Entries from February 2021 ↓

Reset, Part deux

It might not be exciting as watching the latest version of Seal Team, but the bond market show has been just as full of blood and grit. On Friday five-year Canadas zipped briefly about 1%. Wow. That’s a three-fold increase in four months. It’s a half-point surge in two weeks. And while the yield backed off a little as the weekend dawned, it still felt like a Predator or Reaper killer drone strike. The target being neutralized: hapless newbie house-hunters.

First they faced relentless price inflation, the return of the flippers and speckers, multiple offers, bidding wars and arrogant, let-them-rent realtor rockstars. Now the days of the 1.5% five-year mortgage are doomed.

On Friday we laid out why the bond market’s in turmoil as debt prices fall, yields surge and investors scoff at central bank assurances inflation’s under control. CBs are losing it. Suddenly there’s too much stimulus – government cash, cheap rates and bond-buying – in addition to the vaccines, mass inoculations, corporate profit plumping, a big drop in infections/deaths and economic reopening.

Despite new borrowed billions every week to buy up bonds and suppress rates, it ain’t working. The cost of money is increasing right along with the debt. It’s evident to anyone buying a house, a two-by-four, a puppy, a boat, a few litres of gas or hiring a plumber that inflation is out of the bag. Wage pressures will follow. Imagine where oil prices go when planes start flying again. Rates will keep rising. Governments that spent wildly beyond their means, banking on historically low carrying costs, could whack us all. From pandemic depression to pathogen excess in a few short months. Who knew?

Ron is a Toronto realtor who’s been chucking properties for decades. This weekend he sent me predictions worth sharing. (I’m unsure if he drives an Audi, but let’s take that risk…)

1) Those living off their house ATM will feel it first. Banks will pull the plug on further lending, and reduce lines of credit. The stress would kick in earlier for some than others, but I figure by 6 months those who needed the LOC in the first place will be feeling the heat. Frequently they turn to the grey market @ 10% or above, then capitulate and dump the house.

2) Affordability takes a nose dive as the cost of money jumps up. That takes the real buyers out of the market. The specs will sit on the sidelines waiting for more blood in the water. Bottom line is demand drops, and supply pops.

3) Many Boomers have been waiting for the Pandemic to list because they were uncomfortable selling with all of those germs hanging around.  Look for thousands of listings to hit the market in April onwards.

4) My inbox if flooded every day with Condo developers offering me a full 6% to sell one of their 2 and 3 bedroom units. In the recent past those sales were done by salaried employees, who cost a fraction of the 6% of sale price. Now they just need to move the product. Thousand more units are coming on stream that were planned before the world changed

5) At our office meeting this week, one of the managers more or less read verbatim the glowing 2021 projection prepared by the Toronto Board. It was so bright, I had to dim the monitor on my computer. Being a good team player, I said nothing, as did the other old timers who have seen this rodeo before, a long time ago.

6) Wild card? When. The sweet spot for a Federal election is between the early economic dead cat bounce that will begin by early May, and the havoc caused by higher interest rates, that kick in after July.  I think the second half of the year is going to be a lot rougher than the first half.

Some practical news flowing from these changes: lenders are being deluged with mortgage applications as people desperately grasp for the lowest rates in Canadian history. TD moved a quarter-point higher on Friday. Others will follow. If you have a variable rate, lock in. If you haven’t pre-approved yet to finance a purchase, do so. It was only a matter of time, after all, before the cost of money started to normalize. All those people in the steerage section who told you higher rates were impossible were snorting hopium.

What else?

Well, it’s March now, going into the eight or ten most frenetic weeks of the year for housing. There have never before been conditions like this – insane-high prices, a global pandemic, mass vaccinations, historic govy spending, central bank intervention, rapid rate changes, crushed affordability, plus the virus, nesting and WFH that erased listings and inflated demand. It’s a new world for buyers. And not a swell one.

But maybe Ron’s right. Inventories could jump along with loan costs. Maybe a slew of smart owners will realize it’s an historic opportunity to be sellers – cashing out at the top then buying into falling prices. Maybe the kids will grasp that it’s better to have a higher rate on less debt than the opposite. Or that FOMO is lethal. Or that the future may look nothing like the present.

