real estate – Dennis Tubbergen

The Coming Storm in Real Estate

Did you hear about the latest lunacy out of Washington?

Mark my words; it will create yet another headwind for a real estate market that is beginning to flounder without this change.

Seems that homebuyers with good credit and larger down payments will now pay more in mortgage origination fees than poorly qualified, more marginal home buyers.

Really.

You can’t make this stuff up.

This from “The New York Post” (Source: https://nypost.com/2023/04/16/how-the-us-is-subsidizing-high-risk-homebuyers-at-the-cost-of-those-with-good-credit/)

A little-noticed revamp of federal rules on mortgage fees will offer discounted rates for home buyers with riskier credit backgrounds — and force higher-credit homebuyers to foot the bill, The Post has learned.

Fannie Mae and Freddie Mac will enact changes to fees known as loan-level price adjustments (LLPAs) on May 1 that will affect mortgages originating at private banks nationwide, from Wells Fargo to JPMorgan Chase, effectively tweaking interest rates paid by the vast majority of homebuyers.

The result, according to industry pros: pricier monthly mortgage payments for most homebuyers — an ugly surprise for those who worked for years to build their credit, only to face higher costs than they expected as part of a housing affordability push by the US Federal Housing Finance Agency.

“It’s going to be a challenge trying to explain to somebody that says, ‘I worked my whole life for high credit and I’ve put a lot of money down and you’re telling me that’s a negative now?’ That’s a hard conversation to have,” one worried Arizona-based mortgage loan originator told The Post.

“It’s unprecedented,” added David Stevens, who served as Federal Housing Administration commissioner during the Obama administration. “My email is full from mortgage companies and CEOs [telling] me how unbelievably shocked they are by this move.”

The tweaks could further complicate the strenuous mortgage application process and add more pressure on a core segment of buyers in a housing market already in the midst of a major downturn, the experts added. The average 30-year mortgage rate is hovering at 6.27% as of last week — up from about 5% one year ago and more than twice as high as it was two years ago, according to Freddie Mac data.

Under the new rules, high-credit buyers with scores ranging from 680 to above 780 will see a spike in their mortgage costs – with applicants who place 15% to 20% down payment experiencing the biggest increase in fees.

“This was a blatant and significant cut of fees for their highest-risk borrowers and a clear increase in much better credit quality buyers – which just clarified to the world that this move was a pretty significant cross-subsidy pricing change,” added Stevens, who is also the former CEO of the Mortgage Bankers Association.

LLPAs are upfront fees based on factors such as a borrower’s credit score and the size of their down payment. The fees are typically converted into percentage points that alter the buyer’s mortgage rate.

Under the revised LLPA pricing structure, a home buyer with a 740 FICO credit score and a 15% to 20% down payment will face a 1% surcharge – an increase of 0.750% compared to the old fee of just 0.250%.

When absorbed into a long-term mortgage rate, the increase is the equivalent of slightly less than a quarter percentage point in mortgage rate. On a $400,000 loan with a 6% mortgage rate, that buyer could expect their monthly payment to rise by about $40, according to calculations by Stevens.

Meanwhile, buyers with credit scores of 679 or lower will have their fees slashed, resulting in more favorable mortgage rates. For example, a buyer with a 620 FICO credit score with a down payment of 5% or less gets a 1.75% fee discount – a decrease from the old fee rate of 3.50% for that bracket.

When absorbed into the long-term mortgage rate, that equates to a 0.4% to 0.5% discount.

The FHFA-ordered overhaul of LLPAs affects purchase loans, limited cash-out refinances and cash-out refinance loans.

Yep, you read that correctly. If you have a credit score of 770 and have 20% down, you’ll now pay more for your mortgage, while someone with a 600 credit score, up to their neck in debt, will pay less.

This will be an additional drag on real estate moving ahead in a real estate market that is already struggling. While residential real estate is slowing, the commercial real estate market is really hurting, with more pain on the horizon.

This from “USA Today” (Source: https://www.msn.com/en-us/money/realestate/commercial-real-estate-is-headed-for-a-crisis-worse-than-2008-morgan-stanley-analysts-say/ar-AA19Bwyd)

In February, a PIMCO-owned office landlord defaulted on an adjustable rate mortgage on seven office buildings in California, New York and New Jersey when monthly payments rose due to high interest rates.

Brookfield, the largest office owner in downtown Los Angeles, that month chose to default on loans on two buildings rather than refinance the debt due to weak demand for office space.

They are a bellwether for what is likely to come, as more than half of the $2.9 trillion in commercial mortgages will be up for refinancing in the next couple of years, according to Morgan Stanley.

“Even if current rates stay where they are, new lending rates are likely to be 3.5 to 4.5 percentage points higher than they are for many of CRE’s existing mortgages,” wrote Morgan Stanley Chief Investment Officer Lisa Shalett, in a recent report.

Even before the collapse of Silicon Valley Bank and Signature Bank in March, the commercial real estate market was dealing with a host of challenges including dwindling demand for office space brought on by remote work, increased maintenance costs and climbing interest rates.

With small- and medium-size banks accounting for 80% of commercial real estate lending, the situation might soon get worse, says experts.

Commercial property prices could fall as much as 40% “rivaling the decline during the 2008 financial crisis,” forecast Morgan Stanley analysts.

