Morning Report: Construction boom in 2018?

Vital Statistics:

	Last	Change
S&P Futures	2738.0	-4.5
Eurostoxx Index	398.3	1.0
Oil (WTI)	61.6	0.2
US dollar index	85.9	0.0
10 Year Govt Bond Yield	2.47%
Current Coupon Fannie Mae TBA	102.375
Current Coupon Ginnie Mae TBA	103.25
30 Year Fixed Rate Mortgage	3.91

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

Should be a relatively quiet week, data-wise. The only potential market moving report will be inflation data on Friday. We will have a lot of Fed-Speak this week however. 

The National Association of Realtors thinks we could be in for a construction boom in 2018. Much of the action will be in non-residential, mainly office building, lodging and logistics. Residential is a mixed bag - we have had a boom in apartment construction, but single family is still weak. The biggest problem for construction is labor, and many construction workers are aging out of the workforce. In 2017, a net 190,000 construction workers entered the job market, which is lower than the three year average of 284,000. This means construction firms are going to need to raise wages. One thing is for sure: if we do in fact see a construction boom in 2018, the Fed's 2018 estimate of 2.5% growth is going to be too low. It also means the Fed will probably raise rates a little faster than expected. 

The Fed Funds futures are currently pricing in a 61% chance of a 25 basis point hike in March. Despite the weak payroll number on Friday, the futures upped their probability of a hike. 

One market-based measure of inflation - the TIPS spread - broke 2% for the first time in 9 months. TIPS (Or Treasury Inflation Protected Securities) increase the principal amount of the note by the annual consumer price inflation number, so they act as a hedge (at least in theory) against inflation. The 2% break-even yield is important as that is the Fed's inflation target. 

Republicans and Democrats are still far apart on a spending deal to keep the government open. Democrats want something done on DACA, while Trump wants funds allocated to a southern border wall. We are still far enough out that much of what we are seeing may just be posturing, but there is a possibility we could be looking at a government shutdown. Loan officers who need 4506-T tax transcripts should keep this in mind. The deadline is January 19. 

Delinquencies rose in November, according to Black Knight Financial Service's November Mortgage Monitor. You generally see an increase in November due to seasonality, but this year also includes the effects from the hurricanes in Texas and Florida. The report also checked in on negative equity. We still have homes more than 15% below their peaks in the areas hit hardest by the housing bubble (inland CA, Las Vegas, Florida, parts of the Northeast). The map below shows the current state of affairs:

Morning Report: S&P swings back

Vital Statistics:

	Last	Change	Percent
S&P Futures	1513.0	-0.1	-0.01%
Eurostoxx Index	2631.2	8.6	0.33%
Oil (WTI)	97.59	0.6	0.58%
LIBOR	0.292	-0.001	-0.34%
US Dollar Index (DXY)	80.28	-0.031	-0.04%
10 Year Govt Bond Yield	1.97%	0.00%
RPX Composite Real Estate Index	193.2	-0.1

Markets are flattish as the G-7 countries promise not to target currency rates with economic policies. Barclay's is cutting 3,700 jobs. The President gives his state of the union address tonight, and it will focus on the economy and job creation.  Bonds and MBS are flat.

The National Association of Realtors reported that the median price of an existing home rose 10% in Q411 to 178,900 from 162,600 in Q411. That puts the median house price to median income ratio roughly at 3.53x, which is towards the top of its historic 3.15 - 3.55x range. This begs the question:  Is housing overvalued?  Perhaps, but wages have gone nowhere for 6 years.  Perhaps this time, wages catch up.

Chart:  Median House Price to Median Income Ratio:

The National Federation of Independent Businesses released its Small Business Optimism survey, and while it increased, it was still a dismal reading. On the plus side, more small business owners are hiring than firing. Capital Expenditures are increasing, although they are still in maintenance mode. Overall, the report suggests that sentiment is improving, albeit from very low levels.

McGraw Hill (owner of Standard and Poors) comes out swinging against the DOJ in their latest earnings release. They point out that the US cherry-picked a few emails, and that alone is only evidence of an atmosphere of "vigorous debate" but not wrongdoing.  They note that they were downgrading CDOs with 2006 vintage RMBS a year and a half before Lehman failed (which actually co-incides with the beginning of the financial crisis, IMO).  I remember the credit markets beginning to freeze in the summer of 2007, which was being called a "buyers strike."  Finally, they note that virtually everyone missed the housing bubble, and the fact that their actions proved to be insufficient in hindsight does not prove intentional misconduct at S&P.

