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Are we close to the pivot?

| September 21, 2022

Welcome to the last week of summer. Autumn officially starts this Thursday. As the days are getting shorter in the northern hemisphere and a major dose of needed rain coming to California, things in the Northwest certainly shifted quickly. Although we should still have nice high temperatures, the lows have gotten down to jacket weather.

Regarding things that have changed fast, the real estate market has changed very fast, especially in the Western US.

My guess would be that we would “lose” half of the price appreciation since the start of COVID. Let’s take a look at that number.

We’ll use round numbers for this. Prices pre-COVID were $410,000 and they peaked at $630,000. That is a change of $220,000.  If I’m right, I would expect the average price to come down to $520,000 by the time the housing adjustment has finished ($630,000-$220,000 x ½). Which means, if current prices are at $615,000, we still have a way to go. The next official update will be Wednesday. I would expect a significant drop from the previous month.

On the issue of housing, the NAHB builder sentiment index came out this morning and is showing considerable weakness.

You can see that builders are feeling almost as bad as the beginning of COVID and worse than any time in the last five years (ex-COVID).

Our good friends at Alpine Macro broke down PCE inflation into supply-driven and demand-driven inflation. Remember, the Federal Reserve can’t control supply, so they are trying to drive down demand by increasing the cost of borrowing. I just showed you a couple of examples of demand (at least in the housing market). Here is their look at supply-based inflation expectations.

You can see that their estimate of demand-driven inflation is already below 2% (are you paying attention FED?) and their estimate of supply-driven inflation should come down below 2% by the end of 2023. Not fast enough for the FED you say? I think that’s where the policy mistake could be.

As we look forward to the Federal Reserve meeting, we see that expectations for rate hikes are between a 0.75% and 1% increase. See the chart below.

 

You can see toward the bottom, that expectations have been increasing from a month ago. What happened a month ago? Jackson Hole, which we wrote about here

Finally, like Wayne Gretzky, who famously quoted that he skated to where the puck will be (not where it was), we want to be watching where the economy will be, not where it’s been.

One of the pieces we’ve been talking about as a clue to what will cause the market to rebound is a reversal in the US dollar. That will largely be a function of the Federal Reserve slowing or reversing the pace of interest rate increases. We may not be there yet, but this is on our radar screen.

 

The first will likely be at that 105.5 level, which provided a couple of areas of resistance on the way up and one area so far of support in August. That should be an early indicator that the FED is done raising rates, in turn leading to an increase in stock prices.  

In the meantime, it looks like there are finally some other investment opportunities developing in the markets, especially bonds. Say goodbye to TINA (There is No Alternative)! If you are a Wall Street Journal subscriber, there was a great piece on Monday about this shifting dynamic in the markets. It’s worth a read. In short, the return of attractive yields in the fixed income (bond) market should remove some marginal buyers from the stock market, as bonds can now (after many years) play a meaningful role in helping investors build a portfolio that lines up with the returns they need for their financial plan to succeed. If you don’t have a plan that helps you know what that number is for you, please reach out. It's so important, and it’s what we’re here to do.

Let’s wrap it up. Everyone is patiently waiting to see what the FED says and that will likely dictate the second half of the week’s direction. Sounds like a broken record, but ‘FED watching’ is just what this year has been about. That will change at some point, but that point isn’t here yet. For now, have a good week. Let us know if you have any questions about the market or larger planning issues.

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