“These kinds of challenges can hurt not only the real estate industry but also entire business communities related to it,” says Shalett.

While the Morgan Stanley analysts are forecasting a 40% decline in commercial real estate values, I’d forecast more downside than that. With nearly $3 trillion in commercial mortgages in existence, a 4% increase in interest rates on mortgage renewals on properties that may already be having difficulty cash flowing could be the difference between surviving and foreclosure.

According to the “USA Today” article, the commercial real estate sector is already in trouble. Commercial real estate includes hotels, office buildings, and shopping centers.

Not surprisingly, office space is having the most difficulty. 44% of office building loans were in delinquency in 2021 when measured by volume.

That is simply a huge number.

This will undoubtedly lead to additional problems in the banking sector.

If you or someone you know could benefit from our educational materials, please have them visit our website at www.RetirementLifestyleAdvocates.com. Our webinars, podcasts, and newsletters can be found there.

Stagflation Imminent?

Last week, I discussed the inevitable outcome of government overspending and central bank overprinting.

This outcome will be as ugly as it will be predictable in my view.

Eventually, inflation will give way to an ugly deflationary environment. In the meantime, we will probably see stagflation – rising consumer prices and falling asset prices. Professor Noriel Roubini has a similar take. This from “Markets Insider” (Source: https://markets.businessinsider.com/news/stocks/nouriel-roubini-economy-recession-inflation-debt-market-crash-dr-doom-2023-3):

A “perfect storm” is brewing, and markets this year are going to get hit with a recession, a debt crisis, and out-of-control inflation, the economist Nouriel “Dr. Doom” Roubini said.

Roubini, one of the first economists to call the 2008 recession, has been warning for months of a stagflationary debt crisis, which would combine the worst aspects of ’70s-style stagflation and the ’08 debt crisis.

“I do believe that a stagflationary crisis is going to emerge this year,” Roubini said Thursday in an interview with Australia’s ABC.

With consumer inflation still sticky at 6.4%, Roubini said he estimated that the Federal Reserve would need to lift benchmark rates “well above” 6% for inflation to fall back to its 2% target.

That could spark a severe recession, a stock-market crash, and an explosion in debt defaults, leaving the Fed with no choice but to back off its inflation fight and let prices spiral out of control, he added. The result would be a steep recession, anyway, followed by more debt and inflation problems.

“Now we’re facing the perfect storm: inflation, stagflation, recession, and a potential debt crisis,” Roubini said.

He has remained ultrabearish on the economy, despite the market’s growing hope that the US could skirt a recession this year.

Though more bullish commentators are making the case for a healthy rebound in the S&P 500, which fell 20% last year, Roubini has previously said the benchmark stock index could slide another 30% as investors battled extreme macro conditions.

“They will continue to go down,” he said of stocks, pointing to the recent sell-off as investors priced in higher interest rates from the Fed. “The market is already correcting.”

He urged investors to protect themselves by choosing inflation hedges, such as gold, inflation-indexed bonds, and short-term bonds. Those picks are likely to beat stocks and bonds, he said, which could suffer.

I believe Roubini is correct on a couple counts.

Stocks will likely decline further in my view. One only needs to look at the Buffet Indicator to quickly conclude that despite last year’s decline in stock values, stocks remain heavily overvalued.

And, in order to tame inflation, as I have stated previously, real interest rates need to be positive – interest rates need to be higher than the inflation rate.

There are already signs of stagflation emerging. The real estate market is a good example. Wolf Richter, had this to say on real estate (Source: https://wolfstreet.com/2023/03/04/housing-bust-2-has-begun/):

The housing market in the United States has turned down, and in some big markets very dramatically so. Other markets lag a little behind.

That’s how it went during the last Housing Bust, that I now call Housing Bust #1. During Housing Bust #1, Miami, Phoenix, San Diego, Las Vegas, etc. were a little ahead; other places, like San Francisco were a little behind. In 2007, people in San Francisco thought they would be spared the housing bust they saw unfolding across the country. And then it came to San Francisco with a vengeance.

This time around, San Francisco and Silicon Valley, and the entire San Francisco Bay Area, are at the forefront, along with Boise, Seattle, and some others. In the San Francisco Bay Area, during the first 10 months of this housing bust, Housing Bust #2, the median house price has plunged faster than it did during the first 10 months of Housing Bust #1. That’s what we’re looking at. I’ll get into the details in a moment.

Across the US, home sales have plunged month after month ever since mortgage rates started to rise a year ago. In January, across the US, total home sales plunged by 37% from January last year. Sales plunged in all regions, but they plunged worst in the West, by 42% year-over-year, and the least worst, if I may, in the Midwest, by 33%. This is happening everywhere.

The median price of all types of homes across the US in January fell for the seventh month in a row, down over 13% from the peak in June. Some of the decline is seasonal, and some is not.

This drop whittled down the year-over-year gain to just 1.3%. At this pace, we will see a year-over-year price decline in February or March, which would be the first year-over-year price decline across the US since Housing Bust 1.

Active listings were up by nearly 70% from a year ago, though by historical standards they’re still low. Lots of sellers are sitting on their vacant properties and are holding them off the market, and are putting them on the rental market or are trying to make a go of it as vacation rentals. And they’re all hoping that “this too shall pass.”

