on rolling. CoreLogic reported that home prices rose 0.5% in November and 3.7% year over year. The year over year reading increased from last month’s report, which showed a 3.5% gain. It’s also the largest annual gain in almost a year. The states with the highest increases were Idaho (10.2%), Maine (8.6%), and West Virginia (6.9%).
CoreLogic forecasts that home prices will appreciate by 5.3% in the year going forward, which is a slightly lower pace from the 5.4% forecasted in the previous report, however still very strong.
A 5.3% gain on a $300,000 home would translate to $15,900 in appreciation over the course of a year.
What to Look for This Week
The focal point of this week will be inflation data. The Consumer and Producer Price Index reports will be released, showing inflation on both the consumer and producer levels. Inflation is an important metric to follow and can have a big impact on the Bond market. Below is an example of why Inflation is so important.
If you were to lend $100,000 of your own money to someone, for ease of use of numbers, you would expect a coupon or rate of return. For the purpose of this example let’s say it’s 4%. Each year you would receive a fixed payment of $4,000. However, if inflation starts to rise you would still receive the same fixed payment of $4,000, but it wouldn’t go as far. You would be able to purchase less, as the cost of goods has risen. This happens in the real world too in which the only way to be compensated in a rising inflation market, is with a higher rate. For that reason, interest rates are tied very closely to inflation and when inflation rises, so too do interest rates.
The Consumer Price Index will be an important report to follow – Any unexpected jumps in inflation could be negative for the Bond market and interest rates.
Technical Analysis Breakdown
Mortgage Backed Securities Continue to trade in a very wide 137bp range between overhead resistance at 101.904 and support at 100.53. Support was tested last week, but as seen on the chart, it held on two occasions. Because Bonds are trading in such a wide range, they can be susceptible to large price swings before reaching the aforementioned levels of support or resistance. This means that there could be more volatility this week.
If Bonds were to break beneath 100.503, there is a triple floor of support beneath that, formed by the 100, 25, and 50-day Moving Averages (the purple, brown, and black lines). The key things to look for this week are inflation and Stocks. If inflation data is tame, Bonds may have a chance to move higher. Perhaps more importantly, if Stocks take a breather, some of that money may come into Bonds. If Stocks continue to march higher, it may be difficult for Bonds.
Last week was not only the last week of the year, but also the last week of the decade. The Stock market posted impressive gains in 2019 with the major indices posting the following year over year gains:
S&P 500: 28.9%
With last week being a holiday shortened week, things were quiet, but Mortgage Bonds were able to edge higher and break above some important technical levels.
The US and Iran conflict has escalated after a series of events over the last two weeks. An American contractor was killed by an Iranian-backed rocket attack, which eventually led to the US drone strike and killing Iranian General Qasem Soleimani. As a result, Stocks did sell off at the end of the week and will likely continue to do so this week as the Stock market does not like uncertainty. Typically, when this occurs there is a “flight to quality” trade, where money flows into the Bond Market, and Mortgage Bonds are benefiting.
The question on many investor’s and individual’s minds will be “Can the Stock market continue to move higher in 2020?” Stocks are at pricey levels and a lot of the run up was due to euphoria over the US and China Phase 1 trade deal. As mentioned in last week’s issue, the Fear/Greed index is also at extreme levels of greed, which is a reliable contrarian indicator. If there is a pullback in Stocks, Bonds will likely be the beneficiary. Another question is “When will there be a recession?” The US is in the longest expansion on record and it’s not a matter of if, but when the next recession will come. Some are calling for a recession in 2020, while others think it will happen in 2021 or beyond. One thing we know for sure is that when the recession hits, Stocks will drop significantly and interest rates will fall.
One of the key early warning indicators we are watching is Initial Jobless Claims.
Claims Remain Steady but Could Play Important Role in 2020
Initial Jobless Claims, which measures individuals filing for unemployment benefits for the first time, showed that there were 222,000 Claims. The level of 222,000 was in line with expectations and 2,000 lower than the previous week, which was revised slightly higher from 222,000 to 224,000. Claims have been hanging around this level and have been steady…but this is an early indicator that we want to watch for a recession. If we start to see this report spike higher, it could be a warning sign. Why? When things do slow down, the first thing a business will do is stop hiring. Next, the business will let workers go.
Once businesses start to fire employees, those individuals will file for unemployment benefits and it will show up in Initial Jobless Claims. And eventually, the unemployment rate will move higher. With 100% accuracy, the unemployment rate has been a predictor of recessions. Interestingly, it’s not when the unemployment rate is at its highest point, but when it’s at its lowest point and then turns higher. The unemployment rate is currently at 3.5%, so if it moves slightly higher to 3.6% or 3.7%, it’s not something to worry about. But if it moves above 4%, it could be a sign of a recession to come in the next 6 months or so. Keep a close eye on a consistent spike in Initial Jobless Claims, as that will be the first sign.
