Eq: Total Market
There is a little known recession predictor that has done a good job historically of predicting when the economy is about to go into reverse: conception rate. Based on analysis from 1989 to 2016, a period with over 100 million US births, three economists have found that conception rate consistently dropped just prior to recessions. Conception rate is different than birth rate in that it measures the decision to have a baby, not the actual birth of one. The economists found that months or quarters before a recession, the decision to have a baby declined.
FINSUM: So conception rate and birth rate are different, but obviously very linked. So, what is scary to find out is that the US birth rate just hit its lowest level since 1987. Reason to worry?
Investors beware, credit quality is quickly eroding in the real estate sector. While lending standards started strong after the Crisis, they have eroded significantly in the last few years as investor demand for yields has pushed lenders further down the credit spectrum and eroded protections. The credit quality of both prime and sub-prime borrowers has fallen and the popularity of CRT (credit risk transfer) securities, or mortgage bonds not fully backed by Fannie and Freddie, has risen. Worryingly, yields have not reacted to the decline in quality, as such risky CRT bonds have recently traded at less than a 100 bp premium to Treasuries.
FINSUM: So the big worry with mortgage bonds is that they always collapse faster than any model can predict. Because mortgage payments are so linked to the underlying economy and employment, when a recession happens, the defaults just flood in. We could be headed in that direction.
There are a lot of investors worried about the US housing market at the moment. As rates rise, and a potential recession looms, some think housing could falter. On the flipside, however, it is often considered that home supply is low and demand is high, which has been pushing up prices and shows no signs of abating. Now, there is another factor to consider—US building materials prices are surging. Everything from lumber (up 16%) to insulation is jumping in price. Homebuilders say that despite the rise in costs, they have been able to offset the increases by hiking their prices, which they say consumers have been willing to pay.
FINSUM: The appetite for homes and new construction seems very strong at the moment, and certainly good enough to carry the market for a while yet.
There have been growing fears over the real estate market for the last couple of years, and now one corner of the market is in the middle of a growing apocalypse. Retail real estate is currently on trend to have by far the worst year in memory. Already in 2018, 77 million square feet of retail store space has been closed. In 2017, which was seen as the pinnacle of the collapse, 105m closed the entire year. The sector has been hit by the rise in ecommerce and changing shopping habits. Now landlords don’t even know what to do with all their space. They will likely “Try to re-let it as a gun range or a church—or it’s going to go back to being a cornfield”, says a head of real estate at a private equity firm. The US has 24 square feet of retail space per person, by far the highest in the world.
FINSUM: Not only do you have ecommerce as a threat, but consumer spending is starting to tighten as we near the end of this cycle. This is going to be a major bust.
While the housing market has been doing well and credit markets still look solid on a fundamental basis, there is big trouble brewing in US housing. The proportion of highly indebted mortgage borrowers is surging. Fannie Mae recently increased the amount of total debt as a proportion of income it allows for federally-backed mortgages from 45% to 50%. Rising house prices and stagnant incomes mean that 1 in 5 mortgage borrowers now have 45% or more of their pre-tax income eaten up in debt every month. That is triple the same proportion of borrowers compared to 2016 and the first half of 2017.
FINSUM: The mortgage market has been running out of prime borrowers, and in response, the proportion of subprime borrowers seems to be rising, though this is being accommodated by increased federal support for such mortgages. Are we headed down the same road again?
There is a lot of rhetoric out there about how the labor market is extremely tight, which will push wages up and force the Fed to raise rates. According to Barron’s, if you really compare this year’s labor market data versus last year, it looks like there is an unemployment pool of at least around 1 million Americans that could re-enter the labor force. This group is often referred to as the “hidden unemployed”.
FINSUM: This means that there is actually more capacity for the labor market absorb jobs than is often reported, meaning there may not be as much upward pressure on wages, and therefore, rates, as expected.