?? Entering The Next Market Phase

?? Entering The Next Market Phase

Remember the US banking crisis of 2023? It's over. Remember when that Systemically Important Swiss Bank was merged with that other Systemically Important Swiss Bank? That's over too.

So... what's next?

I checked my crystal ball. It doesn't know. Checked my Magic 8 ball. That didn't help either...

So, let's take a look at what's happening now...

We've navigated the banking crisis without too much pain. Some regional bank business models have taken a hit from the rapid rate rise (and the free advertising money market funds and larger banks got from the coverage).

But Silicon Valley Bank was unique in many ways. They took their asset/liability mismatch to extremes and their incestuous depositor base of highly-connected & ultra high net worth customers (a massive?94% of SVB deposits were above the FDIC limit of $250,000) made them especially vulnerable to a bank run.

Bank earning calls have been no disaster so far. Pretty much what you'd expect in a slowing economy. More regionals will report this week, but the banking?emergency?looks to be a fading theme... ??

It might not be?over, but it's over?for now...?The 3 month 10 year spread remains deeply inverted, which isn't helpful for lending, and portfolio mark to market losses remain a potential concern/risk...

Economically, there are more mixed signals than anything else. Especially for wages/incomes.

Bank of America's Consumer Checkpoint report highlighted a downturn in wage growth, especially for the high income group ??

BofA says the higher-income duress,"could be due in part to hiring freezes or job cuts in industries such as tech and financial services, which are putting downward pressure on wages in these sectors."

At the lower end of the income scale, the SNAP (Supplemental Nutrition Assistance Program) is returning to normal...

It's not a cliff edge, more of a?'right-sizing'?as the generous pandemic era programs end... ??

One-person households will lose an average of $132 per month, while three-person households will see a larger average reduction of $197 per month. Larger households will lose more because the SNAP benefit is scaled to household size to account for each person’s needs.

Those benefits won't disappear entirely, but the drop is likely to impact spending capacity at the lower income levels.

To top it off, BofA data points to lower-income households receiving smaller tax refunds, although some of the difference is exaggerated by the end of the enhanced Child Tax credits which juiced refund sizes in 2022.

"last year many people received the third stimulus payment of $1,400 through a tax refund, which increased the average refund size. Second, the enhanced Child Tax Credits expired in 2022, so families with two children under 6 years old won't receive the extra $3,200 worth of tax credit."

It's a messy picture, best summed up as?"things aren't as good as they were, but those times were exceptional..."

Transitioning from?exceptional?to?terrible/slow?(rate hikes are intended to slow the economy & wage growth) is a process.

It takes time, and it doesn't look like we're there yet...

Contrary to the BofA data, the Atlanta Fed wage growth tracker still has wages well above trend.

And, in a wonderful twist of fate, annual inflation is falling rapidly. As the months of huge energy driven inflation disappear from the comparison, we're likely looking at US inflation with a 3 handle by June.

Lower inflation is a double-edged sword. On one side, real wage growth turns positive. Inflation eating away less at incomes leaves purchasing power intact and/or rising... ??

GS: “While there are risks on both sides, we think the real income upturn is likely to be the stronger force as we move through 2023, especially because the financial conditions drag will likely diminish assuming Fed officials do not deliver dramatically more tightening than the rates market is currently pricing.”

On the other side, this inflation drop would put short term rates firmly in positive/restrictive territory. Longer term rates, not so much. This missing term premium has been supportive of equities. If you want to put money to work over a longer horizon, you still only get 3.5% in US 10 year bonds.

Perhaps we're at a tipping point here too.

Presuming the Fed delivers another 25bps hike in May, the seemingly magical 5% handle will be achieved. But only at the front end.

Inflation is expected to stay below 4% for the rest of the year with economic growth slowing...

John Authers'?note from earlier in the week had some good info on this.

Arguably, the second statement describes where we are now, while the first statement is more likely where we're eventually heading...

But when?!

The million dollar question. It's not hard to envisage company earnings generally staying resilient (or not as bad as feared) as input costs fall and the economy ticks along, buoyed by renewed inflation-adjusted spending power on the consumer side.

But that won't last indefinitely...

So what can keep the stock market underpinned, or even pushing higher from here?

It's the liquidity, stupid

Or at least... It?was.

I keep wondering... Have we seen the latest liquidity peak?

An upcoming theme is liquidity withdrawal. Once the debt ceiling situation is resolved, the Treasury will need to refill the general account, sucking liquidity out of the financial system and into their coffers as they do.

Ironically, the debt ceiling resolution is a potentially bearish catalyst.

Problem is... The debt ceiling resolution could be rapid (wishful thinking?) or drag on for months yet.

Yellen says the Treasury can hold out until June, some analysts think they could last longer.

Until the resolution, the TGA can't be refunded.

At some point in the next 12 months, the US economy will obviously collapse too, (otherwise?The Economist?covers will have lost their mojo as a contrarian indicator...) ??

From a valuation perspective, it's hard to shake the feeling that there's little room for error with stocks up here.

Immaculate disinflation seems unlikely. If the economy picks up, other things happen too. Like fuel prices rising*, which can trigger another round of inflation (nowhere near the first one, but maybe enough to stop the Fed from cutting this year).

RBOB = Gasoline Futures*

So, what's the next market phase?

Uncertainty.?While it would be no surprise to see the S&P 500 seek out some liquidity in the 4200 zone, spending much time above there seems unthinkable, but then sentiment and positioning (see below) don't exactly scream that markets are exceptionally bullish or ignoring risks either...

Likewise, it makes little sense (to me) to bet on positive catalysts propelling the index?significantly?higher. Employment numbers have?started?to turn lower, and betting on the Fed pivoting at?'just the right time'?while we're this side of 4k just isn't appealing.

