Morning Report: Leading Indicators show strong growth ahead

Vital Statistics:

			Last	Change
S&P futures			2808	-8.25
Eurostoxx index			386.86	-18
Oil (WTI)			68.23	-0.53
10 Year Government Bond Yield				2.87%
30 Year fixed rate mortgage				4.51%

Stocks are lower as earnings continue to come in. Bonds and MBS are down.

Initial Jobless Claims fell to 207,000 last week, which is the lowest level since 1969. Despite the tightness of the labor market, wage growth is tough to come by.

I have discussed at length the disconnect between the Northeast and the rest of the country when it comes to the real estate market. It turns out that not only does the real estate market lag, so does mortgage banking. Last year was a rough year for mortgage banking, and the typical profit per loan was about 31 basis points. That varied by region, with the Midwest in the lead at 39 basis points while the Northeast lagged at 8. 

The Fed's Beige Book characterized the economy as strong, and said that labor shortages are beginning to impede growth. Engineers, skilled construction workers, truck drivers, and IT professionals are in short supply. So far increasing input prices are not translating into higher inflation - corporate margins are taking the hit. Residential housing continues to improve ever so slowly, and commercial real estate is flat. Overall, the picture points to a strong economy, with room to run. The lack of pricing pressures gives the Fed the leeway to go slow as they get off the zero bound. 

The Conference Board echoed this assessment, with the Index of Leading Economic Indicators increasing 0.5% in June. The LEI is still rising faster than the CEI (basically the future indicators are showing that growth should accelerate) which means we have no sign of a slowdown.

Kathy Kraninger, the Administration's nominee to run the CFPB, will appear before the Senate Banking Committee today. Little is known about her views on financial regulation. Congressional aides have said that she will have enough support to pass the Committee on a party-line vote. In her prepared remarks, she said she will continue Mick Mulvaney's work of balancing the need for consumer protection with the need to treat the financial sector fairly. Suffice it to say, having come from OBM, she doesn't really fit the type of bureaucrat who would normally be tapped to run the CFPB, and that may be the point. If her nomination bogs down, Mick Mulvaney can continue to run the agency.

Interesting stat: 70% of the Millennials who own a home have buyer's remorse. Many used their retirement savings to fund the down payment, which is generally a bad move. Many first time home buyers completely underestimate closing costs as well. Others underestimated the costs of upkeep, which is around $16,000 a year. I suspect many of these lessons are learned by every generation who buys their first home. 

The CoreLogic Mortgage Fraud Risk Index rose 12% in the second quarter compared to a year ago. An increase in borrowers taking on loans for multiple properties (i.e more professional investors) appeared to drive the increase. 

Morning Report: Fed Beige Book points to strong labor market

Vital Statistics:

	Last	Change
S&P Futures	2729.3	6.0
Eurostoxx Index	374.0	1.3
Oil (WTI)	61.2	0.0
US dollar index	83.6	0.1
10 Year Govt Bond Yield	2.87%
Current Coupon Fannie Mae TBA	102.25
Current Coupon Ginnie Mae TBA	102.5
30 Year Fixed Rate Mortgage	4.4

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

Donald Trump is set to impose tariffs on steel and aluminum, however there is talk of exempting Canada and Mexico from them (which is where we get most of our foreign steel to begin with). That exemption will be used as leverage to renegotiate NAFTA. So far, the trade war is largely symbolic - Trump tweeted that he wanted to see a $1 billion decrease in our trade deficit with China, which is about $375 billion. In other words, it is a drop in the bucket, and all for show. That might have been an error however, some reports are saying he meant $100 billion, which probably makes more sense. That said, stocks are taking the trade war in stride, and bonds seem to have found a level here. 

Initial Jobless Claims rose to 231k last week from 220k. Job outplacement firm Challenger, Gray and Christmas reported that companies announced 35,369 job cuts in February. 

The overall economy grew at a modest to a moderate pace in January and February, according to the Fed's Beige Book survey. With regard to employment, it said: "On balance, employment grew at a moderate pace since the previous report. Across the country, contacts observed persistent labor market tightness and brisk demand for qualified workers, as well as increased activity at staffing placement services. Several Districts reported continued worker shortages across most sectors, with contacts often mentioning shortages in the construction, information technology, and manufacturing sectors. In many Districts, wage growth picked up to a moderate pace. Most Districts saw employers raise wages and expand benefit packages in response to tight labor market conditions. Contacts in a few Districts conveyed reports of modest increases in compensation following passage of the Tax Cuts and Jobs Act." The increases in wage inflation are a good sign for the economy overall, but not so much for interest rates. The Street is looking for a strong reading in wage growth in tomorrow's Employment Situation Report: an increase of 2.9% YOY. 