Appreciation Remains Strong
The Case-Shiller Home Price Index, which is considered the “gold standard” for appreciation, showed that home prices across all nine U.S. Census divisions were up 3.3% October, which was a slight increase from 3.2% in September. The 20-city Index increased to 2.2% on a year over year basis from 2.1%. Phoenix, Tampa, and Charlotte led the metro areas that are covered. To see what 3.3% appreciation means to you, let’s examine an example:
Imagine you purchased a $300,000 home last January. If your home appreciated 3.3% over the course of the year, your home would be worth $9,900 more…which is very meaningful for wealth creation. And homes that are lower priced and trading near or below the median price in a given market are appreciating at a higher level closer to 5%.
The FHFA (Federal Housing Finance Agency) supports this – Their House Price Index, which measures home price appreciation on single-family homes with conforming loan amounts, represents lower priced homes. While there could be a million-dollar home with a conforming loan, for the most part, the index represents homes under $500,000. The FHFA showed that homes rose 5.0% year over year and this number has been accelerating. It was 4.6% just two months ago.
With inventory levels at record lows and demand remaining very strong, we expect appreciation to continue to be solid in 2020 and even accelerate.
What to Look for This Week
This week is Jobs week, with the ADP and BLS (Bureau of Labor Statistics) Jobs Report released on Wednesday and Friday respectively. The market is expecting between 150,000 and 170,000 job creations in each report. The ADP can give us some clues on Friday’s BLS Jobs report, but often times they do not track closely month to month. Just look at last month – The ADP report showed that there were only 67,000 job creations, while the BLS report showed that there was 266,000…quite the disconnect.
These two reports do correlate closely over time, however. And if they were to come closer to one another, it could happen one of two ways. There could be significant revisions or there could be a “catch up” or “give back” the following month. After the BLS Report surprised sharply to the upside, it would not be surprising if there was a negative revision or weaker figure in Friday’s report. A strong jobs report would coincide with higher Stocks and lower Bonds, while a weak jobs report would send Stocks lower and Bonds higher.
There are a few other factors – The unemployment rate is always an important indicator to watch. The last reading was at 3.5%, but it is expected to rise to 3.6%. Another important and potentially market moving component for the Bond market is average hourly and weekly earnings, which can show if there is wage pressured inflation.
Technical Analysis Breakdown
Mortgage Bonds have made a nice move higher and are now in the middle of a range between support at 101.53 and overhead resistance at the 101.904 Fibonacci level. While the move higher in Bonds is a good thing, they are now in a wide range with roughly 20bp of room to improve and move higher until reaching resistance and 20bp of room to worsen and move lower until reaching support. If the Iran conflict continues to be at the forefront of investors minds, Stocks will likely continue to selloff and Bonds may benefit.
The Stock market must have been on Santa’s nice list this year, as it moved higher Christmas week and has posted gains of almost 30% over the course of the year so far. Mortgage Bonds continued to trade in a sideways pattern, with interest rates still at very attractive levels.
With Stocks seeming to set all-time highs every day now, it makes sense that investors are feeling very optimistic. Investor sentiment is and has always been a very important indicator. Some of the greatest investors of all time were contrarians, meaning they try to do the opposite of the crowd. A contrarian investor believes the people who say the market is going up do so only when they are fully invested and have no further purchasing power. At this point, the market is at a peak. When people predict a downturn, they have already sold out, so there is plenty of money on the sidelines to push the market higher.
Here are a few of the greatest contrarian investors of all time…you should recognize a few listed below:
Warren Buffet – “Be fearful when others are greedy. Be greedy when others are fearful”
Baron Rothschild – “Buy when there’s blood in the streets”
Sir John Templeton – “Bull markets are born on pessimism, grown on skepticism, mature on optimism and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.”
CNN has a very reliable contrarian indicator called the Fear & Greed Index. Just a year ago, the index showed a reading of 5, which is in the Extreme Fear range. According to the contrarian mindset, this would have been a strong buy signal. And sure enough, Stocks have gone up nearly 30% so far this year. Just this past week, the index rose to 92, which is a reading of extreme greed. Stocks may very well continue to move higher, but this is something we should keep an eye on, as it would point to a pullback in Stocks. If that were to occur, Bonds would likely be the beneficiary and rates would move lower.
Stealth QE (Quantitative Easing)
Stocks have gone up for a few reasons, one being the Phase 1 trade deal with China, and another being the Fed. The Fed has been performing what we call “Stealth QE”, meaning that they are quietly adding stimulus into the market. The Fed has been buying, on average, just over $100B per month of Treasury Bills in order to inject liquidity into the market, which is how they have been quietly adding stimulus into the market. Because the Fed has been buying a significant amount of Treasury Bills, short term rates have been kept extremely low. Just how much is $100B per month? At the height of the Fed’s stimulus run they were investing $85 Billion in MBS and Treasuries…so this is even greater than that.
As a result of the buying and short-term rates falling, the yield curve has righted itself, with shorter term maturities yielding less than longer term maturities. Remember not long ago the yield curve was inverted, where shorter term maturities were yielding higher than longer term, which is also a recession indicator. Because short term rates have been financially engineered lower, its very hard to get a return anywhere except the Stock market. For this reason, investors have been forced to buy more Stocks, which has pushed them even higher.