“This too shall pass” – that’s the mortgage rates. The average 30-year fixed mortgage rate went over 7% late last year, then in January, it dropped, went as low as 6%, and the entire industry was breathing a sigh of relief. This was based on fervent hopes that inflation would just vanish, and that the Federal Reserve would cut interest rates soon, and be done with this whole nightmare.

But in early February came the realization that inflation wasn’t just going away. Friday’s inflation data confirmed that inflation is reaccelerating, that it already started the process of reacceleration in December. Some goods prices are down, but inflation in services spiked to a four-decade high. Services is nearly two-thirds of what consumers spend their money on. Inflation is very difficult to dislodge from services. The Federal Reserve is going to have its hands full dealing with this – meaning higher rates for longer.

And mortgage rates jumped again and on Friday were back to about 6.9%, according to the daily measure by Mortgage News Daily. Just a hair below the magic 7%.

And potential sellers are still sitting on their vacant properties, thinking: and this too shall pass.

So how many vacant homes are there? The Census Bureau tracks this. In the fourth quarter last year, there were nearly 15 million vacant housing units – so single-family houses, condos, and rental apartments. That’s over 10% of the total housing stock.

In 2022, the number of total housing units increased by over 1.3 million. If each housing unit is occupied on average by 2.5 people, that’s housing for 3.3 million more people than in the prior year. The US population hasn’t grown nearly that fast in 2022.

Ok, so now here are nearly 15 million vacant housing units. Of them, 11 million were vacant year-round. Some of the 11 million were being remodeled to be rented out, and others were for sale, and that’s the inventory we actually see, and there are other reasons why homes were vacant.

But 6.6 million homes were held off the market, for a variety of reasons, such as that the owners don’t want to sell the property at the moment.

If just 10% of these 6.6 million homes that are held off the market show up on the market, it would double the total number of active listings. If 20% of these homes show up on the market, it would trigger an enormous glut.

This is the shadow inventory. It can emerge at any time. And during Housing Bust 1, this shadow inventory that suddenly emerged created the biggest housing glut ever.

As I noted last week, history teaches us that excessive debt levels lead to deflation.

This time will ultimately be no different.

Deflation will at some point, become the prevalent economic force. In the meantime, expect stagflation.

That will be more bad news for stocks and real estate as well as consumer prices.

The best advice that I can offer is to have some of your assets that will be protected from a prolonged decline in stocks and real estate and other assets that will perform well in an inflationary environment.

Stock, Retail and Housing Update

Despite the recent rally in stocks, when analyzing longer-term price charts, it is my view that stocks remain in a downtrend at this point in time.

As I have often stated in this publication, it is rare that any market moves straight up or straight down. Instead, a downtrend is typically characterized by a series of lower highs and lower lows. Note the price action on the weekly price chart of an exchange-traded fund that tracks the price action of the Standard and Poor’s 500.

Notice the downtrend line that I have drawn on the price chart. It is a textbook downtrend trendline. As is easily seen by the price chart, there is a downward price trend channel on the chart.

Until this downtrend price channel is broken to the upside convincingly, I expect more downside in stocks.

From a fundamental perspective, stocks remain overvalued. One of the most commonly used valuation metrics for stocks is a tool that is now known colloquially as “The Buffet Indicator” ever since the Oracle from Omaha stated in an interview it was his favorite indicator to use to determine if stocks are overvalued or undervalued.

The chart reproduced here, from Advisor Perspectives (Source: https://www.advisorperspectives.com/dshort/updates/2022/10/27/market-cap-to-gdp-buffett-valuation-indicator) shows the current valuation levels of stocks using this indicator.

Notice that stock valuation levels are slightly lower than they were prior to the tech stock bubble imploding about two decades ago and much higher than at the time of the financial crisis. As you probably recall, stocks fell more than 50% in both of those prior time frames.

That tells us that despite the miserable year in stocks that we have just experienced, there is likely more downside ahead.

Meanwhile, the economic news indicates a generally sluggish economy that is being adversely impacted by continued inflation. Black Friday, the most anticipated retail sales day of the year saw most retailers struggling through what should have been their best day of the year. The exception to this were stores that were deeply discounted merchandise. This from “Breitbart” (Source: https://www.breitbart.com/economy/2022/11/25/black-friday-disappoints-thin-crowds-and-desolate-stores/)

The busiest shopping day of the year is not as busy as retailers hoped.

Across the U.S., shopping malls are seeing only thin crowds, according to reports in business media. Inflation and depressed consumer sentiment appear to have dampened the holiday shopping spirit.

Reuters reported:

At Times Square in New York City, which was cloudy with occasional light rain, employees were seen waiting inside stores for crowds that so far had not arrived.

Outside the American Dream mall in East Rutherford, New Jersey, there were no lines outside stores. A ToysRUS employee was seen walking around the mall handing out flyers with a list of the Black Friday doorbusters.

Bloomberg reported:

Around 10:30am at Crossgates Mall in Albany, New York, the ultra-low-cost brands and the higher-end buzzy retailers had the most foot traffic, while the middle-market stores were desolate.