Buyer sentiment fell last month, according to the Fannie Mae Home Purchase Sentiment Index. “Volatility in consumer housing sentiment continued into February, with the new tax law beginning to impact respondents’ take-home pay and the stock market creating negative headlines due to early-month turbulence,” said Doug Duncan, senior vice president and chief economist at Fannie Mae. “Additionally, consumers’ expectations for higher mortgage rates suggest that consumers expect the Fed to hike rates a few more times in 2018. We will continue to track how consumer housing attitudes trend in the coming months as these various market forces play out.”

Morning Report: Housing starts disappoint

Vital Statistics:

	Last	Change
S&P Futures	2802.5	-1.3
Eurostoxx Index	398.1	0.1
Oil (WTI)	64.0	0.1
US dollar index	84.5	-0.2
10 Year Govt Bond Yield	2.62%
Current Coupon Fannie Mae TBA	102.375
Current Coupon Ginnie Mae TBA	103.25
30 Year Fixed Rate Mortgage	4.03

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

The House looks ready to pass a one-month stopgap measure to keep the lights on. Senate Democrats are considering blocking it in order to push immigration reform, but nothing is set in stone. Bottom line, the odds of a government shutdown tomorrow are falling. 

Initial Jobless Claims came in at 220,000 last week. This is a 45 year low. When you take into account population growth and the fact that we had a military draft back then that number is astounding. 

The Beige Book was released yesterday, and contained no major surprises. Growth is "modest to moderate" in most districts and the labor market is tight, to the point of constraining growth. They mentioned that we are seeing wage inflation more broadly in some districts, while inflation is generally under control. Separately, the Philly Fed report showed that growth eased somewhat, however it is still very strong. 

Housing starts came in at 1.19 million units (annualized), which was a big disappointment. Hurricane effects probably played a part, as many construction workers are being diverted to repair work. We did see a substantial (14%) drop in starts in the South. Building Permits came in at 1.3 million. All told, 1.2 million housing units were started in 2017, which was more or less flat with 2016. This is about 80% of the pre-bubble average of 1.5 million units a year. 

Mel Watt discussed housing reform in a letter to the Senate Banking Committee. He urged lawmakers to establish a guarantor framework where shareholder-owned entities guarantee mortgages with a government backstop and a utility model. The utility model means that pricing will be set by the government in order to set an allowable rate of return for the company and nothing more, similar to how gas and electric companies are run. If one of the guarantors runs into trouble, they will be allowed to fail, however the mortgages they guarantee will be backstopped by the government, thus protecting MBS investors. The document also recommended that these guarantors offset their credit risk in the private market when economically feasible and that they hold enough capital to withstand another 2007. 

Morning Report: Reflections on the Crash of 1987

Vital Statistics:

	Last	Change
S&P Futures	2547.0	-13.0
Eurostoxx Index	388.1	-3.5
Oil (WTI)	51.2	-0.9
US dollar index	86.5	-0.2
10 Year Govt Bond Yield	2.31%
Current Coupon Fannie Mae TBA	102.875
Current Coupon Ginnie Mae TBA	103.938
30 Year Fixed Rate Mortgage	3.9

Stocks are lower this morning on overseas weakness. Bonds and MBS are down small. 

Initial Jobless Claims fell to 220,000 last week which was the lowest since we still had a military draft. If you correct for population growth, the number is even more impressive. Note that last week included the Columbus Day holiday, so the number should be taken with a grain of salt. 

The Conference Board Index of Leading Economic Indicators slipped in September for the first time in a year as hurricanes depressed activity. The main source of weakness was in the labor market and residential construction. 

The Fed's Beige Book summary of economic conditions reported that activity was between "modest" and "moderate" for all of the 12 districts in September. Hurricane-related disruptions were reported as a drag on the economy. The labor market remains tight, with shortages in many industries, including construction, health care, and transportation. While wage growth overall remains soft, we are seeing some evidence of wage pressure increasing in these areas, as firms are adding signing bonuses, overtime, and other non-wage benefits. 