The Housing Scoop
New Home Sales, which measures signed contracts on new homes, were up 1.3% in November at a 719,000 annualized pace. It’s always important to look deeper than just the headline which is something the media rarely does. In this case, the 1.3% gain looks strong, but doesn’t tell the whole story. The previous report, which was for October, was revised lower from 733,000 to 710,000. When factoring in the negative revision, sales actually dropped about 2% month to month. The current level of New Home Sales is still very strong, but we bring this up to show how the media and many others get it wrong and don’t fully understand how to interpret the data. Looking at the bigger picture, New Home Sales are up a very strong 17% year over year.
The Median Home Price was reported at $330,800, up 7.2% year over year. This is another metric that causes confusion. The Median Home Price means that half the homes sold above that number and half beneath it. While home prices are going up due to appreciation, this metric can be skewed if more higher priced homes sold Vs. lower priced homes or vice versa. The media explained that it was a bad thing that prices were up 7.2%, however if you were to tell any homeowner their home rose 7.2% in price, they would likely be thrilled. Often the media looks at home sales and homeownership as a driver of the economic activity and not as an investment for the consumer.
Inventory levels remain very tight, with only 323,000 new homes for sale at the end of November. With higher prices and lower levels of inventory, one could argue that the current level of sales show just how strong the housing market is.
What To Look For This Week
This week is another Holiday shortened week. Stocks will have a regular trading day on Tuesday, but the Bond Market will be closing early at 2:00 pm ET. Wednesday both the Stock and Bond Market will be closed for the New Year’s Day holiday.
There will be a few housing reports scheduled for release, including Pending Home Sales, The Case Shiller Home Price Index, and The FHFA House Price Index. Pending Home Sales will give a reading on signed contracts on Existing Homes, while the Case Shiller and FHFA reports will show home price appreciation. Although these are important housing reports, they will not move the markets. This means that technical analysis will continue to play an even more important role this next week.
After trading in a sideways pattern for quite some time, Bonds have broken above their 50, 25, and 100-day Moving Averages. If Bonds can hold onto these gains and remain above these levels, there is significant upside potential until the next ceiling at 101.904. If Bonds move lower, the aforementioned moving averages should provide some support. The Stock market will also have an impact on Bond trading. If Stocks have another blockbuster week, it may be hard for Bonds to gain ground. In short if they sell off, Bonds will likely be the beneficiary.
After all of the posturing, back and forth, tweets, and rumors, a phase one trade deal was finally struck with China last week. The key words here are phase one…and the deal, while a good sign that the two sides were able to put something together, was not very substantial. China will buy products like soy beans from the US, the US will lower tariffs and not implement the new ones that were set to go into effect on 12/15. As a result of the trade news, Stocks set new all-time highs, while Bonds were relatively unchanged in aggregate after a volatile week.
The Fed left rates unchanged, and the decision was unanimous. The Fed felt the current level of the Fed Funds Rate was appropriate after cutting rates three times this year. There were no changes to the Fed’s view on the economy, as it’s exactly the same as it was last meeting. As expected, the statement had no surprises and was a nonevent. The Fed’s dot chart showed that the Fed was relatively unified in letting rates stay right where they are through all of 2020. During his press conference, Powell indicated that he would need a significant and sustained move up in inflation before he would raise rates.
An Update on Inflation
The Consumer Price Index (CPI), which measures inflation on the consumer level, came in hotter than expectations. The headline reading increased from 1.8% to 2.1% year over year, which is the hottest level in a year.
But the more important Core rate, which strips out food and energy prices, remained stable at 2.3%. This marks the 21st month in a row with a core CPI rate that has a 2 handle.
These levels should be even higher, but there are hedonic adjustments that keep inflation artificially low. Let’s use a car as an example: the price of a new car is at a record high, but because of hedonic adjustments, CPI says that prices are flat over the past 5 years. The reason being, even though the price of a car has gone up, there are newer features that account for the rise in cost. However, the car is still more expensive, and some buyers may not want the additional features, but have them forced upon them. The price of the car is still higher and is felt by consumers, which is why we believe the rationale of these reports are flawed.
Looking deeper into the report, rents rose by 0.3% for the month and are increasing at a rate of 3.7% on a yearly basis, which is unchanged from last month. Medical care costs were up 0.3% for the month and are up 4.2% year over year.
Making matters worse, the Fed focuses on the Personal Consumption Expenditures (PCE) report, which is running 0.7% lower on the core rate. And PCE doesn’t really account for the cost to put a roof over your head and out of pocket medical expenses. The Fed’s PCE gauge says there is little healthcare inflation because Medicare and Medicaid reimbursement rates are price fixing things lower. This allows the Fed to cite little or no inflation, meanwhile the average consumer is feeling the rise in prices.
The Producer Price Index (PPI), which measures inflation on the wholesale level, was a bit tamer than expected. Headline PPI held steady at 1.1%, but the Core Reading, which strips out the volatile food and energy prices, dropped significantly from 1.6% to 1.3%.
A Return to Normalcy…Or Not
The Mortgage Bankers Association reported that Mortgage Application volume was up 3.8% last week. As we said would happen, applications rebounded and normalized this week after the holiday skewed previous two weeks. Applications to purchase a home were down 0.4% but are now up 5% year over year. Refinances were up 9.0% and are now up 146% year over year.