Gap Inc.-owned Old Navy, which was offering 60% off most items, had a line so long that some shoppers turned around as soon as they entered the store. Athleisure favorite Lululemon Inc., which had only a few racks of discounted merchandise, and American Eagle Outfitters Inc.-owned Aerie, a popular intimates brand among Gen Z shoppers, also drew big crowds.

Meanwhile, stores like Banana Republic, Macy’s, and Urban Outfitters had no lines at all, and only a handful of shoppers.

Overall, the National Retail Federation has forecast that retail sales will be up six to eight percent this year compared with last year. That is a big slowdown from last year’s 13.5 percent increase and the 9.3 percent rise in 2020. After adjusting for inflation, sales may actually be down. The Consumer Price Index is up 7.7 percent compared with a year ago.

November saw a significant decline in consumer sentiment, according to the University of Michigan’s survey. The index of consumer sentiment fell five percent below the October reading, reversing about one-third of the gain since the historic low in June. The gauge of current conditions dropped by 10.4 percent.

That is bad news for a consumer spending-dependent US economy.

While retail is slow, as I have forecasted, the housing market is continuing its slow-motion crash. Homebuyer confidence is now at a record low going back to 1985 as the chart below from “Zero Hedge” shows (Source: https://www.zerohedge.com/economics/housing-market-obliterated-pending-home-sales-post-record-drop-deal-cancelations-price)

Is Deflation Here?

I have long stated my opinion that, at some future point, the Federal Reserve will reverse course and begin to pursue loose money policies again reducing interest rates and once again engage in quantitative easing.

I have discussed the reasons that I believe this will happen in detail in past issues of “Portfolio Watch” so, in the interest of brevity, I won’t recite the reasons in detail again but suffice it to say that debt levels are too high to allow for interest rates to be increased to a level that would subdue inflation.

Ultimately, the economic path on which we find ourselves leads to a predictable destination. I have often also quoted Thomas Jefferson who told us that if we put private bankers in charge of monetary policy they would destroy the economy first by inflation and then by deflation.

Inflation, succinctly defined, is an expansion of the currency supply.

Deflation, accurately described, is a contraction of the currency supply.

Price increases are a symptom of inflation while a decline in the price of assets is a symptom of deflation.

At this point in time, we have seen inflation in consumer prices and we’ve seen evidence of deflation as stock prices have collapsed this year.

Now, however, there are more signs of deflation becoming more apparent.

Used car prices are beginning to decline perhaps signaling that deflation is beginning to emerge. This from “Zero Hedge” (Source: https://www.zerohedge.com/markets/used-car-prices-record-first-annual-drop-two-years-luxury-car-prices-take-beating):

Used car prices appear to moderate as the latest report from auction giant Manheim found that wholesale used-vehicle prices recorded the first annual drop in more than two years.

Manheim’s wholesale used-vehicle prices fell 3% in September versus the prior month. The index declined to 204.5 and is down .1% from a year ago, the first annual drop since May 2020.

Prices are still elevated but down about 13.5% from the all-time high of 236 in January.

In April, we asked the question: “Are Used Car Prices About To Peak For Real This Time?” Followed by a note one month later titled “Used Car Prices Are Crashing At A Near Record Pace.” And by August, we found that “Used-Car Market Cools As Prices Plunge To One Year Low.”

Unpacking today’s report, compact cars had the most significant yearly increase last month at 5.9%, followed by vans and pickups, both of which increased by 0.8%. Increasing demand for smaller, more fuel-efficient cars could be due to consumer shifts away from gas-guzzling SUVs. Meanwhile, midsize car prices were marginally lower, but what caught our eye was the significant decline in luxury vehicles, down 4.8%.

Over the past couple of weeks, I’ve noted that real estate is beginning to show signs of weakness. This week, “The Epoch Times” reported that mortgage applications are at 25-year lows. That’s a remarkable statistic when you consider it. (Source: https://www.theepochtimes.com/mortgage-application-pace-plunges-to-25-year-low-as-housing-recession-deepens_4776637.html)

The pace of mortgage applications has fallen to a multi-decade low amid high housing interest rates, according to the latest data from the Mortgage Bankers Association (MBA).

The Market Composite Index, a measure of mortgage loan application volume, declined by 14.2 percent on a seasonally adjusted basis for the week ended Sept. 30, 2022, compared to a year earlier. The Refinance Index fell 18 percent from the previous week, while the Purchase Index registered a decrease of 13 percent.

Joel Kan, MBA’s associate vice president of economic and industry forecasting, pointed out that overall mortgage application activity dropped to its “slowest pace” since 1997, according to a press release on Oct. 5.

For the week ended Sept. 28, 2022, a 30-year fixed-rate mortgage was 6.70 percent, which is more than double what it was a year ago, at 3.01 percent.

“The current [mortgage] rate has more than doubled over the past year and has increased 130 basis points in the past seven weeks alone,” Kan said.

“The steep increase in rates continued to halt refinance activity, and is also impacting purchase applications, which have fallen 37 percent behind last year’s pace.”

Mortgage numbers were also affected by Hurricane Ian hitting Florida last week, as it triggered widespread evacuations and closures, he noted. Mortgage applications in Florida alone fell by 31 percent.