The trend of larger houses and smaller outdoor spaces is being reversed, as materials costs are making larger homes unaffordable for many buyers. The average square footage of outdoor space has increased 7,048 square feet. Yard sizes peaked in the mid 70s, at around 12,000 feet before bigger and bigger houses became the norm. Since 1973, the average size of a single family home increased 62% to 2,467 square feet. 

For an example of rising materials costs (aka sticks and bricks) here is a chart of lumber futures going back to the mid 80s. We are at prices not seen since the bubble.

You see some of this in the suburbs of Manhattan, where luxury homes languish. This home was first listed at $17.35 million in 2 years ago, cut to $11.5 million and still hasn't sold. It was taken off the market in September. All real estate is local, and the Northeast is pretty much the opposite of the West Coast, where demand is overwhelming supply. 

Brian Montgomery, Donald Trump's nominee to run the FHA, represented banks for years, helping them fight penalties imposed by the agency. Many on the left are worried that he will be unable to think solely from the perspective of the public interest. The government wants to see more FHA lending, but the Obama Administration's use of the False Claims Act (which awards treble damages) has driven the business to smaller non-bank lenders. HUD Chairman Ben Carson recognizes the issues with FHA lending, and wants to see a more balanced approach. 

Today is the 30 year anniversary of the Crash of 1987, where markets fell 23% in one day. Many people blamed program trading and wonder if the same thing could happen today as high frequency traders dominate the market. That is certainly a possibility, however high frequency traders usually step away from the markets once volatility kicks up, so they probably wouldn't force stocks down, the way portfolio insurance did in the mid 80s. The biggest risk today is that liquidity will vanish at the worst possible time. Technology and regulation have reduced stock trading commissions and bid / ask spreads to almost nothing, and have driven the market-maker and stock specialist (the "traffic cops" who helped maintain an orderly market) out of business.  IMO, flash crashes we have seen will probably be the model this time around, where volume becomes so light that a few market sell orders can drive stocks down to nothing. We saw this happen before, where well-known, profitable and solvent companies were driven to a penny a share. The next crash will be an interesting test whether exchange traded funds are all they are cracked up to be as well, especially if we see a big divergence between NAV and trading prices. 

The Crash of 87 also ushered in the Greenspan Put, which got its name after Fed Chairman Alan Greenspan assured the markets that the Fed stood by ready to provide liquidity as needed in the aftermath of the crash. This probably prevented the crash from turning into a wholesale financial crisis, however that policy became more or less codified to where the Fed began to ease whenever asset markets had a hiccup. It prevented a recession in the mid-90s, which could have occurred after any one of financial hiccups, whether the MBS implosion in 1994, Long Term Capital Management, or the Asian Financial Crisis. The idea that the Fed would save the day with interest rate cuts or more liquidity whenever asset prices fell became known as the Greenspan Put, which had the effect of lowering risk premiums and making investors more willing to pay high multiples or earnings. Stocks became a "can't miss" proposition. (Remember the talking heads on CNBC? Don't worry about P/E ratios - just buy "quality" companies.) The poster child of this theory was Cisco Systems, which hit a high of over $77 a share in early 2000 and is less than half that today, over 17 years later. 

The Greenspan Put also set the stage for the residential real estate bubble of the mid 00s. Years of easy money found its way into different asset classes, especially the residential real estate market. Nobody wanted to talk about Cisco any more, they were too busy flipping condos in Las Vegas. Rock bottom interest rates had investors reaching for yield, which made for an insatiable appetite for mortgage backed securities. We all know how that ended. And even today, people are willing to tie up their money for 30 years lending to the US government at 2.8% while we have a Federal reserve hell-bent on creating inflation. Or they are invested in auto asset backed securities, lending for 8 years at 3.2% for an asset that depreciates like sushi. It is strange to think how this state of affairs was largely the unintended consequence of well-intentioned Fed policy in the aftermath of the Crash of 1987. 

Morning Report: Professional investors exiting the foreclosure market

Vital Statistics:

	Last	Change
S&P Futures	2162.0	16.0
Eurostoxx Index	338.8	3.0
Oil (WTI)	45.6	0.8
US dollar index	86.9	-0.2
10 Year Govt Bond Yield	1.53%
Current Coupon Fannie Mae TBA	103.2
Current Coupon Ginnie Mae TBA	104.2
BankRate 30 Year Fixed Rate Mortgage	3.47

Stocks are higher this morning after the Bank of England declined to cut interest rates. Bonds and MBS are down

Initial Jobless Claims fell to 254k in a holiday shortened week. 