The average 30-year mortgage rate ticked up from 3.97% to 3.98% week over week, bringing rates 110 basis points (bp) or about 1 1/8% lower than this time last year. The Refinance share of mortgage activity increased from 59.0% to 62.4%. ARM’s made up 5.0% of all applications, up from 4.8% last week. The FHA share of mortgage activity rose to 13.9% from last week’s 12.7%
The other report that has been skewed due to the holidays is Initial Jobless Claims. And while Mortgage Apps have smoothed out and are finally showing more reliable figures, Initial Jobless Claims is still all over the place. The latest report showed that there were 252,000 individuals that filed for unemployment benefits for the first-time last week. This was 49,000 higher than the previous week, which was unrevised at 203,000 and 39,000 higher than estimates of 213,000. Last week we told you this number could be higher because some people were not going to file during Thanksgiving week. And those individuals naturally filed the following week, making this figure higher than it should be. In this regard, there may be some weakness that could be concerning. The next report will be important to follow and will likely show some clarity on which way is right and which way is wrong.
Technical Analysis Breakdown
Mortgage Bonds are being squeezed between a reliable floor of support that has held the last several times tested, and a familiar triple ceiling. The aforementioned floor of support is at 101.094 and has held the last 5 or so times it was hit, limiting the decline in Bonds. The triple ceiling, created by the 25, 50, and 100-day Moving Averages, will make gains this week a bit challenging. And the optimism surrounding the US and China trade deal should be a good thing for Stocks and potentially negative for Bonds. Because of this, we must be careful and watch Bonds closely, because if support is broken, there is a lot of downside potential.
Last week was all about Jobs…And there were certainly many more individuals working in the month of November. Additionally, the US and China trade talks continued to spin the markets “Right round baby right round, like a record baby, right round, round, round” like the Dead or Alive song goes.
Conflicting Jobs Data
The first of two jobs reports that were released last week was the ADP Employment Report. This report showed that there were only 67,000 job creations in the month of November, which was the slowest growth in 6 months and a big miss from market expectations of 150,000. Adding to the weakness, the October report was revised lower by 4,000 from 125,000 to 121,000.
When we peel back the curtain and look deeper into the report, goods producing companies lost 18,000 jobs, with 6,000 coming out of manufacturing and 6,000 out of construction and natural resources/mining. The service side saw 85,000 job creations, leaving us with 67,000 in job growth.
After receiving the weak ADP report, you might think that the more important Bureau of Labor Statistics (BLS) Jobs Report would also show some weakness. After all, the two reports do correlate well over time. This was not the case – The BLS reported that there were 266,000 jobs created in the month of November, which was much higher than the 180,000 expected.
Even when factoring the approximately 50,000 in jobs we got back from the GM Strike being over, there were 216,000 jobs created, which is very strong. Additionally, there were 41,000 in positive revisions to the previous two months – September was revised higher by 13,000 from 180,000 to 193,000 and October was revised higher by 28,000 from 128,000 to 156,000. This brings the average over the last 3 months to 205,000.
The Unemployment Rate ticked down from 3.6% to 3.5%. Let’s take a look at why – There are two different surveys within the Jobs Report – The Business Survey, where the headline jobs figure is derived from, and the Household Survey, where the Unemployment Rate comes from. The Household Survey also has a job creation component, which said that there were only 83,000 job creations…conflicting data even within their own report! But there is another component that goes into the Unemployment rate – The labor force increased by 40,000 and since the job creation component was double than the gains in the labor force, the unemployment rate decreased.
Average hourly earnings increased from 3.0% year over year to 3.1%. Average Weekly earnings, which we focus on more, increased from 2.7% to 3.1% year over year.
Overall, it’s hard to poke any holes in this report. The strength was broad based and showed some real strength in jobs.
More Strong Housing Data
CoreLogic reported that home prices rose 0.5% in October and 3.5% year over year. The year over year reading remained stable from last month’s report and is a sustainable and meaningful level for wealth creation. The states with the highest increases year-over-year were Idaho (10.9%), Maine (7.5%) and Indiana (7.1%).
CoreLogic forecasts that home prices will appreciate by 5.4% in the year going forward, which is a slightly lower pace than the 5.6% forecasted in the previous report. How significant is 5.6% appreciation? If you bought a home today for $250,000 and that home appreciated by 5.4% over the next 12 months, you would gain $13,500 in appreciation.
Another widely followed measure of appreciation from Black Knight showed that home prices appreciated 4.25% year over year in October, which was the biggest year over year gain in 9 months.
Media Screw Up of The Week
There were some reports that had to be taken with a grain of salt last week due to the Thanksgiving Holiday the week before. The media sure did not catch on and touted significant weakness in Mortgage Applications and strength in Initial Jobless Claims, but incorrectly so. Let’s break this down –
The Mortgage Bankers Association reported that Mortgage Application volume was down 9.2% last week. Applications to purchase a home were up 1.0%, but were down 24% year over year. This is a huge change from the previous week, where purchase applications were up over 50%.
