Week of April 24th, 2023

Key Points for the Week

• Market and economic sentiment remain bearish, and negative sentiment could be positive for stocks down the road.
• Housing is another potential positive for the economy.
• Housing was a drag on GDP in 2022 but has improved in 2023, which is a positive for the economy.
• Sales are rising, housing starts are up, and builder confidence is rebounding.

Economic Update

It’s earnings season – the time when publicly traded companies report on how profitable they were during the first quarter of 2023. So far, reports suggest that companies listed on United States stock exchanges did better than many had anticipated. Almost 20 percent of companies in the Standard & Poor’s 500 Index have reported and three-out-of-four have exceeded earnings expectations, per FactSet.

At any given moment, earnings expectations reflect everything that’s happening in the world, from the economy and the Federal Reserve to interest rates and geopolitics. Right now, most of the fear stems from expectations about the economy. The Fed has lifted interest rates to tamp down inflation by reducing economic demand, and so far, that seems to be working. The rate of inflation has been cut almost in half from its post-COVID peak, but growth is slowing with it...And since higher rates operate with a lag, the full effects of the rate hikes probably haven’t been felt yet, raising the possibility of a recession.

Jacob Sonenshine, Barron’s

Banks were among the first companies to report earnings, and the news reassured investors who were concerned about financial stability after the collapse of three regional banks. Despite contributing $30 billion to bailout a regional bank, big U.S. banks generally reported healthy results and higher interest income in the first quarter, reported Max Reyes of Bloomberg.

Banks still face significant challenges. Loan delinquencies have been rising from historic lows as pandemic policies have come to an end. The four largest lenders in the United States saw a 73 percent increase in consumer loan defaults and have significantly increased the assets set aside to cover loan losses.

This Week in the Markets

Stocks have had a mixed start to 2023, and the economy continues to surprise many despite higher interest rates. Internationally, China is showing improvement. If one of the world’s largest economies is quickly advancing, what does that do for the odds of a U.S. recession?

What’s fascinating is various signs of sentiment are showing over-the-top negativity. From a contrarian point of view, this type of negativity could be viewed as bullish.

Here are a couple signs that suggest investors are overly pessimistic, which could prove positive for stocks.

• The recent Bank of America Global Fund Manager Survey showed the most underweight stocks relative to bonds since the global financial crisis. This survey reviews more than 600 money managers and clearly shows the crowd is defensive. Note how popular stocks were relative to bonds in January 2022, just as stocks peaked and entered a vicious bear market.

• JP Morgan published a survey of institutional investors that showed 95% of those surveyed expect stocks to drop by the end of the year. Only 5% expect stocks to gain, and virtually no one expects stocks to gain significantly by the end of the year.

This negativity is rubbing off on Americans. A CNBC survey showed public pessimism on the economy hit a new high recently. According to the latest CNBC All-American Economic Survey, 69% of those surveyed held negative views about the economy now and in the future, the most pessimistic levels ever. Just 24% said it was a good time to invest in stocks, the lowest in the 17-year history of the survey.

Housing

Housing was the biggest drag on economic growth last year. The economy grew by 2.1% in 2022, but that overcame a 0.93%-point drag from residential investment, i.e., housing. In fact, it’s been a drag on GDP growth for seven straight quarters, through the end of 2022. It got worse over the last three quarters of 2022 as mortgage rates surged from below 3% to just above 7%, thanks to an aggressive Federal Reserve. Housing is likely to have been a drag for the eighth quarter in a row in the first quarter of 2023.

People Want Houses, But Inventory is Low

Existing home sales fell 34% in 2022 but are up 10% over the first three months of this year. Some of that is because mortgage rates have pulled back from the peak level of 7%+ last fall. However, rates are still high, and they are significantly higher than a year ago when 30-year mortgage rates were around 3%.

In fact, based on the median price of an existing home, and assuming a 20% down payment, monthly mortgage payments have jumped from about $1,200 at the end of 2021 to $1,900 as of March. That’s not because of an increase in home prices — the median price increased about 5% to $376,000 during this period. It’s because the 30-year mortgage rate jumped from about 3.1% in December 2021 to 6.5% in March 2023! In short, affordability is low.

Nevertheless, as rebounding home sales have shown, there’s still pent-up demand. A big factor is the population of 25-34 year olds, which is prime homebuying age, is at record highs. For perspective, the number of potential first-time homebuyers is up from 39.5 million in 2006 to 46.1 million today. Pent-up demand was evident in the latest existing home sales report. Properties typically remained on the market for 29 days in March, and 65% of homes sold in March were on the market for less than a month. So, demand is clearly strong despite high mortgage rates.

The problem is there are not many homes for sale. Inventory of existing homes is currently at 2.6 months of supply at the current sales pace, which is well below a normal range of 4-6 months.

You can probably guess some of the reasons why inventory is low. First, many homeowners are “locked-in” to their homes since they got their existing mortgages at ultra-low rates. As a percentage of disposable income, mortgage debt service payments were just 4% at the end of 2022. That’s lower than it was pre-pandemic and lower than at any point during the last four economic expansions. This is great from a consumption point of view, since it means households are less financially constrained. However, it also means a lot of homeowners are unlikely to move. Who would want to sell their low-rate mortgage and buy a new home at 6.5%? The second reason, as a country we have not built enough new homes to meet population growth. This has been the case ever since the 2007 financial crisis.

