The Right Combination

Issue 311

By Jeffrey Trusheim, Chief Financial Officer, Mortgage Solutions of Colorado, LLC DBA, Mortgage Solutions Financial.

Mortgage Solutions presents Issue 311 of Market Pulse. This commentary will provide Trusheim's perspective of the economic, political, and technical considerations that will have an impact on the global & domestic financial marketplace. The report will provide a recap of the previous week's activity as well as a look at the important market-moving factors in the week ahead.

As those of us in the mortgage/real estate business painfully know, fewer and fewer potential homebuyers are able to experience the American dream of home ownership. In fact, home affordability is currently at its worst level since at least 1989 and has dropped by nearly half since the pandemic-era low interest rates in 2021.?

The medium price of a home is about $400k, and when mortgage rates were at 3% a couple of years ago, about 50 million households could get a loan. Now, with mortgage rates hovering around 8%, only 22 million households would qualify. The qualifying income for a medium-priced house in 2020 was about 70k. Now it’s more than 107k, according to the NAR (National Association of Realtors). Redfin puts the figure at about 115k.?

The big three numbers that determine affordability are: family income, the price of the house, and the mortgage rate. Although family incomes have risen 19% to $98k since 2020, that pales in comparison to the increase in home prices (up 38% since 2020), and the surge in mortgage rates from 3% to 8%. That’s a 167% jump, driving a $1,200 increase in monthly mortgage payments on a newly bought medium-priced house.?

So, what has to happen to bring affordability back into its historical range? The NAR ran a few scenarios to help illustrate how far affordability is from the average between 1989-2019:

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If home prices are stable, rates need fall to 3.5%.

If prices grow 5%, rates need to fall to 3%.

If prices are stable and incomes increase 5%, rates need to fall to 4.0%.

If mortgage rates stay around 8%, medium home prices need to fall by 35%, to $265k.

If rates and home prices stay at current levels, income needs to increase by 63%.?

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The other issue is supply versus demand. There is not enough new housing in America. There is normally an ebb and flow of existing homes for sale. That is currently not the case. The baby boomers are retired and are aging in place. The Gen X group, at peak earning years, have locked into 3% mortgages. So, it’s up to the builders.

Freddie Mac estimated a long-term housing shortage of 3.8 million homes, before the pandemic. That number has most likely grown since. Builders have begun work on only 692k new single-family homes this year, and 1.1 million if you include condos and apartments. So, it will take nearly four years to build enough houses to replenish supply, not counting new household formations. In a few years, the millennial generation will be moving into their peak earning years, promising to add millions of potential buyers to the market.?

To get affordability back to a comfortable range will take a combination of higher wages, lower interest rates and stable to lower home prices. It is hard to visualize this combination coming to fruition anytime soon. My scenario of a pending recession starting in 2024 still stands and could be the catalyst for a correction in the housing market during the next several years. Unemployment will increase, home prices will likely experience a downward correction, the Fed will cut interest rates, mortgage rates will drop, and the housing/mortgage markets will come back into balance. When and where, you ask? I am always hesitant to give a time and a price forecast for a future event, but since you asked: How does a 5% mortgage rate by 2026 sound?

THE STOCK MARKET

It was another brutal week for the S&P 500, falling 2.5% and posting losses in four out of five reading sessions. For what it’s worth: The S&P 500 is now officially in a correction, having fallen 10%+ from it’s 52-week high near 4600 in July. Interesting, that after a 500-point decline the talking heads on TV are now telling us that the market is in a correction. I’m sure glad they told us…I may not have known!

All kidding aside, the market outlook has taken a turn for the worse. As mentioned in last week’s missive, a trade below 4275 stopped-out our trading position for a small loss, and further declines below 4165 would invalidate the longer-term bullish count. Prices did indeed fall below 4165 and continued lower to 4103 on Friday before finishing the week at 4117, down 107 points.?

Technically, I am now viewing the 500-point decline from the July high as all, or part of, the initial wave-1 of the next declining phase, which has potential to test or exceed the October 2022 low near 3500. That’s the bad news. The good news is that there will be a corrective wave-2 rally coming soon, that has potential to retrace higher into the 4300-4400 region in the months ahead. The indicators are flashing oversold, and the sentiment readings are about where they were at the October 2022 lows. I continue to hold 6-month T-Bills as my primary investment, with a secondary position in gold.

THE BOND MARKET

Bonds had another wild week, with the 10-year Treasury reaching a fresh high yield at 5.02% on Monday, only to plummet to 4.80% on Tuesday, then finished the week at 4.84%, down 7 basis points. Of note was news that two prominent bond bears, Bill Ackman and Bill Gross, dropped their bearish stances and covered their short positions. The latest CFTC report shows record volume on Treasury futures positions, and all skewed to the bearish side.?

The FOMC meets this week, and the latest indication from the fed fund futures market shows a zero probability of a rate hike at this meeting, as well as a very low (25%) probability of a hike at their December meeting. I may sound like a broken record (some of you probably don’t know what that means!), but I continue to see bond yields at or very new their peak. I am looking to move out on the yield curve to the 2-year to 5-year maturities, as my T-Bills mature.?

Important, potential market-moving data this week includes: The FOMC meeting, ADP jobs update, JOLTS report, Challenger job cuts report, and the granddaddy of them all - the monthly non-farm payrolls report.?

Also, keep in mind that late October is usually the time when the Federal Reserve starts adding reserves to the banking system to support consumer spending during the Christmas season. There was also a recent $100 billion inflow due to the government spending. These both could support stock and bond market prices as part of the seasonal tendency.?

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Have a great week and Happy Halloween!

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Jeff Trusheim is the CFO of Mortgage Solutions Financial. Jeff is a 30+ year veteran in the Wall Street arena, with a background in economics, risk assessment and finance (banking and mortgage). He has previously worked in Fortune 500 companies in growing their portfolio and economic footprint.?? ?