Refinances were down 16.0% and up only 61.2% year over year. Again, this was a big change from the previous week where refinances were up 314%. Why? Thanksgiving fell a week earlier in the previous year. That means that the year over year figures from last week, which were a holiday, are being compared to a regular week in the year prior. Of course, you could expect less individuals to be applying for mortgages during Thanksgiving week. For these reasons, we have to throw out the year over year figures and wait for next week where we are betting there will be some big gains.
Another report affected by the holiday was Initial Jobless Claims, which showed that there were only 203,000 individuals that filed for unemployment benefits for the first-time. This was 10,000 lower than the previous week, and 15,000 lower than estimates. But don’t be fooled by the lower reading…The period measured in this report was Thanksgiving week, where many were likely not filing for unemployment benefits. Expect a spike higher next week.
What to Look for This Week
The themes of this week will be the Fed and inflation. The Fed’s two-day meeting will start on Tuesday, with the Fed Statement and Press Conference on Wednesday. We don’t expect anything of substance here, as the Fed made it clear that they are going to pause after cutting rates three consecutive times at the previous three meetings. Additionally, the strong Jobs data shows strength in the economy and supports not cutting rates.
Inflation data is always important to follow, as it has a direct correlation with interest rates. Think about it – If you were to purchase a Bond, let’s say for 30-years, you would receive a fixed interest payment over that time period. But if inflation is on the rise, that fixed payment could purchase less and less. As a result, in a rising inflation market, the investor must be compensated with a higher rate of interest. As a result, when inflation is on the rise, interest rates rise.
The Consumer Price Index (CPI) report will be released on Wednesday, with the Producer Price Index (PPI) on Thursday. The really important report to watch will be the CPI, which measures inflation as felt by the consumer. The CPI report has two components, headline inflation and core inflation. The core strips out food and energy prices and is our main focus.
The previous readings, which were for October, headline inflation was reported at 1.8% and core at 2.3%. If inflation surprises to the upside, it could apply pressure on Bonds and send rates higher. Another interesting component within the report is rental increases. The last release showed that rents, across the US, are going up at 3.7%. Einstein once said that the 8th wonder of the world was compound interest. Those that understand it, earn it, those that don’t, pay it. Many renters would likely be surprised to see the impact that has over time on their rent payments.
Technical Analysis Breakdown
Mortgage Bonds were pressured lower after strong economic data and optimism surrounding the US and China’s initial trade deal. As a result, Bonds broke beneath an important triple floor, formed by the 50, 100, and 25-day Moving Averages. These levels will now act as a triple ceiling and will make it hard for Bonds to move higher. There is support nearby that is prevent Bonds from moving much lower on Friday. The level is a trend line that can be drawn by from the close of September 13th to the close of November 7th to the low of Friday’s candle. While this level did hold Friday, it may be fickle. And if Bonds break beneath it, there is significant room for Bonds to move lower until reaching the next floor at 100.547. Because of this, Bonds could move lower next week.
Last week was an action-packed holiday week, with both the Stock and Bond Markets closed all day on Thursday and early on Friday for the Thanksgiving celebration. And speaking of Thanksgiving, we all have so much to be thankful for. It seemed fitting to share portion of this passage from our friends at The Garrett, McAuley Report:
“How’s your health? Not so good? Give thanks you’ve lived this long. Are you hurting? Millions are hurting more. Visit a veterans’ hospital or a hospital for children to appreciate what you have.
When you woke up this morning, were you able to hear the birds sing, use your voice, walk to the breakfast table, read the paper? There are a lot of people today who are deaf, blind, paralyzed, or unable to speak.
How’s your financial situation? Not good? Most people on this planet have no welfare. No food stamps. No pensions. No health insurance. In fact, hundreds of millions of people in the world go to bed hungry every night.
Are you lonely? The way to have a friend is to be a friend. If nobody calls, call someone. Get out and do something nice for someone.
Are you unhappy? Go out of your way to smile at people you bump into during the day.
And be kind to everyone, for everyone you meet might be fighting a hard, lonely battle of some kind.”
The above passage does a good job of reminding us that things could always be worse and to remember to try to live your life with gratitude. Also remember that everyone has their own struggles they face and to be kind before passing judgement.
Onto the news of the week, which provided a Thanksgiving helping of data. All of the reports were packed into Tuesday and Wednesday, due to the market being closed on Thursday…And the theme was stronger data.
The Housing Scoop
On the housing front, acceleration accelerated. The Case-Shiller Home Price Index, which is considered the “gold standard” for appreciation, showed that homes appreciated 3.2% on a year over year basis in September. The 3.2% gain was a slight increase from the previous annual figure of 3.1% reported for August.
Just how significant is 3.2% appreciation? On a $300,000 home, a 3.2% gain in appreciation translates to a $9,600 gain over the course of the year…which is meaningful.
The FHFA (Federal Housing Finance Agency) released their House Price Index, which is another widely viewed measure of appreciation, but only on single-family homes with conforming loan amounts. Because it’s measuring homes with conforming loan amounts, they are most likely homes under $500,000, which is the area of the market we have been seeing the strongest demand. As a result, the appreciation figures are much stronger – Year over year homes appreciated 5.1%, up from 4.6% in the previous report. Again, a sign of acceleration.