Or not.

What a rutting season this will be. Incoming!

The handoff

RYAN   By Guest Blogger Ryan Lewenza

Hey, do you want the inside scoop on the stock market? Do you want to know with a high probability where the S&P 500 will be in a year from now and what will be the main driver of this move? Well, you’re in luck! Below I provide the most important chart that investors need to be following over the next 9-12 months. Interestingly enough, I used to cite the importance of this chart during the recovery from the 2008 financial crisis. It’s funny how history repeats.

During economic recessions central banks respond by adding monetary stimulus to help reflate their economies and engineer an economic recovery. Historically, the main policy tool used by central bankers was lowering interest rates. This changed in the financial crisis as the Federal Reserve (Fed) took rates down to zero but with little effect. Given the severity of the downturn and damage done by the financial crisis, the Fed initiated a new policy tool, known as ‘quantitative easing’ (QE).

QE simply entails the Fed printing money and with the newly printed dollars they turn around and purchase bonds. They do this to help drive long-term interest rates lower.

During the financial crisis the Fed implemented a number of rounds of QE and now they are back at it and this time they are not messing around. Every single month the Fed is purchasing US$120 billion of government bonds and for the first time, corporate bonds. In total, since Covid-19 hit, the Fed has printed and injected over US$3 trillion into the US financial system. Just breathtaking figures.

What’s the connection with the stock markets?

Stocks love Fed money printing and QE. There’s two key reasons for this. First, the bond buying drives bond yields lower, which makes stocks more attractive, on a relative basis. Second, the message this sends to market participants is that the Fed has our back and they will do whatever it takes to reflate the economy.

Below I capture this relationship between the Fed’s bond buying and the S&P 500. Note the tight relationship and correlation of the S&P 500 and the Fed’s expanding balance sheet. So, given the Fed will continue its bond buying program, likely for the remainder of the year, this should help to keep driving the equity markets higher.

S&P 500 and Federal Reserve Bond Buying

Source: Bloomberg, Turner Investments

Now this can’t last forever, and likely doesn’t need to as the stimulus from this bond buying and low interest rates should help lead to an economic recovery over the next few years. Effectively we should see a ‘handoff’ from all the Fed money printing and support, to the US economy then strong enough to grow on its own without the need for all the stimulus. I’ve been using the analogy of a relay race where the baton will pass from one runner (the Fed) to the next runner (the overall economy). That’s exactly what happened during the 2008 financial crisis/recession.

In total the Fed implemented three rounds of QE from 2008 through to 2013. In the above chart you can see this with the green line (Fed balance sheet) rising from roughly US$2 trillion in 2009 to over US$4 trillion by 2013.

Then the ‘handoff’ occurred.

Finally the US economy was strong enough to stand on its own two feet and no longer required these emergency policy measures. The Fed ended its QE policies and we then started to see the economic recovery pick up.

Below I chart S&P 500 earnings and US total people employed from this time. You can see from 2013 (when Fed ended their QE policies) up till 2019 that S&P 500 earnings rose from $100/share to over $150/share. Similarly, total US persons employed rose from 135 mln to over 150 mln. Essentially, there was a successful handoff from the Fed to the economy and I see the same thing playing out this go around.

I believe the Fed will continue these emergency policy measures with them buying additional bonds for the remainder of the year. Then as the economy rebounds with the recovery really taking hold, the Fed will then curtail their bond buying (expect a market correction when this happens), effectively resulting in a ‘handoff’ from the Fed to the economy.

So now you know the most important chart to be watching and how we see the next year or two playing out. You’re welcome! And if I’m wrong just blame Garth. He was crazy enough to let me on here.

Fundamental (Jobs and Earnings) Improved following end of QE

Source: Bloomberg, Turner Investments
Ryan Lewenza, CFA, CMT is a Partner and Portfolio Manager with Turner Investments, and a Senior Vice President, Private Client Group, of Raymond James Ltd.