Juggling Dynamite

The US 10-year Treasury yield has been below the 3-month yield since November 2022 (14 months and counting). This rare yield ‘inversion’ has preceded each recession (grey bars) since 1982, with no false signals. As usual, equity bulls perpetually bet this time will be different. In past cycles, the US Fed stopped hiking when the yield curve inverted, but unusually, this time, they overlooked the warning and continued to hike as the inversion deepened.

These are complex systems with variable lag times, and being alert for recessions requires attention span, independence, maturity and discipline. However, given the significant financial implications, not staying alert for recessionary signals ends up being much worse in the end. Individuals must decide how to manage their financial risk accordingly.

The economist who first documented the predictive power of inverted yield curves explains the history in the segment below and why a recession is indicated in 2024. Cam Harvey is a Professor of Finance at Duke University’s Fuqua School of Business, Research Associate of the National Bureau of Economic Research (NBER), Director of Research and Partner at Research Affiliates.

Harvey argues that since his 10-year / 3-month signal inverted in the fall of 2022, the first and second quarter of 2024 is when a potential economic slowdown would occur (the average lag between the inversion of the 10-year / 3-month spread is 12 months, but the longest lag is 22 months). However, Harvey notes that there are several positive forces supporting the U.S. economy, such as fiscal stimulus and a strong labor market, as seen by job vacancies in excess of unemployment. While Harvey hopes that these forces can induce a “soft landing,” it is his base case that the 10-year / 3-month inversion will go 9 for 9 in forecasting an economic slowdown. Here is a direct video link.

Canadian home prices are retreating. In previously hot areas, properties are selling up to 20% below 2022 prices, but nationally, the average sale price was just -11.4% in the latest quarter.

After an outrageous 59% average price increase nationally between Q1 2020 and Q1 2022, the mean-reversion prospects remain big from here. As shown below, courtesy of Better Dwelling, Canadian real estate prices remain extreme compared with other G7 countries with much larger economies and GDP per capita.

There is hope that the spring will bring more buyers, and that’s usually true. At the same time, however, new listings are rising amid financially stressed owners, power of sale proceedings, increasing unemployment and a growing wave of restrictions on short-term rentals. See: Reno flips gone bad lead to 2024 hangover:

Onlookers have been busily predicting the outlook for real estate in 2024, but one hangover from 2023 still looms over the market: observers say a remarkably high number of homes are still being sold under power of sale.

Most mortgage agreements allow the lender to force the sale of a property if a borrower fails to make required payments.

“Most of the stuff you’re seeing now is reno flips gone bad,” said Ron Butler, broker and owner of Butler Mortgage Inc., referring to homes that appear to have racked up big debts to renovate and upgrade to attract a higher-end buyer. “What we’re seeing here is the collapse of speculation: it takes a while to collapse; it’s never instantaneous … there’s a policy point where the lender says ‘let’s cut our losses.’”

As painful as this may be for present owners, more supply suggests lower prices and rents–both are much needed. See the latest move in Kelowna approves sweeping restrictions on short-term rentals:

Kelowna city council has voted to eliminate most short-term rentals, such as those listed on Airbnb, across the city with some small exceptions.

Council was asked by city staff to endorse sweeping changes to the city’s short-term rentals bylaw, far exceeding restrictions being introduced by the province.

Council heard the potential hardship from those utilizing short-term rentals as a way to afford making monthly mortgage payment during a recent public hearing while also hearing from staff that short-term rentals are having an adverse affect on the city’s long-term rental stock.

Coun. Rick Webber told his colleagues the decision for him came down to what would benefit the community as a whole and not individual landowners.

“Listening to the discussion today the argument seems to be will this get more people into homes or force a lot of people out of their homes,” said Webber.

“Well, that’s a hell of a question to answer, and there is no obvious answer to this.”

Webber sided with the majority saying if the province’s legislation and the city’s restrictive bylaw works as intended, it will make more homes available for more people.

The first 57 minutes of this presentation are a worthwhile macro overview. (The final 17 minutes are a micro dive into individual debt types for US investors and less accessible for Canadians and lay people).

In his annual “Just Markets” webcast presented Jan. 9, 2024, DoubleLine CEO Jeffrey Gundlach among other outlooks shares his forecast for a U.S. recession, sees U.S. stocks forming a bearish double top and down the road expects an initial rally in bonds upon recession followed by an inflationary monetary response. He also warns of federal deficits turning critical amid an explosion in the federal debt in the context of higher interest rates and, thus, higher interest expense on that debt. Here is a direct video link.