Construction spending in the country, an indicator of total spending on all types of construction, had fallen for the second consecutive month in August, according to a U.S. Census Bureau report, signaling that the housing market is slipping further into a recession.

In July, the National Association of Realtors (NAR) had warned that the United States was in a “housing recession,” as existing home sales fell by 5.9 percent.

I expect that deflationary forces will soon take over and the fact that the economy is in a recession is a fact that I believe will soon become widely accepted. I also expect the recession to be deeper than anything we’ve experienced in recent memory.

Keith McCullough, who is CEO and founder of Hedgeye Risk Management recently did an interview with “Market Watch” (Source: https://www.marketwatch.com/story/this-stock-market-strategist-says-the-coming-recession-could-be-the-biggest-ever-i-recommend-prayer-11664819562) in which he makes a similar forecast.

Here are some excerpts from the interview:

Recession today is what “transitory” inflation was a year ago. The Fed is as wrong on recession risk as they were on inflation.

I’m about as bearish as I’ve been since 2008. Instead of the economy having a soft landing, I think the landing is going to be hard. The recessionary economic data keeps getting worse, not just in the U.S. but in Europe as well.

Free money forever created behavioral problems and a behavioral bubble for the markets and investors. You believe you’ll have unlimited access to easy money and your behavior, whether you’re building profitless growth companies through storytelling or cryptocurrencies that also are just stories. You’re coming from the mother of all behavioral bubbles that now will be addressed with tighter money. When you’re printing money and the economy is accelerating to the fastest growth rate ever, you’re going to have the mother of all bubbles. Now, GDP is going to slow to zero, and you get the opposite.

Unfortunately, I believe Mr. McCullough is spot on.

Is Housing Confirming the Recession?

Last week, I offered practical evidence that the US economy was in recession citing the examples of FedEx pulling its 2023 earnings guidance and the ‘unretirement’ trend that is now picking up steam.

If you are among those who are of the belief that the long-held and widely accepted definition of a recession (two consecutive quarters of economic contraction) no longer applies, the real-world facts don’t support such an idea.

This week, I’ll present some evidence that the real estate market is on the heels of the stock market, ready to move significantly lower.

Incidentally, year-to-date, the Standard and Poor’s 500 is down more than 22% by my measure. I expect that stocks will ultimately go lower and the evidence suggests that real estate is now following suit.

Wolf Richter gathered some data this past week on the current state of the real estate market (Source: https://wolfstreet.com/2022/09/21/housing-bubble-woes-home-prices-drop-3-5-steepest-monthly-drop-since-jan-2016-sales-already-at-lockdown-levels-drop-further-active-listings-rise-further/)

In July and through mid-August, mortgage rates fell sharply from the 6%-range in mid-June, on the widely propagated fantasy of a Fed “pivot” on rate hikes. By mid-August, the average 30-year fixed mortgage rate was down to 5%. Yesterday, they were at 6.47%. But the brief interlude of dropping mortgage rates slowed down the decline in home sales – sales declined again in August from July but at a slower rate – with Realtors in mid-August talking about the market waking back up.

But prices backed off for the second month in a row, and in a big way, amid widespread price reductions, and that also helped get some deals done.

The median price of existing single-family houses, condos, and co-ops whose sales closed in August dropped a hefty 3.5% in August from July, the largest month-to-month percentage drop since January 2016, after the 2.4% drop in the prior month, to $389,500, according to the National Association of Realtors. While there is some seasonality involved, the percentage drop was much bigger than normal in August, whittling down the year-over-year price increase to 7.7%, down from the 25% year-over-year increases last summer (data via YCharts):

In the West, price drops are further advanced, amid dismal sales. For example, in San Francisco and in Silicon Valley, median prices have plunged in recent months – now down on a year-over-year basis in San Francisco and Santa Clara County (San Jose) and up just a hair in San Mateo County, according to data from the California Association of Realtors.

Sales of existing houses, condos, and co-ops across the US dipped a smidgen from July, after the 5.9% plunge in the prior month, to a seasonally adjusted annual rate of sales of 4.80 million homes, roughly level with lockdown-June 2020, according to the National Association of Realtors in its report. This was the seventh month in a row of month-to-month declines.

Beyond the lockdown months, it was the lowest sales rate since 2014, and down by 29% from October 2020 (historic data via YCharts).

Sales of single-family houses dropped by 0.9% in August from July, and by 19% year-over-year, to a seasonally adjusted annual rate of 4.28 million houses.

Sales of condos and co-ops rose 4% from July to 520,000 seasonally adjusted annual rate, down 25% year-over-year.

Compared to August last year, sales fell by 20%, the 13th month in a row of year-over-year declines, based on the seasonally adjusted annual rate of sales.

Sales volume has been low because potential sellers are clinging to their aspirational prices of yesteryear when mortgage rates were 3%, and many would rather keep the home off the market or pull it off the market than sell for less, for as long as they can. But price reductions have now taken off, by sellers who want to sell.

Price reductions started spiking in May from record low levels last winter and spring as sales stalled, and as mortgage rates surged. In July, they reached the highest level since 2019, according to data from realtor.com. In August, price reductions dipped just a little as sellers might have felt that price reductions were less needed, amid the declining-mortgage-rate-Fed-pivot fantasy in July and August.

