Spiking Mortgage Rates Hurt Housing Market

Spiking Mortgage Rates - Soaring

Housing was weak this summer because affordability was a problem. Real wage growth basically treaded water while interest rates soared. That’s not a recipe for strength in housing.

When you add in the increased costs for metals because of the tariffs, we’re in an unusually terrible situation for homebuilder stocks. Their prices reflect this as the ITB home builder ETF is down 26.18% since January 22nd.

The index is down 21.91% year to date. Home builder index peaked a couple years before the last recession. But housing isn’t going to cause a similar collapse in the economy this time: don’t panic.

The weakness in housing could start to hurt the overall economy if rates continue higher.

As you can see from the chart below, 5/1 year adjustable rate mortgages have the highest interest rate in over 8 years. When the 30 year mortgage interest rate increased from 3.85% to 4.71% in the past year, monthly payments increased 10.7%.

For example, if monthly payments were going to be $1,400, they would be $1,550 instead.

Spiking Mortgage Rates - There Won’t Be Another Crisis

Mortgage rates depend on the credit score of the buyer, but all else being equal, rising rates make housing less affordable.

Housing prices need to come down to compensate for this. It might become a buyers’ market, affordability still won’t be great if rates are up.

The best buyers’ market was after the housing bust when prices fell. It was good last year in terms of borrowing costs, but prices were increasing.

Besides credit scores, location is a huge factor in home buying. Places like Denver, Seattle, and San Francisco have affordability crises because of prices.

Spiking interest rates could catalyze a sharp decline in those markets. Markets aren’t efficient. If someone held real estate for years during the up trend, they will want to get out as the market craters to lock in some of their gains.

The housing market won’t catalyze a huge crisis. There are a few reasons why. The most important reason is lending standards increased and there aren’t many adjustable rate mortgages.

In the next recession, there will be a lower default rate because only people who can afford houses own them. Credit scores for home buyers have increased; there are strict rules on debt to income ratios for buyers.

Another reason there won’t be another crisis can be seen in the chart below. Subprime lending market catalyzed the crisis. As you can see, subprime mortgages as a percentage of the total mortgage market peaked at nearly 18% in 2006.

Current level is only 4% as it has declined to below the level in the early 2000s which was the lead up to the crisis. The end of bubbles is usually when unbelievable craziness occurs. That’s the only way to describe the 2006 housing market.

Spiking Mortgage Rates - Factory Order Growth Beats Estimates

Month over month August factory order growth was 2.3% which beat estimates for 2.1%. There was an easy comparison as growth was -0.5% last month.

July’s reading was revised up from -0.8%. The August report beat estimates because of aircraft orders just like the industrial production report. Commercial aircraft orders were up 69% with defense aircraft orders increasing 17%.

If you take out this increase, the increase in ships and boats, and the 1% growth in motor vehicles, factory orders were only up 0.1%. Durable goods orders were up 4.4% because of aircrafts.

Non-durable goods orders were only up 0.2%. The principle gains in non-durable goods orders were beverages and paper.

The biggest negative was core capital goods orders which is a big problem since aircraft orders will likely not grow as much in September as they did in August. Core capital orders fell 0.9% after rising 1.5% in July and 0.8% in June.

Core capital shipments fell 0.2% after increasing 1.2%. This conflicts with the ISM reports which are extremely positive. Ultimately, the ISM numbers don’t matter when it comes to the economy.

Aircraft order strength is masking overall weakness, which means GDP growth could be inflated. Regardless, GDP growth will be way below the 4.6% rate implied by the September non-manufacturing ISM report.

Unfilled orders were up 0.9% because of gains in transportation and metals. Metals unfilled orders were up because of pre-buying before the tariffs. Total inventories were down 0.1% which is down from last month.

The bright side of this report is seen in the chart above which shows year over year growth is still strong, with shipments up in the high single digits and new orders up 10%.

Transportation equipment drove growth, but overall August was a flat month for manufacturing. The hard data from manufacturing in August is now done.

Industrial production report in September comes out in 2 weeks. I’m expecting weaker headline growth because aircraft orders won’t match August’s growth rate. I’m not expecting the amazing growth implied by the ISM surveys.

Spiking Mortgage Rates - Earnings Growth Deceleration Finally Hear

After 20 S&P 500 firms have reported earnings, it appears I was wrong to suggest Q3 would have the quickest earnings growth of the year. Instead, the deceleration fear which didn’t cone true in Q2, might be coming true now.

As you can see from the top chart below, the first 20 S&P 500 firms had 21.57% earnings growth which is below the 25.19% growth rate in Q2 and the 31.42% growth rate in Q1.

Many more firms will report, but it’s not a good sign Q3 earnings estimates have fallen while estimates for the first two quarters of 2018 rose.

Q2 growth ended up being faster than Q1 despite the lag seen in the chart. That means a similar reversal can occur this quarter, but it doesn’t look promising that estimates fell.

The good news is that sales growth remained strong for these first 20 firms. As you can see from the bottom chart, the sales growth was 11.33% which is within 1% of the past two quarters.

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