Morning Report: Are we hitting price exhaustion at the high end of the market?

Vital Statistics:

	Last	Change
S&P Futures	2432.3	4.3
Eurostoxx Index	374.4	1.6
Oil (WTI)	47.4	0.0
US dollar index	86.2	0.3
10 Year Govt Bond Yield	2.21%
Current Coupon Fannie Mae TBA	103.09
Current Coupon Ginnie Mae TBA	103.97
30 Year Fixed Rate Mortgage	3.89

Stocks are higher this morning on no real news. Bonds and MBS are lower. 

House prices rose 1.6% in the second quarter and are up 6.6% YOY, according to the FHFA House Price Index. The fastest growth was out West, with Washington up 12.4%. The weakest areas were in the Northeast and Mid-Atlantic, particularly CT. 

Morgan Stanley is warning that stocks and corporate bonds could be vulnerable once the Fed begins to let its portfolio of Treasuries and MBS run off. A committee of investors and banks hypothesized that corporate credit spreads could widen as much as 135 basis points. Will that have the same effect on mortgage backed securities spreads? Quantitative easing itself didn't move in spreads all that much, so I cannot imagine something that will amount to a tiny fraction of that having much impact either. The Fed's balance sheet is now about $4.5 trillion. Pre-crisis it was under $1 trillion. Many market observers think the Fed may never be able to get its balance sheet back down to where it was pre-crisis. 

Tensions with North Korea and fears of a debt ceiling standoff have pushed down the market's assessment of future Fed Funds hikes. The December Fed Funds futures are now predicting a 62% chance of no hike versus a coin toss about a week ago. 

The government plans to try and get some sort of tax reform done this year, however it will be difficult. We are much more likely to see some sort of "tax reform light" which probably won't have a massive impact on the economy in the near term. The first order of business is to fund the government and to get an increase in the debt ceiling. Meanwhile, Bridgewater CEO Ray Dalio is taking off risk due to political polarization and buying gold. 

The DOJ ended the Obama Administration's Operation Choke Point, which was sold as an attempt to prevent banks from funding fraudulent actors, but in reality was just an attempt to prevent banks from doing business with payday lenders, which the Administration opposed on ideological grounds. The idea was to hopefully drive payday lenders out of business by making them unable to find banks to service them. 

Luxury homebuilder Toll Brothers reported earnings this morning, and the stock is down a touch pre-market. Average selling prices fell due to a change in product mix. ASPs for signed contracts were flat and contracts were up 25%. Could we be seeing exhaustion, pricing-wise- at the high end of the market? Perhaps, but Robert Toll, Chairman of the Board said: “We believe our industry has room to run. Single-family housing starts, at 811,000, are still well below the 50-year industry average of 1.02 million units. The home ownership rate is on the rise but also still below historic norms. Interest rates remain low, unemployment is low, and more and more buyers are entering the upscale market. Based on these trends, we believe Toll Brothers is well positioned for future growth.”

Despite the lousy housing starts numbers, homebuilder stocks have been on a tear, rising 31% this year. Part of this was due to corporate tax reform - since homebuilders generally have little to no international exposure, a drop in the statutory rate would boost their earnings the most, compared to someone like Apple who has international entities all over the world. Builders have been struggling with their own issues however, especially a shortage of skilled labor. Many of the skilled laborers who worked in homebuilding during the boom either retired or went to work in different industries. Second, construction materials (aka sticks and bricks) are rising as well, and any sort of trade war with Canada will affect framing lumber prices. One thing to remember about homebuilding is that it is a very cyclical business, and during booms, multiples compress. The average homebuilder P/E is about 11 right now, and during the go-go years, it got down to 8.5. In other words, you could be right on earnings increasing, but wrong on the stock price as it goes nowhere while earnings grow. The other side of that argument is that there is so much pent-up demand for housing right now that a slowdown is simply not on the horizon. 

A new lending firm claims it can cut the closing process down to 8 days, and the borrower never has to speak to a loan officer. The industry average is 43 days.