Active listings – total inventory for sale minus the properties with pending sales – rose to 779,400 homes in August, the highest since October 2020, up by 27% from a year ago, according to data from realtor.com:

The National Association of Realtors is clamoring for more single-family houses to be built. But homebuilders, they are having trouble selling the houses that they have already built or are building, sales have plunged, inventories have spiked to the highest since 2008, and homebuilders have started cutting prices, buying down mortgage rates, and piling on other incentives to get their inventory moving.

If you read that carefully, you noted an amazing statistic – inventories of ‘spec’ houses are now at the highest level since 2008 which saw the worst of the Great Financial Crisis. At that point, housing prices had already experienced a big decline. Now, we find ourselves in a similar situation and it seems we may be at the onset of the housing price decline.

I expect it to be severe.

Just like the recession.

Forecast on Target

Last week, I gave you an update on the housing market. It’s my strong opinion that real estate is now at the beginning of a decline that will rival the plunge in prices experienced at the time of the Great Financial Crisis.

This development fits in with my long-held belief that our economy will experience inflation followed by deflation. In the interest of full disclosure, this is not an original economic theory, one of the founding fathers, Thomas Jefferson warned us of this inevitable outcome if we allowed private bankers to control the issue of our currency.

I don’t need to convince anyone reading this that we are now experiencing the inflation part of this cycle. However, beginning in 2022, we are now seeing the beginning of the deflationary part of the cycle.

As I’ve commented in the past in this publication, the time frames separating inflationary periods from deflationary periods are not perfectly defined; there is evidence of both phenomena emerging at the same time.

It’s becoming increasingly probable from my viewpoint that we are headed for a stagflationary time – the prices of consumer essentials rise while the value of some financial assets fall.

Some of you are likely taking issue with that forecast given what Federal Reserve Chair, Jerome Powell had to say last week after the Jackson Hole Fed meeting.

In case you missed Mr. Powell’s statement, here is a bit from an article published on “Yahoo Finance” (Source: https://news.yahoo.com/jerome-powell-us-stock-markets-235847493.html) (Emphasis added):

Stock markets in the US ended the week sharply down following tough comments by the head of the country’s central bank, the Federal Reserve.

The bank’s chairman, Jerome Powell, said the bank must continue to raise interest rates to stop inflation from becoming a permanent aspect of the US economy.

His words sent US stocks into a tailspin, with markets tumbling 3%.

It comes as Americans are having to pay more for basic goods.

Inflation in the world’s largest economy is at a four-decade high.

During a highly anticipated speech at a conference in Wyoming on Friday, Mr. Powell said the Federal Reserve would probably impose further interest rate hikes in the coming months and could keep them high “for some time”.

“Reducing inflation is likely to require a sustained period of below-trend growth,” he said at the meeting in Jackson Hole.

Investors are concerned that if economic growth falters, higher interest rates will increase the likelihood of a recession.

Mr. Powell conceded that getting inflation under control would come at a cost to American households and businesses but he argued it was a price worth paying.

“While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses,” he said.

“These are unfortunate costs of reducing inflation but a failure to restore price stability would mean far greater pain.”

Mr. Powell wants to avoid inflation becoming entrenched. Simply put, that means if people believe inflation will be high, they will alter their behavior accordingly, making it a self-fulfilling prophecy. For example, someone who thinks prices will go up 3% next year is more likely to seek a 3% rise in wages.

The last time this happened, Mr. Powell’s predecessor, Paul Volcker, had to slam on the brakes, raising interest rates dramatically and sending the economy into recession.

In March, the Federal Reserve’s key interest rate was almost zero; it has since been raised to a range of 2.25% to 2.5% in an effort to tackle inflation.

Interesting that the author of the article referenced Paul Volcker, comparing the actions of Volcker as Fed Chair to the policy decisions of the current Fed Chair, Powell.

THEY ARE VASTLY DIFFERENT.

Volcker increased interest rates to nearly 20% to tame inflation; that’s a far cry from the current 2.5%!

As I have previously stated, from my research, inflation will not be subdued without real positive interest rates. Interest rates need to be higher than the inflation rate.

I will also go out on a limb here and put forth my prediction that the Fed will reverse course as deflation takes hold. As noted above, deflation signs are becoming more obvious. Last week, I provided a housing update; this week, let’s look a bit more closely at corporate layoffs which are becoming more prevalent. This from Michael Snyder (Source: http://theeconomiccollapseblog.com/the-layoff-tsunami-has-begun-50-of-u-s-companies-plan-to-eliminate-jobs-within-the-next-12-months/):

Unfortunately, a brand new survey that was just released has discovered that 50 percent of all U.S. companies plan to eliminate jobs within the next 12 months. The following comes from CNBC…

Meanwhile, 50% of firms are anticipating a reduction in overall headcount, while 52% foresee instituting a hiring freeze and 44% rescinding job offers, according to a PwC survey of 722 U.S. executives fielded in early August.

These are executives’ expectations for the next six months to a year, and therefore may evolve, according to Bhushan Sethi, co-head of PwC’s global people and organization group.

Can those numbers be accurate?

I knew that things were bad because I write about this stuff on a daily basis.

But I didn’t think that half of the firms in the entire nation were already looking to cut workers.

Wow.