There were two other reports pertaining to housing, New Home Sales and Pending Home Sales. New Home Sales, which measures signed contracts on new homes, were down 0.7% in October. But because of the strong revision in September, in aggregate they were much higher and showed a lot of strength. Perhaps of more importance, year over year sales increased from 15.5% in August to 31.6%.
Pending Home Sales, which measures signed contracts on existing homes and is a good leading indicator for Existing Home Sales, were down 1.7% in October. This reading was weaker than expectations, but again, year over year sales rose 4.4% from 3.9% in the previous report. Overall, Pending Home Sales remain at very strong levels, but the minor drop was due to a lack of inventory according to the National Association of Realtors.
Lastly, the Mortgage Bankers Association reported that Mortgage Application volume was up 1.5% last week. Applications to purchase a home were down 1.0%, while Refinances were up 4.0%. Year over year Purchases were up 55% and Refinances up 314%…which would normally seem fantastic.
Remember that data is not always what it seems, and you have to dig deeper than the headlines in many cases. The year over year figures in this report were skewed heavily because last year the Thanksgiving holiday fell one week earlier, so these results are being measured against a holiday week and appear much greater. Keep in mind that next week we will likely see the reverse occur and will need to wait a few weeks for these figures to smooth out.
How Strong is the Economy?
Let’s switch gears from housing and take a look at some of the economic reports released that show how the economy is fairing. Judging by the data received last week, the economy appears to be on pretty solid footing. The second look at Q3 GDP showed that it increased from 1.9% to 2.1% and was stronger than expectations of 1.79%. Consumer Spending was up 2.9%, which was slightly stronger than the 2.8% expected. Additionally, Durable Goods, which was expected to show a decline, surprised to the upside. Initial Jobless Claims, which measures individuals filing for unemployment benefits for the first time, dropped after two consecutive weeks of higher prints. Overall, the economic data was strong and helped Stocks set several new all-time highs.
The Latest on Inflation
Inflation is something that we follow closely, as it has a direct correlation to interest rates. Think about it – If you were to purchase a Bond, let’s say for 30-years, you would receive a fixed interest payment over that time period. But if inflation is on the rise, that fixed payment could purchase less and less. As a result, in a rising inflation market, the investor has to be compensated with a higher rate of interest. As a result, when inflation is on the rise, interest rates rise.
The highly anticipated Personal Consumption Expenditures (PCE) Report, which is the Fed’s favored measure of inflation, showed that headline inflation remained very tame at 1.3%. The Core rate, which strips out food and energy prices and is the most important reading that we focus on, was reported at 1.6%, which was lower than September’s reading of 1.7%. There are other factors, but the low readings of inflation will help to keep rates low.
What to Look for This Week
It’s jobs week, which means we will be getting the ADP Jobs Report on Wednesday and BLS (Bureau of Labor Statistics) Jobs Report on Friday. ADP will give us some clues as to what to expect on Friday, but the two don’t always correlate month to month. The real market moving item here is Friday’s BLS Jobs Report. There are there main components the market will be focusing on keenly – The overall job creation figure, the unemployment rate, and average weekly and hourly earnings.
There are always estimates that are released that set the bar for the level of job creations expected. If that figure is beat heavily to the upside, usually the Stock market rallies at the expense of Bonds. If the figure is much weaker than expected, the opposite is usually also true. The unemployment rate is also very important, as it can be an early warning signal that the economy is slowing and a recession could be on the horizon. Lastly, average weekly and hourly earnings will show if there is wage pressured inflation, which the Bond market will be watching closely…Remember Bonds hate inflation.
It’s always hard to handicap the Jobs Report figure, but job growth has been slowing. It is not at a concerning level yet, but it’s something to keep an eye on. When businesses slow, the first thing they do is stop hiring. Next, they lay people off, which will show up in the Initial Jobless Claims figures. And eventually, the unemployment rate will rise…which is probably the best recession indicator.
The major stock market indices ended the week at all-time closing highs, propped up on optimism of a US and China trade deal. Mortgage Bonds also ended the week higher, recovering much of the downturn in the previous week.
Fed Chair Powell spoke on Wednesday and said, “We see the current stance of monetary policy as likely to remain appropriate as long as incoming information about the economy remains broadly consistent with our outlook.” This translates to keeping the Fed Funds Rate where it is, unless the economy takes a big downturn.
There were several economic reports released this week, with the highlight being the Cass Freight Index and inflation data. The October Cass Freight shipments index is an extremely telling and important report, but it is little followed by those in the media and mainly by those “in the know”.
Their methodology eloquently describes what they’re measuring: “As we try to navigate the ebb and flow of the economy, we don’t pretend to have any ‘secret sauce’ or incredibly complex models that have exhaustively analyzed every data point available. Instead, we place our trust in the simple notion that the movement of tangible goods is the heartbeat of the economy, and that tracking the volume and velocity of those goods has proven to be one of the most reliable methods of predicting change because of the adequate amount of forewarning that exists.”
The October Cass Freight shipments index was down year over year for the 11th straight month, decreasing nearly 4%. Cass Freight repeated what they have said for the past 5 months – That the shipments index has gone from warning of a potential slowdown to signaling an economic contraction. Cass Freight thinks we can see a negative GDP print as soon as Q4. We think there is a good chance of a recession in 2020.