Loads of talk about?hedge fund positioning?setting things up for a squeeze.

Hedge funds are 'very short' (but nobody knows if those positions are hedges or directional bets), while CTA's are apparently flipping long the S&P 500, with some speculating that they'll chase higher on a break of 4200...

Even as tech is 'most overcrowded' per BofA's fund manager survey, and 'everyone's' underweight equities vs bonds...??

Messy.

The banking crisis should be?another factor to crimp lending over time, creating a drag on the economy and eventually the stock market, but it's hard to strongly advocate for shorts with this kind of sentiment and positioning...

Fun times ahead. In my humble and unbiased opinion, if you're going to FOMO long into anything today, it should be THIS.

?? As Safe As Houses

The US housing market continues to confound and confuse.?Search social media and plenty are still waiting for an '08 style crash.

However... ??

Which, considering the supposed drag from higher interest/mortgage rates is a little surprising...

So, there must be a good reason, right?

Let's focus on two of the big guns. Lennar (LEN) and D.R. Horton (DHI). Some?quick context from this Harvard paper????

Together, D.R. Horton and Lennar grew their market share of new single family homes sold by some 9.0 percentage points from 2002 to 2020, accounting for about two thirds of the gains made by the top 100 builders, as well as all of the share increases of the top 10 and top 5 builders.

TL;DR: they're the big guns. And the only reason DHI didn't post a new 52 week high yesterday is because it traded a smidge higher at the start of February...

So why would anyone want to own housing stocks if the real estate industry is on the verge of crisis?

Is the market just dumb, and can't see?WHAT'S COMING...?

"I'm smart and the market's dumb"?isn't usually a good strategy...

Homebuilders such as Lennar have sacrificed margins, but kept building regardless...

For Q1 2023,?Lennar reported:

• New orders decreased 10% to 14,194 homes; new orders dollar value decreased 18% to $6.4 billion
• Backlog decreased 29% to 19,403 homes; backlog dollar value decreased 33% to $9.0 billion
• Net margin on home sales decreased 560 bps to 13.8%

In the earnings call, Miller explained the reason for the margin compression.

While?margins fell 360 basis points over the prior quarter?and 570 basis points year over year,?they reflected the use of price reductions and incentives, that is, closing cost payments and interest rate buydown, to offset volatile interest rate and market shifts.

We used these tools both to sell homes, as well as to protect our backlog, by adjusting pricing and incentives to ensure closings. Our first quarter cancellation rate improved to 21.5%. While this is higher than the 10.2% last year, it is decidedly lower than the 26% last quarter and has been falling in each consecutive month.

On top of this, he thinks that people are getting used to higher rates, plus input cost reductions will be able to offset any further incentives that will be required to keep sales ticking over...

The sudden sticker shock of rapidly rising interest rates in 2022 has mellowed. And while net prices are lower, incentives are moderating, cancellations have been normalizing lower, and margins have been bottoming as cost reductions are beginning to provide an offset.

This improving, optimistic sentiment ties in with the NAHB Index...

After hitting its lowest level in 10 years (excluding the drop during the COVID outbreak) the NAHB Market Index has steadily risen in early 2023 (top chart), as limited inventory is helping boost demand.

While still far below pre-pandemic levels, the gains in the headline index?indicate the housing market may have already faced the worst of the current Fed hiking cycle.

And, as we have repeatedly said, there's no real reason to panic over the housing industry right now. Yes, it's cyclical, but there are ways to bridge the gap from current higher rates to what buyers hope will be lower rates a couple of years down the line.

But that still doesn't answer the original question...

Why would anyone be buying homebuilders NOW near ATH's?

Goldman covered the sector recently. LEN's trading at $109, very close to the GS $112 price target. DHI is trading at $102, a little?over?Goldman's $99 price target...

Maybe you can make the case that they're solid companies with cash flows and operating profits, and/or that they should lead the recovery if/when the Fed pivots, but there's not a lot of margin for error here.

Maybe you buy them for the dividends?

Lennar's dividend yield is currently 1.43%. Hardly groundbreaking, but it's something at least...

DR Horton's dividend yield currently sits just under 1% (subject to change - the company reports earnings tomorrow after the close).

Those dividends might not be too reliable going forward either. Jefferies screened for?companies likely to disappoint on dividends?(based on their view that slowing global growth, tight liquidity, higher rates and a profit recession will be significant headwinds to dividend strategies this year) and found Lennar as one of the most likely candidatesl...

So are these homebuilder stocks?priced for perfection?

The immaculate disinflation, a soft landing, access to credit stays easy and open, lower mortgage rates soon, & low available housing inventories keep homebuilders ticking over, with only a very mild recession if there's even a recession at all...

I mean... Maybe?

But then, people said the same about the used car market too, and we'll see how tightening credit impacts there soon enough...

Credit tightening has definitely started and is expected to continue. Here's what?Ally Financial?said today:

As we progress throughout 2023, we continue to see opportunities across all our businesses, but are mindful of the current environment and?are making necessary adjustments to manage risks.

Our focus remains on?risk-adjusted returns, which may lead to slightly lower origination levels as we look to tighten underwriting in certain segments that don’t meet return thresholds

i.e. We will be lending less, and/or charging more to lend (which amount to the same thing).

So, on the back of my Tweet.

There might actually be more compelling shorts in the sector than the homebuilder ETF (once the worm finally turns). Homebuilders generally look vulnerable to bad news.

Signs of a genuine credit crunch, a re-acceleration of inflation, pricing out of 2023 rate cuts and/or long rates moving higher are key risks to a sector pricing something close to perfection.