At this moment, I am at a loss for words.

It’s going to get bad out there. If you have a good job right now, try to do whatever you can to hold on to it.

Sadly, some of the biggest names in the corporate world have already started to lay off workers. For example, Ford Motor just announced that it will be laying off “roughly 3,000 white-collar and contract employees”…

Wayfair has also decided that now is the time for mass layoffs…

I thought that Wayfair was doing quite well.

I guess not.

In a desperate attempt to stay afloat, Peloton has also chosen to lay off “hundreds of workers”…

And even Groupon is getting in on the act. 500 of their workers will now be updating their resumes…

Other big names that have announced layoffs in recent weeks include Best Buy, HBO Max, Shopify, Re/Max, and Walmart.

Unfortunately, this is just the tip of the iceberg.

As this new economic downturn deepens, countless more Americans will lose their jobs.

And as that happens, all of a sudden there will be vast numbers of people that can’t pay their mortgages or make their rent payments, and that will make our new housing crash even worse.

We are now very clearly past the peak of the housing bubble, and the ride down is going to be really painful.

Last year at this time, the housing market in California was extremely hot, but now the numbers are definitely heading in the other direction…

Snyder goes on to quote statistics on the California real estate market. He notes that the sales volume of single-family houses in California fell 14% in July from June and by 31% from one year ago. Sales of single-family homes in California have fallen for 13 consecutive months. Price declines are now starting to follow sales declines as one might expect. Prices were down 3.5% in July from June. While that may seem like a relatively small decline, it’s significant should it continue month-after-month.

The forecast of inflation followed by deflation that I put out there in my “New Retirement Rules” book is now playing out.

The Beginning of the End for Real Estate?

In the September issue of “The You May Not Know Report”, I discuss my view that the housing market is beginning to slow and is on the verge of a decline much like the one we witnessed at the time of the Great Financial Crisis.

There are many reasons that I come to this conclusion which I discuss in detail in the September newsletter.

Bottom line, it’s my view that if you have plans to sell your house and you can sell it now at a good price, you should think seriously about it. If you are planning a purchase, you might be wise to wait a bit.

This from the September newsletter:

Another month, another plunge in housing.

Hot on the heels of the latest catastrophic homebuilder sentiment print and plunging single-family starts and permits, analysts expected existing home sales to accelerate their recent decline with a 4.9% MoM drop in July They were right in direction but severely wrong in magnitude as existing home sales tumbled 5.9% MoM in June.

That is the 6th straight month of existing home sales declines – the longest stretch since 2013 – pulling home sales down a stunning 20.2% YoY. From the NAR:

“The ongoing sales decline reflects the impact of the mortgage rate peak of 6% in early June,” said NAR Chief Economist Lawrence Yun.

“Home sales may soon stabilize since mortgage rates have fallen to near 5%, thereby giving an additional boost of purchasing power to home buyers.”

The collapsing housing market means the SAAR is now below the full-year pace of 2012 – one decade ago.

SAAR is an acronym meaning Seasonally Annually Adjusted Rate.

Despite the economist from the National Association of Realtors stating that home sales may soon stabilize, I don’t expect it.

Private lenders in the mortgage space are starting to go bust due to rapidly declining demand for mortgages. This from “Zero Hedge” (Source: https://www.zerohedge.com/markets/private-mortgage-lender-bust-begins-loan-applications-crash):

The US mortgage industry could be on the cusp of a bust cycle as the Federal Reserve’s most aggressive interest rate hikes in decades have sent mortgage loan application volume crashing.

The 30-year fixed mortgage rate jumped from 3.27% at the start of the year to as high as 6% in mid-June, sparking what we’ve been warning readers about is an affordability crisis where demand for homes has evaporated.

Plunging demand for homes can be seen in the pace of mortgage application volumes, falling to levels not seen since the lows of the Dot-Com bubble implosion of 2000.

This means that the rate shock has abruptly curbed the pipeline of new loans and refinancings for mortgage companies — where the poorly capitalized ones will fail first.

From the same article:

The epicenter of the implosion will be independent lenders, such as First Guaranty, who recently filed for bankruptcy after it held onto loans it made that quickly dropped in value earlier this year while trying to package them up to sell to investors.

Court papers revealed lending volume dropped when mortgage rates spiked earlier this year. The company said it could no longer bundle new loans as its pipeline dried up. First Guaranty owes Flagstar Bank and Customers Bank approximately $418 million. It also cut hundreds of employees.

Another independent lender, LoanDepot, laid off 4,800 jobs in July as its pipeline of mortgage volume dried up.

I expect a repeat of the housing crash that occurred at the time of the Great Financial Crisis at some level.

The evidence suggests the onset of that collapse may be getting close.

About Stocks and Bonds

The stock market highs of November have not yet been taken out and my long-term trend-following indicators continue to become more bearish. At this point, a “Santa” rally looks less likely especially given the Fed’s recent statements about accelerating the taper or slowing the rate of currency creation.

As the longer-term readers of “Portfolio Watch” are aware, I believe the Fed’s taper talk is just that. The math doesn’t lie; the federal government cannot fund its deficit spending without currency creation. While the Fed may taper officially, liquidity will have to be made available in order to close the budget gap.