New Buyers Pushed to New Homes

Of course, those who must move have little choice but to buy a house. And if there’s not much inventory in the existing home market, they will look for new houses. That is why new home sales are up 16% from last September through February. There’s relatively more inventory in this market, about eight months of supply at the current sales pace. However, on an absolute basis, the inventory of new homes is under 450,000 — less than half that of existing homes, which is close to 1 million.

The inventory of completed homes is rising while the number of homes under construction is falling, as supply-chain issues fade. Homebuilders are also starting fewer homes than they are completing. This is not a problem now but does mean supply next year is likely to be constrained. The good news is new housing starts may have bottomed — starts are up 7% over the past five months through March.

Homebuilders are Feeling Good, and the Market is Responding

Combine the pent-up demand with relatively low supply, and builders are feeling good, as witnessed by a rebound in homebuilders’ confidence.

The market is sensing this conviction.

More activity in the new home market is even better for GDP growth. It involves activities such as design and construction, as well as large household appliance purchases, which is not the case for existing homes.

Single-family home construction makes up almost 40% of residential activity within GDP. And over the last three quarters of 2022, it crashed 23%, which is why housing was such a big drag on GDP last year.

The good news is we may have seen the back of that, with single-family construction no longer sinking. That by itself would be a positive for the economy. Any rebound, if it happens, will be even better.

Power Outage? There’s a Hybrid for That

In recent years, storms have led to lengthy power outages in many parts of the United States. When ice storms knocked out the Texas power grid in the winter of 2021, some people relied on generators to supply their energy needs. Others turned to hybrid trucks, reported Paul Eisenstein of NBC News.

One hybrid truck owner in Texas purchased the optional generator feature, thinking he would use it when camping or to fire up power tools in remote areas. Instead, after the storm hit, he hooked the vehicle up to his house. For three days, it “provided enough energy to handle a refrigerator, a freezer, lights, the cable and internet box and a television.”

When the supply of generators ran low, one U.S. truck manufacturer asked its Texas dealerships to lend any hybrid trucks they had in stock to people who needed power.

Hybrid trucks that double as generators is just one example of innovation in the auto industry.

The $4 trillion automotive industry is going through three big transformational changes at once. Two of those – the rise of electric vehicles and the gradual emergence of autonomous driving – have attracted most of the attention. But the third one could be more powerful still: Cars are becoming computers on wheels.

Eric Savitz, Barron’s

There are more lines of code in automobiles than there are in jumbo jets, according to a C-suite executive at a semiconductor firm who was cited by Barron’s. In fact, automakers have been scooping up workers laid off by technology companies to help develop branded software.

Not too far in the future, it’s possible that drivers will be loyal to vehicle brands in the way they are to mobile phone brands. When drivers change brands, they’ll have to learn a new system – and that could give industry leaders a competitive advantage.

Homestead Tax Credit

If you are a resident of Montgomery County, Maryland, use the link below to determine if you are eligible to receive the Homestead Tax Credit. Per the Montgomery County Department of Finance, over 85,000 properties do not currently have a Homestead application on file and are at risk of losing the credit.

https://www.montgomerycountymd.gov/Finance/homestead.html

You can also check the Real Property Database to find out if you have already filed the application. The status of your Homestead application is located at the bottom of your real property’s page.

https://sdat.dat.maryland.gov/RealProperty/Pages/default.aspx

The Homestead Tax Credit Eligibility Application is needed to ensure that homeowners receive the Homestead credit only on their principal residence.

You are not required to reapply for the Homestead Tax Credit to retain the Montgomery County Income Tax Offset Credit ahead of the May 1 filing deadline. An 'Approved' or 'Application Received' status next to the Homestead Tax Credit Status line on your property's page means that no further action is required. Please be mindful that the Homeowners' Tax Credit is not the same as the Homestead Tax Credit and a 'No Application' status on the Homeowners' Tax Credit Application Status line does not affect the status of your Homestead Tax Credit application.

If you have questions, please contact us.

Did you Know? This Week in History

April 25, 1974: NFL Adopts Overtime for Regular-Season Games

On April 25, 1974, the NFL adopted a new overtime rule for regular-season games to prevent tie games. The rule change came as part of sweeping effort to improve the action and tempo of games. At the same time, the league also moved goal posts from the front to the back of the end zone and limited contact defensive players can make with receivers.

The new overtime rule mandated teams play an extra period if the score was tied at the end of regulation play. In overtime, the first team to score was declared the winner. If the score was still tied after the overtime, the game resulted in a tie. The NFL has since modified the overtime rules.

The season before the overtime rule was adopted, the NFL had seven ties in the regular season. Unlike some changes in NFL rules, the adoption of overtime was beneficial. From 1920 to 1973, the league had 256 ties. Since the 1974 rule change, ties have decreased significantly.

Weekly Focus

There is a difference between being resigned to a situation and reconciled to it.

Amor Towles, Novelist

Imagination is more important than knowledge. Knowledge is limited. Imagination encircles the world.

Albert Einstein, Theoretical Physicist