Juggling Dynamite

The S&P 500 and the US government bond index are now down about 12% from their highs (similar to Canada’s treasury bond index).

A big difference is that while this has been the largest drawdown for government bonds in 40 years (shown below since 1974), stocks are only about halfway to a -20% bear market on the US large-cap stock index and the TSX is just -6% in Canada.

Of course, Treasuries have guaranteed income payments and maturity dates, while stocks have none.  Still, if both are repricing for the sharpest inflation and monetary tightening response in decades, bonds have discounted the worst, while large-cap stocks–slow to get the math–are behind the curve (as usual).

It’s especially the case since equities came into this tightening cycle at some of the highest valuations in history with the most passive index-following products, funds and portfolios ever held by households and institutions.  The median bear market for large-cap equity indices from the few comparable historical extremes (1929, 1973-74, 2000 and 2008) was greater than 50%, not -20.

In recent years, global equities have had an unusually extended period of gains over government bonds.  As shown below, since 1970, this ratio has historically reversed violently during equity bear markets when government bonds take the total return lead for years after that.
As an asset class, equities have more downside work to do before they are attractive as an investment.  Of course, don’t expect most asset managers or sell-side analysts to admit this.  The lion’s share of the finance industry depends on a perpetually bullish equity outlook to keep customers in the highest-fee products and portfolios. It doesn’t work out well in the end, though.  Long-always fees plunge with equity markets every cycle, and many of their clients/customers will jump out of moving vehicles to sell low and leave for another service near the bottom.  Round and round they go.

The JP Morgan representative in the segment below lobs the typical long-always pitch.  The Cantor Fitzgerald rep has a cross-asset analysis mandate, so he can offer a more honest relative-risk assessment.

Phil Camporeale, JPMorgan Asset Management portfolio manager, and Eric Johnston, Cantor Fitzgerald head of equity derivatives and cross asset, join ‘Closing Bell’ to discuss Camporeale’s thoughts on inflation peaking, why Johnston believes the Fed’s hawkishness hasn’t been priced into equity markets and more.  Here is a direct video link.

BUSY WEEK!!! Where to start!?

Let’s start with the most widely held and highly leveraged asset globally, housing.

In the past few months, bond prices have dumped (spiking their yields) to discount for a whopping 3% of central bank rate hike plans over the next year.  The carrying cost of fixed-rate loans (which rise with government bond yields) is now doing a lot of demand-quashing work before central banks even do much tightening.  It’s no wonder.

As shown courtesy of my trustee in bankruptcy friend Doug Hoyes below, Canada’s lowest average 5-year fixed mortgage rate available in March was 3.38%, compared with 2.63% in March 2020.  At the same time, the median detached home price in the Greater Toronto Area rose from $902k to just under $1.3m.  The 44% increase in the median home price and 28% higher interest rate drove the median mortgage payment 56% higher in just two years.  Spoiler alert, median household incomes have not risen along with housing costs.

Even if the buyer had a 20% down payment and no other debts, the minimum income needed to qualify for a mortgage on the median home last month had risen to $138,820 (43% debt-t0-income ratio) from $89,506 two years earlier.

In April, mortgage rates rose further, with the offered 5-year fixed-rate at the big five banks above 4%.  Despite many still having lower pre-approved rate offers (from before the latest hikes), the median single-family sale price in the first three weeks of April was significantly lower than in the first three weeks of February (as shown on left, courtesy of realtor John Pasalis.)  Math is starting to matter again.

These changes may seem relatively modest.  But only if you are not one of those who bought above the current market price.   Imagine the many who purchased to see most of their equity evaporate within the last two months.

Imagine that the history of credit cycles suggests property prices could revert by 30% nationally and remain moribund for several years.

How many of the leveraged investors/speculators, homebuyers, refinancers, lenders and developers (see Greater Toronto Real Estate Development files insolvency after inflation squeeze) who banked on ever-escalating prices and ultra-low interest rates will be content or able to hold on through a housing bear market where the economy slumps and unemployment rises.  Looks like we are going to find out.

Good update on why bonds are deeply oversold and likely to rebound as economic growth and equities continue lower.

The consumer cyclical segments of the stock market can see the recession, but all the bond market sees is endless inflation. For a change, my money is on how the equity folks see things playing out.  Here is a direct video link.