Of course, common sense dictates that this process of currency creation will have to cease at some future point. When it does, it is my belief that a reset will have to occur that will affect many assets including stocks and real estate.

Both stocks and real estate are in a bubble in my view.

David Stockman, former budget director, penned an article last week that examines just how extended stocks likely are. Here is a bit from Mr. Stockman’s piece (Source: https://internationalman.com/articles/david-stockman-reveals-the-truth-about-the-stock-market-and-what-it-means-for-you/)

The fundamental consequence of 30 years of Fed-fueled financial asset inflation is that the prices of stocks and bonds have way overshot the mark.

That’s why what lies ahead is a long stretch of losses and investor disappointment as the fat years give way to the lean.

These will hit hard the bullish investor herd and aggressive buyers of calls who can’t imagine any other state of play. They will be shocked to learn — but only after it is way too late — that the only money to be made during the decades ahead is on the short side of the market by buying puts on any of the big averages: the FANGMAN, S&P 500, NASDAQ 100, the DOW and any number of broad-based ETFs.

The reason is straightforward. The sluggish, debt-ridden Main Street economy has been over-capitalized, and it will take years for company profits and incomes being generated to catch up to currently bloated asset values. Accordingly, even as operating profits struggle to grow, valuation multiples will contract for years to come, owing to steadily rising and normalizing interest rates.

We can benchmark this impending grand reversal on Wall Street by reaching back to a cycle that began in mid-1987. That’s when Alan Greenspan took the helm at the Fed and promptly inaugurated the present era of financial repression and stock market coddling that he was pleased to call the “wealth effects” policy.

At the time, the trailing P/E multiple on the S&P 500 was about 12X earnings — a valuation level that reflected a Main Street economy and Wall Street financial markets that were each reasonably healthy.

The US GDP in Q2 1987 stood at $4.8 trillion and the total stock market was valued at $3.0 trillion, as measured by the Wilshire 5000. Back then, Wall Street stocks were stably capitalized at 62% of Main Street GDP.

Over the next 34 years, a vast unsustainable gulf opened up between the Main Street economy and the Wall Street capitalization of publicly traded stocks.

During that three-decade period, the Wilshire 5000 market cap rose by 1,440% to $46.3 trillion. That’s nearly four times the 375% gain in nominal GDP to $22.7 trillion.

Accordingly, the stock market, which was barely three-fifths of GDP on Greenspan’s arrival at the Fed, now stands at an off-the-charts 204% of GDP.

If we assume for the moment that the 1987 stock market capitalization rate against national income (GDP) was roughly correct, that would mean that the Wilshire 5000 should be worth $14 trillion today, not $46 trillion. Hence, the $32 trillion of excess stock market valuation hangs over the financial system like a Sword of Damocles.

In fact, we believe that the gulf between GDP and market cap has been growing wider and more dangerous since the Fed sped up money printing after the Lehman meltdown. To wit, since the pre-crisis peak in October 2007, the market cap of the Wilshire 5000 is up by nearly $32 trillion, while the national income to support it (GDP) is higher by only $8 trillion.

The stock market’s capitalization should be falling, not soaring into the nose-bleed section of history. After all, since the financial crisis and Great Recession, the capacity of the US economy to generate growth and rising profits has been sharply diminished. The real GDP growth rate since the pre-crisis peak in Q4 2007, for instance, is just 1.5% per annum, which is less than half its historical trend rate of growth.

Back in October 2007, the stock market’s capitalization was 106% of GDP and in just 14 years it has soared to the aforementioned 204%. So even as the growth rate of the US economy has been cut in half, stock market capitalization has doubled.

Given that the stock market has gotten way, way ahead of the economy, the longer-range implication is a long spell during which financial asset prices will stagnate or even fall until they eventually recover the healthy relationship to national income.

Looking at this from a different angle, the current $46 trillion market cap of the Wilshire 5000 would not return to 62% of GDP until US GDP reaches $75 trillion. At an average of 3.3% per annum increase in nominal GDP since Q4 2007, it would take 38 years to get there!

That’s right. The massively over-valued stock market is currently capitalizing on an economy that might exist by the year 2060… if all goes well.

Mr. Stockman offers a terrific perspective on where stock valuations have moved since the Fed began the ‘temporary’ policy of currency creation.

Real estate has followed a course similar to the course tracked by stocks.

The Case-Shiller Housing Index is the commonly used metric of housing values. The chart illustrates housing values for the past 25 years.

Looking at the chart, one can see the decline in housing values at the time of the financial crisis. The index fell from 200 to about 150.

Notice that housing values began to increase in earnest after the Fed began quantitative easing. Since that time, housing prices have nearly doubled.

And, as inflated as housing prices were at the time of the financial crisis, they are far more inflated presently – they are about 50% higher than they were prior to the collapse that began in 2007.

Of course, as we have demonstrated many times in the past if real estate and stocks were priced in gold rather than depreciating US Dollars, one gets a completely different perspective. In 2007, gold was about $650 per ounce. Today, the spot price of gold is about $1800. That’s an increase of about 275%. Priced in gold, both stocks and real estate have declined in value which one would expect given the massive levels of debt that exist.

The reality is that the US Dollar and every other fiat currency around the world is no longer an accurate metric when examining economic data and asset pricing.