Consumer comfort increased last week to 44.7 from 43.5

Producer prices increased 0.5% in June, versus expectations of a 0.3% increase. On a YOY basis, they increased 0.3%. Higher energy prices drove the increase, however we are a long way from seeing true inflationary pressure. Inflationary pressure won't build until we start seeing wage inflation, and there we have a dichotomy: Firms with highly skilled labor are having to raise wages to keep top talent, while technology is depressing wages for people in jobs that will eventually be replaced by robots and expert systems. Note the Fed's Beige Book characterized wage growth as "modest to moderate." This is Fed-speak for "almost imperceptible." That said, wage growth appears to have broken free from post-crash 2% level and is beginning to register in the mid 2%s.

JP Morgan reported better-than-expected earnings this morning. Mortgage banking revenue was up 2% QOQ and 5% YOY. Portfolio growth and and production revenue increases were offset by lower servicing revenues. The stock is up 2.5% pre-market.

Has the big rally in prices for foreclosed homes run its course? RealtyTrac suggests that it may have, as more and more "mom and pop" investors are winning foreclosure auctions and the professionals are pulling back from the market. Professional investors accounted for almost 10% of all home purchases in the depths of the housing bust, now they account for about 2.5%. There are some fears that this signals another housing bubble. FWIW, home prices are stretched compared to incomes, however that ignores the effect low interest rates are having. Housing bubbles are rare things - prior to the 2006 bust the last bubble in real estate popped in the 1920s. Anyone reading this will probably never see another one. 

Speaking of foreclosures, the people who got foreclosed on early in the housing bust basically missed out on about 10 years of house price appreciation. To add insult to injury, many sold into a cheap housing market (to the professional investors mentioned above) and moved into expensive rentals (managed by the professional investors above). 

Earnings season has just started, and the S&P 500 is at record highs. Is this rally for real? It will depend on earnings, which have been declining the past several quarters. The other thing that will drive the market is share buybacks. With the world's central banks driving down interest rates, they are lowering Corporate America's cost of capital. Many companies are choosing to issue debt to retire stock. This move is essentially a no-brainer for corporate CFOs who don't have much in the way of profitable expansion opportunities. When you can issue debt for 4% to retire stock with a cost of capital of 10%, you do it. 

The flip side of ultra-low interest rates is a boring, risk-averse economy. This has been a conscious choice among policy-makers (remember "Make banking boring again"?). Of course a major problem is that usually global economies de-leverage after asset bubbles, but that hasn't happened this time around. As global debt levels rise, they act as sand in the gears for the economy, slowing it down. Ironically, the policy-makers who drove this are concerned first and foremost about inequality, and the unintended consequence of their policy has been an economy that gooses asset prices and retards business formation (which means less jobs). This increases inequality even further - the opposite of what they intended. 

Of course the endgame for these policies is Japan, which is discussing new fiscal measures to try and pull their economy out of a 25-year bust.

Speaking of Japan, do you have kids that are playing Pokemon Go? (the latest craze). This has really caught investors by surprise: Nintendo stock is up 76% over the past week.

Morning Report: Earnings season is off to a rough start

Vital Statistics:

	Last	Change	Percent
S&P Futures	1994.0	10.0	0.50%
Eurostoxx Index	3230.5	38.9	1.22%
Oil (WTI)	45.66	-1.0	-2.10%
LIBOR	0.321	0.000	-0.08%
US Dollar Index (DXY)	94.55	0.618	0.66%
10 Year Govt Bond Yield	2.00%	0.03%
Current Coupon Ginnie Mae TBA	105.2
Current Coupon Fannie Mae TBA	104.5
BankRate 30 Year Fixed Rate Mortgage	3.8

Stocks are higher this morning after some strong economic data. Bonds and MBS are down.

Initial Jobless Claims fell to 255k last week matching the low set in July. That 255k print is the lowest since 1973. Pretty amazing number given how much the population has increased. 

However that is translating into weak real wage growth. Last week real average weekly earnings increased 2.2%, We definitely have a tight labor market in some areas but wage growth has been hard to come by. 

Inflation at the consumer level fell 0.2% in September on a month-over-month basis and is flat year-over-year. Ex-food and energy, consumer prices rose 0.2% on a MOM basis and are up 1.9% YOY.

The Bloomberg Consumer Comfort Index edged up last week to 45.2 from 44.8. 

The Philly Fed manufacturing index improved to -4.5 in October. 

