By I know many of you opened your statements on June 30 at the end of the second quarter and probably wished you hadn’t. You may or may not have burned them. That said, July was a good month as equities and bonds recovered from their lows. During this same period of time, we also had a hot inflation number we hadn’t seen since the early ‘80s of 9.1 percent. We also saw the Fed raise rates another .75 percent.
Now, how in the world can the market be rallying, you may be wondering? Well, the market is always looking 6 months in advance, and since it’s been dropping since November, a turnaround that coincided with the worst inflation print we’ve seen since the early ‘80s is confusing people. How can things start to get better when inflation is getting worse?
The reason it’s bouncing back is that many institutional investors are banking that we’ve seen the worst of inflation. I mentioned a month ago that commodities like corn, lumber wheat and copper are all falling. The only thing that hadn’t was oil and the corresponding gas prices at the pump, but now, energy commodities have also started to correct. Energy is close to levels we haven’t seen since mid-February, prior to the invasion of Ukraine.
The reason energy is down doesn’t really matter. The fact is that we need energy costs to be lower, as that feeds into every aspect of our supply chain, and we end up paying for it in all facets of our lives. In addition, we’ve also begun to see a decline in the growth rate of residential real estate. What was growing at upwards of 20 percent is slowing to around 17 percent year over year.
Inflationary pressures of what it costs to buy a home, fill up our cars, buy groceries, heat our homes, or buy tools means that these prices are and should continue to go down. As the fed continues to raise rates in an attempt to slow demand, that slowing should help our broken supply chain heal and fix itself so that going forward, the inflation we’re currently experiencing does not continue at 9.1 percent. Where does this put us at the end of year? Perhaps closer to 5 percent. Where does this put us at the end of 2023? No one has any clue. But estimates say inflation will still be higher than the targeted 2-2.5 percent range.
Now, you’re thinking, is this the ‘70s again Dave? I don’t believe so. I know many of you lived through it and are sure that this is a repeat, but the US dollar has been super strong, and we didn’t have this strength in the dollar during the inflationary periods of decades ago. The strong dollar protects American goods & services from outside pressures. I expect that as the Fed is done with interest rate hikes in 2023, the dollar should soften as it historically does.
We’re in the midst of earnings season, and we’ve heard from roughly 2/3 of the portfolio. What we’re hearing is that while the supply chain is improving, commodities costs are higher than prior year and conversion to the US dollar is costlier than prior year, making forecasts somewhat unknown due to all of these issues. Some companies are choosing not to give guidance, but the majority are, and from the sound of it, many are back to the old game of under-promising and over-delivering, as we’ve seen company after company beat their earnings estimates. So, corporate America is healthy.
How do these rate hikes affect the consumer? Certainly for people who have consumer debt or are taking on consumer debt, there is a cost to that. Higher interest rates mean a greater headwind cost they have to carry, and that does hurt the consumer as we go through this corrective process fighting inflation.
That brings me to my thought for today, which is that I hear nonstop how the housing markets have to collapse. Because many of you are convinced that this is the housing crash of 2008 part 2. First off, I don’t believe it is. I have my reasons, the main ones being consumers have more cash on hand than ever, mortgage underwriting is tighter than it’s historically been, and unemployment is very low. Although I’ll give it to the bears – going into any recession, even a shallow one, unemployment is typically low. So you can throw that reason out if you don’t like my theory.
The thought I have is, when you purchased your first home, what was the interest rate you paid? Think about it. In talking to you, some have told me 16, 14, or 12 percent, or for younger clients, 2.3 percent. It ranges. When you bought your house, what was the reason for that purchase? For me, I had graduated from a one-bedroom apartment to a 2-bedroom, then to a townhouse, and I needed more space for my growing family. I did the math on a starter home vs where I was, and it was a little more, but I decided to start building equity and have something I could call mine. I was actually excited to start mowing my own lawn and doing my own gardening (things I’m not so excited about now…). But that’s the bliss of your first home, right?
The thought I have for you is, when you bought your first home, did you give a thought to what interest rates had done in the year or two prior? Did you think about where the economy was in its current cycle, vs can I afford my payment? The majority of you have said the only thing they were worried about was qualifying and affording that payment. I don’t believe this time will be any different for the Millennials. Sure, interest rates may have just doubled in the last 18 months and that may push some of the demand for new housing as a new generation has to figure out to afford that monthly payment. But I don’t believe we’re going to lose a whole generation of homeowners. I believe homeownership will continue to increase in this country as we still have a positive birthing rate and new households are being created. That’s a marvelous thing for the growth and prosperity of America.
I do think it would be healthy for the housing market to cool and not go up 20 percent every year, but I don’t see a 20/30/40 percent crash to the housing market unfolding, as long as corporate American stays strong, and unemployment stays low.
Yes, it may mean that the next generation of homeowners has to save a few more sheckles before they can buy that first home, and demand may go back from open bidders of 50 people for a house to the normal 5 (which is four more than bid to buy my last house!).
Just as none of us thought about what the housing market was doing, or what interest rates were doing, or what the economy was doing when we bought our first homes, there’s an entire generation that’s just beginning to make that move, and there’s tons of pent-up demand. Furthermore, across the country there still aren’t enough homes being physically built to keep up with demand. Will this right itself? Certainly, and some markets will get hot at certain times. But the American consumer is alive and well and will remain alive and well as long as corporate America stays strong, unemployment stays low, and that leads to stability in housing prices.
So what interest rate did you have on your first house? How much were you required to save? Was it the full 20 percent? I know over the years there have been plenty of incentives to encourage home ownership. What’s your story? We’d love to hear about.
Article by David Smyth, Senior Partner at Family Financial Partners — a financial services firm in Lexington, Kentucky.