On the inflation front – The Consumer Price Index (CPI), which measures inflation on the consumer level, showed that headline inflation increased from 1.7% to 1.8% year over year.
The Core rate, which strips out food and energy prices, decreased slightly from 2.4% to 2.3%. In context the 2.4% reading was an 11-year high. The Fed focuses on the PCE (Personal Consumption Expenditures) report, which we received last week and is running much lower. Headline and Core PCE were 1.3% and 1.7% respectively.
Within the report, rents rose by 0.1% for the month and are increasing at a rate of 3.7% on a yearly basis, which is slightly lower than the 3.8% last month. Medical care costs were up 1% for the month and are up 4.3% year over year.
The Producer Price Index, which measures inflation on the wholesale level, increased 0.4% month over month in October, which was higher than expectations of a 0.3% gain. But on a year over year basis, headline PPI fell sharply from 1.4% to 1.1%. The Core reading, which strips out the volatile food and energy prices, was up 0.3% month over month, also slightly higher than the 0.2% gain expected. But once again, the year over year figure decreased significantly from 2.0% to 1.6%.
The Mortgage Bankers Association reported their Mortgage Application data for last week, as they do every Wednesday. Overall, Mortgage Application volume rose by 10% to the highest level in over a month. Applications to purchase a home were up 5.1% for the week and are up 15% from this time last year…a big jump from the 7% year over year gain last week. Refinances were up 13% and are up 188% year over year. The Refinance share of mortgage activity increased from 59.5% to 61.9%. ARM’s made up 4.9% of all applications while 13.1% of loans were FHA.
The average 30-year mortgage increased from 3.98% to 4.03% week over week, bringing rates 112 bp or about 1 1/8% lower than this time last year.
Economic Calendar – for the Week of November 18th, 2019
Mortgage Rate Forecast with Chart – UMBS 30-Year 3.0% Coupon Bond
Mortgage Bonds made some nice gains this week, recovering much of the losses from the previous week. Volatility is likely to remain in vogue, with the markets reacting sharply to every comment on the US and China trade relations. Bonds have made some strong technical advances, breaking above their 25, 100, and 50-day Moving Averages. Bonds will likely contend with the 101.46 ceiling, which is a falling trend line and will be an important level to watch. If Bonds can break above 101.46, there is room for Bonds to move higher and rates to move lower. If Bonds stall at this level, at least there are three floors of support beneath present levels.
The major stock market indices ended the week at all-time closing highs, while Mortgage Bonds moved much lower, sending rates higher. Propelling Stocks and dragging on Bonds were reports that an initial trade deal with China could be signed within weeks. The initial deal will include soybean purchases, currency parameters, and the opening up of the Chinese financial industry. The additional tariffs that were supposed to go into effect on December 15th will no longer happen, but there are still tariffs on $360b of Chinese goods. There is really nothing of substance within the initial deal, besides the additional tariffs being removed. There is no talk on some of the more important matters, like intellectual property protection.
Adding to the optimism on Tuesday was a report that said the US was considering rolling back the September 1st tariffs on $110b worth of consumer goods. On Thursday, Gao Feng, a ministry spokesperson for China’s Commerce Ministry, said that both sides had agreed to simultaneously cancel some existing tariffs on one another’s goods in phases and in the same proportion. After this release, Stocks rallied to all-time highs, while Bonds moved to their lowest levels since September 13th. Finally, on Friday, President Trump came out and denied that the US agreed to remove additional tariffs, tempering some of the optimism, but did say that things still looked on track for a phase one deal.
In housing news, CoreLogic reported that home prices rose 0.4% in September and 3.5% year over year. The year over year reading dropped slightly from 3.6% in August, but remains at a sustainable and meaningful level for wealth creation. Remember that on a $300,000 home, an annual appreciate rate of 3.5% would translate to a gain of $10,500. The states with the highest increases year-over-year were Idaho (11.8%), Utah (8%) and Maine (8%).
In the year going forward, CoreLogic forecasts that home prices will appreciate by a very strong 5.6%, which is slightly lower pace from the 5.8% forecasted in the previous report.
Frank Martell, the President and CEO of CoreLogic said that “All 50 states posted positive home price trends in September with the average price nationally rising 3.5%,” said Frank Martell, president and CEO, CoreLogic. “As a group, more millennials are entering the home-buying market and they report spending more money than they anticipated.”
HousingWire echoed Frank Martell’s thoughts, posted an article citing that more millennials are going to be entering the housing market over the next few years than we have seen in a long time. And it’s not something that is up for debate, it’s a fact based on birth rates. The median age of a first-time homebuyer is 33 years old. In order to figure out how many individuals will be turning 33 years old each year and coming to market to either rent or buy a home, you have to look at the birth rates 33 years ago. The chart below shows how over the next several years, the number of individuals turning 33 will be increasing, leading to more demand for housing. This should continue to fuel an already strong housing market. Additionally, it’s supportive of strong appreciation, as there will be more demand.
The Mortgage Bankers Association reported that overall Mortgage Application volume was essentially unchanged week over week, down 0.1%. Applications to purchase a home were down 3% for the week but are still up 6.8% from this time last year. Refinances were up 2.0%, and they are up 144% year over year.
