The Week in Charts (10/8/23)
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The most important charts and themes in markets and investing…
1) Well, That Escalated Quickly
Back in March 2020, the 30-year Treasury yield briefly moved below 1% for the first time in history. Fears of deflation and a second great depression led to panic buying of long-term Treasuries, and some pundits were predicting the US would join the negative interest rate insanity that was prevalent throughout Europe and Japan.
Fast forward to today and we have the complete opposite environment, with fears of inflation dominating the narrative and panic selling of these very same securities.
As a result, the 30-year Treasury yield rose above 5% last week for first time since 2007.
Higher treasury rates are driving yields higher in corporates as well, with investment grade bonds now sporting a yield of 6.3%, the highest since June 2009.
Meanwhile, no one is saying “cash is trash” anymore with 3-month treasury bills now yielding 5.63%. That’s the highest we’ve seen since 2001.
At the end of 2021, bonds were nearly all risk with little prospect of reward. Today, less than two years later, that picture looks completely different…
2) The Longest Bond Bear Ever
The higher bond yields of today have come after much pain for existing investors.
This is by far the longest bond bear market in history, at 38 months and counting.
And with the current drawdown of over 15%, absent a sharp decline in yields it will take a good while longer for investors to recover from these losses.
The 15% loss in the US bond market over the past three years is unprecedented. But it’s important to remember that what preceded this decline was also unprecedented – that being the lowest bond yields in history.
In the short run, the direction of interest rates drive bond market returns, but in the long run it is the starting yield that really matters. And with the highest starting yields since 2007 (10-year at 4.8% = 4th decile), the long-term future should be much better than the recent past.
3) More Mortgage Pain
Higher long-term Treasury yields continue to impact the mortgage market. The 30-Year Mortgage Rate in the US has moved up to 7.49%, the highest level since December 2000.
Assuming a $3,000 monthly budget, the 2.65% mortgage rate in January 2021 could have bought you a home worth $641,000. At today’s 7.49% rate, that same $3,000 would only buy you a home worth $426,000. That’s a $215,000 decline (-34%) in purchasing power.
As a result, mortgage purchase applications in the US have fallen to their lowest level since 1995. The average American household simply cannot afford the average home at current mortgage rates and current prices.
4) Higher Rates, Less Building
New construction of Apartment Buildings in the US has plummeted 41% over the past year, the largest YoY decline since 2010.
What’s driving the sharp decline in construction activity?
The biggest factor: the spike in financing costs, moving from 4% to 8% over the last year and a half.
Another big consideration for builders are increasing vacancy rates, which hit 7% in Q3.
With higher vacancies, there’s more supply, and rents have been moving lower as a result. This makes new construction less appealing.
Finally, increasing costs are a major issue as well, with everything from labor to materials to insurance moving higher during the recent inflationary wave.
According to Moody’s, commercial real estate insurance costs have risen 7.6% per year on average since 2017, hurting profitability at a time when there’s already many other headwinds for builders to confront.
5) The Coming Default Cycle
Speaking of headwinds, office occupancy in 10 major U.S. cities remains below 50% of pre-covid levels. This is having a profound impact on the office property market.
As their leases come due, many employers are downsizing, leading to more and more unleased space. The average office vacancy in the US rose to 19.2% in the 3rd quarter, which is just below the historical peak of 19.3% in 1991 (Moody’s Analytics).
With higher vacancies and lower income, many of these properties are worth considerably less than they were just a few years ago. The bond market is expecting that to lead to a wave of defaults, with CMBS spreads now at their widest levels in over a decade (1,325 bps).
6) Lower Prices Bring Bears Out of Hibernation
Back in July when the S&P 500 was trading at 4,600 and in the midst of one of its best starts to a year ever, I noted some signs of extreme optimism among active managers (going levered long) and individual investors (30% spread b/t bulls and bears).
The recent 8% pullback in the S&P 500 has changed that in a hurry, with active manager exposure moving down to 36% and the percentage of bears in the AAII poll rising to over 41% (highest since May).
It’s always remarkable to witness how quickly sentiment and narratives can change with changes in prices. And while investors should become more bullish when prices fall, it’s nearly always the opposite that occurs.
7) An Oversold Extreme
Only 8% of stocks in the S&P 500 closed above their 50-day moving average last Tuesday October 3), which was the most extreme oversold level since October 2022.
What happens when stocks are extremely oversold? They tend to bounce, with above-average forward returns.
But alas, “tends to” is far from always. There have been exceptions where the bounce is so short-lived that it is barely noticeable on a chart, and is soon followed by lower lows and yet another extremely oversold condition. We learned this lesson most notably in October 2008.
8) More Jobs, More Participation
336,000 US jobs were added in September, well above expectations (consensus: 160,000 jobs). That’s the 33rd consecutive month of jobs growth.
The increase in total jobs of 2.1% over the last year, however, was the lowest YoY growth rate since March 2021.
This fact combined with slower wage growth (4.15% increase in hourly earnings, lowest since June 2021) are pointing to a continued loosening in the labor market.
The best news in the jobs report continues to be the high rate of participation among prime age (25 to 54) workers. At 83.5%, this is the highest we’ve seen since May 2002.
9) Expecting the Unexpected
If I told you 3 years ago that the Money Supply was going to increase 14%, inflation by 18%, and National Debt by 24%, you probably would have guessed that would have been bad for the US Dollar and good for Gold.
What actually happened? A 19% increase in the Dollar Index ETF ($UUP) and a 5% decline for the Gold ETF ($GLD).
The more time you spend observing markets, the more you learn to expect the unexpected.
10) The Nature of Markets
3M is down 58% from its peak in 2018, the largest drawdown in the company’s history.
Back in January 2018 when 3M peaked it was trading at a crazy Price to Sales ratio of over 5x. Today it trades at 1.5x sales. Investors loved it back in 2018 and hate it today. That’s the nature of markets.
11) A Few Interesting Stats…
a) “Rivian vehicles sell for over $80,000 on average. Yet they’re so expensive to build that in the second quarter the company lost $33,000 on every one it sold. That’s roughly the starting price of a base model Ford F-150.” – WSJ
b) General Motors ($GM) stock hit a 3-year low last week, down 54% from its peak in early 2022. It has made no gains over the last 12+ years (total return, including dividends).
c) The US National Debt has now increased by over $2 trillion since the debt ceiling was suspended just 4 months ago.
d) The Fed’s balance sheet is now over $1 trillion lower than its peak in April 2022. How much more QT would be needed to unwind the massive QE from March 2020- April 2022? $3.8 trillion.
e) The market is expecting the Fed to start cutting rates in June 2024. Here’s a look at how bonds have fared during prior rate-cutting cycles.
f) 61,000 bar & restaurant jobs were added in September, brining the total number of jobs in the sector up to 12.37 million. That marks a new high for the first time since February 2020, a full recovery from the covid-induced crash.
And that’s it for this week. Have a great week!
-Charlie
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