Those of us who grew up in the 1950s and 1960s watching television cartoons may remember a famous character from Looney Tunes: Wile E. Coyote, a cartoon character who was forever bested by The Road Runner. On occasion, Wile E. Coyote would be hanging suspended in midair over a chasm. Everything seemed fine for a while, and then Wile E. Coyote would suddenly realize his peril and when that happened, he would plummet hundreds of feet to the ground.
Some of today’s most important markets are now beginning to resemble Wile E. Coyote hanging suspended in midair, awaiting the inevitable disastrous crash to the ground.
Consider the residential real estate market. Rates on 30-year fixed-interest mortgages are now in the vicinity of 8 percent, having risen from the 3 to 4 percent range over roughly the last two years. People who are ready to sell that starter home and move up to a grander residence are stymied because although they may have been able to qualify for a loan at 4 percent, they can’t qualify for a 7 for 8 percent loan. One of the results of this is that the inventory of homes for sale has dropped sharply. With diminished supply, and applying the iron law of supply and demand, housing prices have more or less held steady for the time being, but how much longer can that last?
Other factors are in play as well. The old game of refinancing an old 7 percent mortgage loan and picking up a new loan at 4 percent — while at the same time taking out cash for present consumption based upon the higher value of the home — is now over.
At some point, the dam is going to break, and housing prices will plunge ala 2008-2010. The percentage of single-family homes owned by investors (as opposed to an owner residing in the home) has risen markedly over the years. If these investors perceive that the rents they are collecting won’t compensate them for the diminution in value of the home over time, they will be much more readily inclined to list the house for sale than a homeowner-occupier who may have a sentimental attachment to the residence and in addition will need to find replacement housing if he or she sells. At some point in the future expect a flood of residential properties hitting the market by panicking investors.
Consider the stock market. Although individual issues have seen huge stock price declines, the S&P 500 and the Dow Jones Industrial Average have held fairly steady at elevated levels. But another way of phrasing this, equally valid, is that stock prices have stagnated — they’re not moving relentlessly higher as they more or less have since around 1982. What this means is that investors must look to dividends for a return on their investment, and must also consider competing yields on U.S. Treasury bonds and double and triple A rated corporate bonds. Relatively few good-prospect companies are paying a dividend of 5 percent or higher (comparable to what one can obtain on shorter term U.S. Treasuries), so unless one can reasonably expect stock price appreciation to make up the difference, logic would dictate exiting the stock market in favor of Treasuries or highly rated corporate bonds. “Risk off,” in other words.
At the moment all seems to be well in the stock market, and if we saw a cooling economy (but not too cooling!) triggered by Federal Reserve interest rate hikes, we might view this as “the pause that refreshes” as opposed to a Wile E. Coyote scenario. If we believe that the Federal Reserve is going to lower rates next year, there might be strong reasons to stay the course in the stock market.
Unfortunately for the Federal Reserve and the stock market, the widely expected “cooling trend” in the economy has yet to materialize. Indeed, things seem to be going the other way on that. Benchmark 10-year U.S. Treasury bonds saw their yields rise to 16-year highs on October 6, 2023. Economists were expecting the jobs report for September to show 170,000 new jobs; instead, we got 336,000 new jobs. Worse yet from the Federal Reserve’s standpoint, the August 2023 jobs report was revised to show 227,000 added jobs instead of 187,000 as previously reported. Wages are still increasing at over 4 percent per annum.
There are a number of ways to cool off the economy, but none of them can be implemented as a practical matter. Raise taxes? Sure, that could do it, but practically no Republicans and only some Democrats in Congress would vote for that. Cut Social Security payments and trim Medicare? Yeah, that could do it, too, but again there is no appetite for that in Congress.
What is especially scary is that the over two-year bond market crash hasn’t of its own force and effect cooled down the economy. Hundreds of billions of dollars (perhaps even into the trillions) in market value of bonds have literally evaporated, and the economy is still chugging along at an impressive rate with only 3.8 percent unemployment. So what kind of a stock market crash or a residential or commercial real property crash would it take to slow things down and bring inflation back to the Fed’s 2 percent per annum target? A Dow Jones Industrial Average at 10,000 instead of over 33,000? Home prices reduced by two-thirds of their current value?
Financial crises have a way of coming on swiftly with devastating effects and with virtually no warning. In the summer and fall of 1929, the great economist Irving Fisher was proclaiming that “stocks have reached a permanently high plateau.” We now know how that turned out.
So whether we view the matter in terms of “chickens finally coming home to roost” or Wile E. Coyote hanging suspended in midair above a chasm, it would seem to be a good educated guess that many of our most important markets are living on borrowed time.
Image Credit: Wikimedia Commons
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