By Paul Nolte.
Housing prices continue to recover from their severe lows of 2009-2010, although foreclosure activity remains an issue in getting housing prices back to “normal”. Mortgage rates remain very close to historically low levels. So it shouldn’t be a surprise that someone with a good background, plenty of assets and income should be able to get a loan or at least refinance their existing loan. However, that is not the case for former Fed Chief Bernanke, who was turned down on a refinancing loan.
In a speech in Chicago last Thursday, he disclosed the recent loan rejection. While a reason was not cited, it may be that his change in job status to ex-Fed Chief may be at the heart of the matter. Although the jobs report last Friday was roundly applauded by Wall Street, Main Street is still wondering what all the celebrating is about. The lack of easy money (for loans) and additional regulation have kept a stranglehold on any real estate recovery. With home prices published daily on websites like Zillow, many are emotionally attached to the monthly wiggles on the value of their home. Buried in the jobs report is the average hourly wages paid, which showed a still meager 2% annual increase. The bull market continues on Wall Street, but Main Street isn’t feeling it.
The momentum of the markets has changed towards the negative side over the last few weeks. Even so, the decline in the averages remains well within a mild correction. The major question is whether the decline will morph into something major or just crash (as in 1987). There are a few things to note in the markets today that are a concern. First is the small stock index (Russell 2000) performance, relative to the SP500, has retraced all of the outperformance over the past three years.
Secondly, on just a price basis, the index is in jeopardy of making new lows for the year that would also break price levels. The next stopping point could be roughly 20% lower. The good news is that, so far, the weakness in the Russell has not spilled into the large stock indices. That could change if the SP500 breaks below 1900 (now at 1968), which would mark the first time in two years it has dipped below a trend. Our best guess is that stocks remain very volatile through much of October and potentially bottom out sometime around the mid-term elections in early November. The changes in the markets over the past six weeks are not getting many indicators close to areas that historically would have signaled turning points.
Bond investors continue to benefit from worries in the stock markets. Yields are once again close to the lows set early in the year, even though the Fed will be likely eliminating QE policy later this month. Low wage growth in the employment report, falling commodity prices and still tight credit conditions continue to keep a lid on yields. Credit growth has been much more robust in the commercial space, consistently above 5% growth over the past three years. For investors in the bond market, expect that yields will remain within a trading range, between 2.25% and 2.75% on the 10 year bond until we begin to see more inflationary pressures from incomes and commodity prices.
Quarter and month end is usually a good time to review some of the changes in the markets over the recent past and note changes that should be made to keep investors in the sweet spot of the markets. This month has seen many of the asset classes decline below their long-term averages, as highlighted by the Russell above.
The only two markets still above are the SP500 and bonds. Even the more conservative REIT market has suffered over the past two weeks. Based upon historical trends and similar declines as we have today, we may expect another 5 decline in stocks over the coming six months. The parts of the market that are holding up during the decline (like technology & healthcare) are likely to be leaders once this period ends. We have not yet cut equity exposure in a meaningful way. However given the deterioration of the past few weeks; we are keeping a close watch on the stock and bond relationship to help determine whether the decline is nearly over.
The decrease in small stocks holdings early in the year has proven to be the right decision. The concentration in large US stocks all year has been the right decision as well. What is next? As outlined above, further weakness is possible, but we are expecting another leg higher into mid-year 2015 as economic growth remains modestly strong. Bond investors will also benefit from a still “easy” Fed, keeping rates near zero well into 2015 and maybe beyond.