The Fed Beige Book survey reported that the US continued to experience modest economic expansion during the August - October period. Pretty much all districts reported growth except for Kansas City. Labor markets tightened in most districts and some are reporting shortages of skilled labor and are seeing upward wage pressure. 

Earnings season is off to a rough start as Alcoa, JP Morgan, Goldman, and Netflix all missed and Wal Mart guided lower. Wal Mart was down 10% yesterday after they announced profit will fall as they retool their stores and face higher labor costs. The strong dollar is weighing on manufacturing and the volatility in the markets over the summer is hurting the banks. 

Americans are more sanguine about the real estate market, according to the National Association of Realtors. House prices are up, less and less people are underwater and the economy has improved. 

Corporate balance sheets are deteriorating, as many took advantage of the record low interest rates to lever up and fund buybacks. Interest coverage ratios are at the lowest since 2009, and companies are returning 35% of EBITDA back to shareholders via dividends and buybacks. Interestingly, the markets are beginning to punish companies with big buyback programs. One thing to keep in mind: when companies spend money on buybacks, they are making a statement about the opportunity set they see for expansion. The other place corporate funds are going: mergers. AB Inbev plans to issue $55 billion of debt to fund its purchase of SABMiller. Dell will issue something like $40 billion in debt to purchase EMC. 

Good breakdown of what the Fed will want to see in order to raise rates in December. Punch line:

• No further market volatility
• Two good jobs reports
• Solid consumer spending and further improvement in housing
• No further deterioration in exports
• No protracted government shutdown

Morning Report - Regulating from the ivory tower

Vital Statistics:

	Last	Change	Percent
S&P Futures	1541.8	2.7	0.18%
Eurostoxx Index	2690.5	10.6	0.40%
Oil (WTI)	90.67	0.2	0.27%
LIBOR	0.281	0.001	0.36%
US Dollar Index (DXY)	82.41	-0.045	-0.05%
10 Year Govt Bond Yield	1.96%	0.03%
RPX Composite Real Estate Index	194.9	-0.3

Markets are slightly higher after initial jobless claims came in lower than expected at 340k. Productivity fell as unit labor costs increased at a faster clip than expected. The ECB kept rates unchanged. Bonds and MBS are lower.

The Fed released the Beige Book yesterday, a sort of 10,000 - foot view of the economy. The words "modest" and "moderate" were used a lot. Residential Construction increased in most districts with the exception of Kansas City. Low inventories were squeezing prices higher in most districts. Banks reported that credit standards are beginning to loosen, and that very few mortgages are being held on their balance sheets.

The CoreLogic Home Price index increased 9.7% in January, the biggest increase since April 2006. Excluding distressed sales, they increased 9.0%. They anticipate a similar gain of 9.7% YOY for Feb, with a .3% month on month drop. This year's seasonal slowdown has barely registered, which portends well for the summer selling season. Only Illinois and Delaware failed to report gains.

Now that the sequestration crisis is out of the way, it looks like the threat of a government shutdown late this month has gone away as well.  The House passed a bill to fund the government through the rest of the year at sequestration levels. The Senate will make its own tweaks to soften some of the spending cuts, but there is a bipartisan optimism that we won't have a shutdown. Separately, the President met with Congressional leaders in an attempt to figure out if there is room for a grand bargain on a package of tax increases and entitlement cuts. Lest the market think the all-clear has passed, we still have the debt ceiling to deal with in late summer.

The Mortgage Bankers Association responded to FHFA Head Ed DeMarco's plan to rationalize and eventually replace the GSEs. "Proposals of this magnitude need a transparent process to engage with stakeholders, articulate objectives and demonstrate that stakeholder concerns have been evaluated and addressed... The Administration, Congress, and regulators need to engage with other stakeholders to move the ball forward.  Until this happens, the uncertainty in the markets will persist and a full recovery of the housing market will remain elusive."  The Obama administration still regulates from the ivory tower and refuses to consult with the private sector.  It happened in Dodd-Frank and it is happening again. I guess the concern over regulatory capture is a valid concern, but remaking the financial sector or the real estate markets without input from the people who actually do this stuff for a living is bound to have major unintended consequences.

One of the bigger issues regarding the new framework involves how to handle Federal guarantees.  The government believes it has been underpricing (in other words, G-fees are too low) and it wants to increase them so they approach the pricing for PMI. One side effect is that the mortgage insurers, once given up for dead, are back.