AS OF LATE
 

I have often long said that investors have no control over how much risk is in the market, so the thing investors should try to focus on here is how much risk your portfolio is exposed to at any point in time. I think today that is likely truer than it has been during any point, certainly in the last 24 months or, maybe even longer. 

 

This idea goes both ways though.  It is not only important to reduce exposures when “risks are coming home to roost”, (like this year so far) but also at distinctly other times when risks have abated, and calmer seas lie ahead (I will come back to this side of the equation many months from now). When there's not a lot of risk in the market, it is definitely time to try to take advantage of that. When there is a lot of risk in the market (now), it is definitely a time to be very risk wary and reduce the risk(s) one is exposed to. 

 

Today, there are a lot of risks permeating into markets so it is a time, as we have been saying for months, to be aware of what money is up to as it is invested.

 

April has shown this to be quite true. We seem to be off to the worst start for markets since 2008 and one of the worst since World War II (long before my time...). The S&P 500 fell -9%+/- in April alone and the previously upward bedazzling NASDAQ is turning into a most dismal falling star, down -13.5% in April alone! 

 

This below shows the S&P 500 Index as well as the NASDAQ Index for the full month of April.  This overriding negative tone in markets really took it's toll last month.      

Similarly, with 3 out of the last four months being negative for stocks, you can see the S&P is now down -14% for the year to date and the NASDAQ has fallen into a full-on bear market, with it down more than -22% as well.
 

 

This chart below shows the S&P 500 Index as well as the NASDAQ Index for the full year-to-date.  This overriding negative tone in markets for 3 out of 4 months is underscoring the weakness in stocks.
 

Since Capital Research has steadily outlined many of the weaknesses in today's market in our writings over the last few months, we won't belabor all of those items here. They are what they are and they seem to be growing in terms of the weakness that they bring to the market. If you'd like, you can review those in previous newsletters by clicking here (maybe start with January and work forward).

The thing we do want to do now is focus on what lies ahead. It's truly our outlook that more weakness does indeed lie ahead for markets. The biggest problem facing the markets today is actually what has happened in the past. The Fed.

The problem really lies in the fact that The Fed created this problem, and the additional fact is that The Fed cannot solve it.  It's really that plain and simple. 

The economy is already slowing down. The numbers are already in on that and it's completely verified at this point. The problem is The Fed wants to step in and continue to exercise its muscle for things we don't need any (or very little) muscle on. 

GDP - Gross Domestic Product not only FELL from the most recent quarter and the previous quarter 1 year ago, it also just went NEGATIVE!  

 

2021 1Q +6.3     2021 2Q +6.7      2021 3Q +2.3       2021 4Q +6.9

2022 1Q -1.4                 

This shows a difference of almost -8.5% change in gross domestic product in just 90 days! It's a stunning number in terms of the fall but it's also a stunning reversal of what was going on previously. As I said earlier, the problem here really is what has happened in the past and it has been completely Fed manufactured. 

If we stop and go back to look at the GDP in 2020, the year the pandemic first started, we see we had a negative number for the first quarter of -6.9, the second quarter was a -33.4 but the third quarter was a hugely positive 41.4!  This was followed in 2020 by a final quarter of a much more normal 3.4 GDP.

 

At that previous point, IF the Federal Reserve had begun to take some of their heavy-handed stimulus away, 2021, would not have been as robust as 2021 was but we also could have had a more gradual approach to affecting the situation and we likely would not be in a negative GDP posture today. (The Fed calls their efforts to be attempts at "Soft Landings" for the economy. Soft landings are made up of two elements-how high you started your approach from AND how quickly you descend from those lofty heights-- So start from a lower height (they should have provided less stimulus) and ease down more gradually-BASIC APPLIED PHYSICS).

As we stated back in January 2022, we felt that inflation was in the peak of its range and the first quarter helped us verify that (the Dallas Fed Reserve office now says 1Q 2022 inflation was 3.1% excluding food and energy).  We noted over a month ago that the cost of lumber had dropped -30% in the month of March and we noted as far back as December that shipping cost, as well as the amount of ships on the water bringing goods to markets around the world was dropping rather precipitously based on demand slowing. 

It is our clear view that agricultural products will continue to see volatility in the coming months both to the up and down sides (that is the nature of volatility itself but most of us yawn when prices go down).

As a follow-on to that lumber price plunge, during April the pricing of lumber did not really go down but lumber also had no upward momentum to its pricing either. Shipping continues to slow around the world, some of it related to the shutdown in China, but some of it is just simply related to Distributors slowing down their orders because they see their inventories rising. When inventories rise, prices go down since distributors of products simply cannot afford to vast amounts of inventory sitting in warehouses and those goods remain unsold. 

Also, as we have seen prices at the pump have begun to  soften and while we may not see a lot more of that, the upside to energy cost may be curtailed for some time. To add to this, while much has been made over the last 18 months of the fast rise in used car pricing, used car pricing has actually started to soften as well. While those prices are not down to the previous levels before the pandemic started, they are down over the last 6 months by more than 20%.

    

We remain watchful!

 

Ken Graves, Chief Investment Officer

Mortgages (click here)  

 

   Rates are up, way up and we discuss them briefly in "Excesses of excesses" below.  They are higher for sure but we forecast this coming long before 2022 got here.

The impact is this - new house payments by new borrowers currently are 26% higher!   The average home in the U.S. is $351,000 s of the end of Q1 2022..  A year ago the "average" house ($280,000) would have had a 30 year payment of $1481.72 for principal and interest @ 3.01%.  Today, that same $351,000 house, has a 30 year payment of  $1866.06.  Almost exactly $400/month higher.



 

 

 

 

 

Excesses of excesses
 

 

 

 

 

So in 2021 we saw the price of residential real estate here in the US increase by the fastest pace ever. Quite the excess. Basically, a 20% increase al across the board in most every market (remember the three most important elements of real estate-location, Location, LOCATION. Prices rose in most every market and some markets obviously rose more than that average 20%.

 

Now we have also seen mortgage rates increase by the fastest percentage in the history of the US mortgage market. In just six short months they basically went up 100%. From 2.5% to just over 5%.

 

When you have a 20% increase in the price of the average house and now add to that a doubling of the interest rate charged for financing that house, the amount of money it will cost the average homeowner, is a lot. It really doesn't matter what price point of house you're shopping for, the cost has jumped tremendously.

 

 

 

What are the impacts of these excesses mentioned here? US housing costs which a year ago today were 18% of GDP have now jumped to 23% of GDP. If that number doesn't seem to work out mathematically for you, you have to remember that with the cost of a house there are housing-related bills, rents and the equivalences of those that are all added into that number.

If we drill down a little bit into those excesses, we now see that March existing home sales dropped 2.7% from the previous month and dropped 4.5% over one year ago.

The National Builder Confidence number in March fell to 77 which is the lowest level in the last 7 months and it also noted that the traffic of potential home buyers is lower than it has been since the summer of 2021. So the potential buyer traffic went up and is quickly falling back down presumably due to housing costs rising so much and financing costs rising so much. We also found information which states price cuts have been occurring in 12% of the current listings for the final week of March and that's the biggest percentage of listings with price cuts since 2015.

 

Likely the only reason that we aren't seeing prices falling quickly for real estate is the low level of inventory of houses on the market. After the 2008 to 2010 housing bubble burst, the number of houses being built annually was very, very low and so we have this backlog of unbuilt houses vs new families created for basically the past decade.
 

While the above data in this graph clearly indicates that low inventory is prce supportive, that supported pricing posture won't stay in play for long simply due to similar houses now being 20% more expensive and current mortgage rates being 100% higher.