The state of Nevada is taking steps to reduce shadow inventory by buying distressed pools of mortgages and working them out to reduce principal.  They will purchase homes at 70% of appraised value and re-work the loan or foreclose and re-sell the property.  It will be administered by a non-profit entity. It will be funded with receipts from the National Mortgage Settlement. Once the loan has been seasoned as a re-performer, it will be sold back into the market and the money recycled.

Morning Report

Vital Statistics:

	Last	Change	Percent
S&P Futures	1319.1	3.4	0.26%
Eurostoxx Index	2181.4	31.3	1.45%
Oil (WTI)	92.34	-0.2	-0.25%
LIBOR	0.467	0.000	0.00%
US Dollar Index (DXY)	81.2	0.119	0.15%
10 Year Govt Bond Yield	1.78%	0.04%
RPX Composite Real Estate Index	175.7	0.1

Markets are generally firmer this morning on hopes of further stimulus out of China and Europe. Euro sovereign yields are lower. US bond futures are down a point and MBS are down slightly.  MBS underperformed bonds in the rally, so they should outperform as bonds retrace.

Richmond Fed came in below expectations. This survey looks at the service sector for Richmond, Baltimore and Charlotte. Revenues actually contracted in May. They note that service providers expect stronger customer demand over the next six months, while retailers do not.

Existing Home Sales came in at 4.62MM annualized.  5.5 million is about "average."  The number is up 10% YOY. The lack of distressed sales and the seasonal move towards bigger houses increased the median price 10% from 161,100 to 177,400. Overall, it notes that the headwinds in the real estate sector are abating.

Yesterday we had a number of sizeable mergers, with Eaton buying Cooper Industries for 12.8 billion, DaVita buying Healthcare Partners for 4.5B and Wanda Group buying AMC. Generally speaking, mergers are a good sign for the markets and the economy in general.

Andrew Ross Sorkin has a good column on why Glass Steagall wouldn't have prevented the crisis. The Glass-Steagall issue has become a facile explanation of what went wrong. Elizabeth Warren even acknowledges this - one of the reasons she has been pushing reinstating GS - even if it wouldn't have prevented the financial crisis - is that it is an easy issue for the public to understand and "you can build public attention behind."  And there you have it. Never mind that nobody else in the world (the UK, Europe, Japan, Canada) separates commercial and investment banking, or even draws a distinction between the two.

What was the rationale behind Glass-Steagall in the first place?  Poorly underwritten deals (for example, Facebook).  Facebook was the quintessential poorly underwritten deal.  An underwritten deal means that the investment banks (primarily Morgan Stanley) actually write a check to the company and buy 421MM shares at 38. It then places those shares with institutional investors.  If the deal is handled well, Morgan Stanley sells all the stock, collects its fee and moves on. This deal did not go well, obviously. Institutional investors sold into the market and FB was in danger of breaking price. Morgan Stanley stood in the market and bought everything that the market was willing to sell at the offer price. (If an IPO breaks price on the first day, that is a MAJOR embarrassment to the investment bank). So Morgan Stanley is now lugging millions of Facebook shares that it bought in the market at 38. The stock is trading at 32.65. Huge loss. Pre-Glass Steagall, what would they do?  Sell the stock to their captive commercial bank at 38. (Hey, we bumped up your allocation to 5 million shares)  Institutional investors will pull their money out quickly if they sense an investment bank is in trouble.  Depositors at a sleepy commercial bank?  Not so much.  Note:  This was done more with bond issues than stock issues, but the rationale remains the same. In the Great Depression, commercial banks were failing and it turned out their assets were not home mortgages or commercial loans - they were all the lousy deals their sister investment bank couldn't unload. That is why we had Glass-Steagall - to prevent commercial banks from being repositories for losing positions.

Fast forward to the financial crisis - commercial banks weren't failing because they bought CDO-squared issues from their investment banking divisions. Or because Citi was stuffing its retail bank with LBO paper it couldn't unload. The reason we had a financial crisis is because we had a residential real estate bubble.  Every bank in the US is exposed to residential real estate in some way, shape, or form. And it didn't matter whether you were exposed to residential real estate through a mortgage backed security or through holding whole loans on your balance sheet.  The small community banks who wouldn't know a CDO from a codfish blew up just the same as the big integrated banks.

Probably the single best thing regulators could do to prevent a re-occurrence would be to deal with the cascading counterparty risk from OTC derivatives. They should demand that OTC derivatives become standardized and exchange-traded with a central clearing party, position limits, and open interest disclosure. That would have prevented AIG from taking the positions it did and exposing all of its counterparties when it failed.