The average 30-year mortgage decreased from 4.05% to 3.98% week over week, bringing rates about 117 bp or about 1.1/8% lower than this time last year. But don’t let this confuse you – Rates actually rose last week. This report was for the previous week, where there was a decline.
Economic Calendar – for the Week of November 11th, 2019
Mortgage Rate Forecast with Chart – UMBS 30-Year 3.0% Coupon Bond
Volatility is likely to continue next week. A look at the Bond chart shows that Mortgage Bonds are now trading in a very wide range, where they are susceptible to big price swings. President Trump is scheduled to speak on Tuesday, and if he talks optimistically on trade relations with China, Stocks will likely rally at the expense of Mortgage Bonds and interest rates. Another very important news item next week will be the Consumer Price Index inflation report. If inflation is muted, it will help Mortgage Bonds move higher. But if inflation is surprisingly high, Bonds will be pressured lower.
The major stock market indexes ended higher, setting new all-time highs. Mortgage Bonds were alsol higher for the week, suriving an action packed news week and strongr than anticipated Jobs Report.
The Bureau of Labor Statistics (BLS) reported that there were 128,000 jobs created in the month of October, which higher than the 90,000 expected. Additionally, there were, 95,000 in positive revisions to the previous two months – August was revised higher by 51,000 and September was revised higher by 44,000.
The Unemployment Rate ticked up from 3.5% to 3.6%. Let’s take a look at why – There are two different surveys within the Jobs Report – The Business Survey, where the headline jobs figure is derived from, and the Household Survey, where the Unemployment Rate comes from. The Household Survey also has a job creation component, which said that there were 241,000 job creations. But there is another component that goes into the Unemployment rate – The labor force increased by 325,000, and since the job creation component was smaller than the gains in the labor force, the unemployment rate increased.
Average hourly earnings increased from 2.9% year over year to 3.0%. Average Weekly earnings, which is even more important, remained stable at 2.7% year over year.
In housing news, the Case-Shiller Home Price Index, which is considered the “gold standard” for appreciation, showed that home prices were up 3.2% year over year in August. Even though appreciation has moderated, 3.2% is still a meaningful level for wealth creation. Remember – On a $300,000 home, a 3.2% gain in appreciation translates to $9,600 over the course of the year.
Pending Home Sales, which measures signed contracts on existing homes and is a good leading indicator for Existing Home Sales, were up 1.5% in September. This reading was stronger than expectations of a 0.7% gain and the second-best number in the last 12 months. The gains were broad based, with sales up in every region. Pending Home Sales are now up 3.9% annually, up from 2.5%. Housing data has been and remains very strong.
The advanced or first look at Q3 GDP showed that it dropped slightly from 2% to 1.9% but was stronger than expectations of 1.7%. Consumer Spending was up 2.9%, which was slightly stronger than the 2.6% expected.
The Mortgage Bankers Association reported their Mortgage Application data, showing that overall Mortgage Application volume was up 0.6%. Applications to purchase a home were up 2% for the week and are still up 10.0% from this time last year. Refinances were down 1.0%, but they are up 134% year over year. The Refinance share of mortgage activity decreased from 58.5% to 58.0%. ARM’s made up 5.2% of all applications. 12% of loans were FHA.
The average 30-year mortgage increased from 4.02% to 4.05% week over week, bringing rates about 105 bp or about 1.0% lower than this time last year. Remember that the rate the MBA cites typically has some fraction of points included.
The Fed cut rate by 0.25% for the third time this year. They removed the language that ‘The Fed will act as appropriate to sustain the expansion’ and replaced it with ‘Will assess the appropriate path of the Fed Funds Rate’. This means instead of certain future cuts, the Fed will be data dependent. The reasons for the cut were global developments and muted inflation. Powell also said that the 3 cuts this year were insurance cuts and he is not thinking about taking them back, which the markets really seemed to like.
Personal Income and Spending was released for the month of September, showing that incomes were up 0.3%, which was in-line with estimates. Spending was up 0.2%, which was also in-line with expectations.
The highly anticipated Personal Consumption Expenditures (PCE) Report, which is the Fed’s favored measure of inflation, showed that headline inflation dropped from 1.4% to 1.3%, which was lower than estimates of 1.4%.
The Core rate, which strips out food and energy prices and is the most important reading that we focus on, was reported at 1.7%, which was lower than August’s reading of 1.8%.
Economic Calendar – for the Week of October 28, 2019
Economic reports having the greatest potential impact on the financial markets are highlighted in bold.
Mortgage Rate Forecast with Chart – UMBS 30-Year 3.0% Coupon Bond
Mortgage Bonds ended the week higher, breaking above the 100, 25, and 50-day Moving Averages. On Friday they moved lower after the strong Jobs Report, but were able to remain just above the dual floor of support, formed by the 50 and 25-day Moving Averages. Bonds will try to remain above these levels, but may have some difficulty with optimism that an initial trade deal with China may be signed in the next few weeks. As a result, Stocks will likely rally. Keep a close eye to make sure support holds for Bonds, otherwise rates could move a bit higher.