Juggling Dynamite

With bond yields rising since last summer, the U.S 30 year mortgage rate moved above 4% this month,  up more than 1.25% over the past year. In Canada, the popular 5-year fixed-term conventional mortgage rate has been climbing too, today in the 3% range and expected to reach the 3.4% area over the next couple of weeks. Variable-rate mortgages and loans, of many forms, increase when central banks start hiking base rates, presently slated for March.

This leap in debt servicing costs comes as average home prices in Canada and the U.S. have increased 30%+ over the past year, and the average purchase loan size hit a record $453,000 in America, $372,000 in Canada, and $582,000 in the most expensive markets of the greater Vancouver and Toronto areas. Toronto, Vancouver, and Montreal are Canada’s largest mortgage markets. With nearly $350 billion in mortgages outstanding, Toronto accounted for about 23% of the country’s $1.5 trillion Canadian mortgage market (source:  Statista Q3 2021 data).

As home prices have become increasingly unaffordable for most households, up to one in 4 homes in high population areas, have been bought by ‘investors’ looking to flip or rent for a profit. In the process, rents have risen in the most populated areas by a whopping 30% on average over the past year, and economic activity has become excessively concentrated in real estate transactions.

These trends are counter-productive to financial stability and resilience and set the economy and balance sheets up for a painful period of normalization. The inevitable weakness in household spending has been evident over the past few months, with December retail sales revised from -1.9% to -2.5% yesterday, the second-lowest real growth rate since May 2020 (EPB Research) and the January non–seasonally–smoothed number was –18.5% month over month. These are foreboding numbers for economies heavily reliant on debt-enabled consumer spending for growth. Government bonds see the trend to slower growth and are rallying as risk markets fall again today.

David Rosenberg discussed these trends yesterday in the clip below.

David Rosenberg of Rosenberg Research talks about the latest inflation data out of Canada, reaching a 31-year high. He says more than three to four rate BoC hikes will hit the economy. He also talks about the “painful” impact of rising rates on the housing market.  Here is a direct video link.

Cash levels remain low as markets move into liquidation mode, and selling has been broad-based. While it’s typical for corporate bond prices to fall with equities, government bonds typically attract capital as it moves away from less principal-secure securities.

So far, despite equity losses, non-commercial traders have persisted with inflation bets and remain net-long large-cap stocks while net short government bonds. Treasury bonds have declined on the now hysterical expectation of seven policy rate hikes in 2022. The US 10-year Treasury yield at 2.04 is significantly above its long-term support at 1.51%, and the case for a government bond rebound has rarely been stronger. Lance Armstrong explains in the segment below.

With rising interest rates and inflation fears, there have been negative attitudes about owning Bonds. With a debt- and leveraged-economy, with low economic output, bonds have certainly been under pressure. A look at the TLT EFT as a proxy for bonder performance history, we can see that bonds have been oversold. With prices on the decline, and yields on the rise as the Fed fights inflation, this is a perfect time to buy as a risk-off hedge for portfolios. There will be more volatility in equities this year, and money flows are expected to go from risky stocks to safe-haven bonds, which history bears out. This is why we believe bonds will be among the better performing assets in portfolios. Here is a direct video link.

Risk markets are rallying this morning on stories that Putin may be stepping back his aggression in Ukraine. But, lest we forget, Ukraine is a side story. The main plot for financial markets is the tidal wave of fiscal and monetary liquidity that is now receding globally.

As Hedgeye’s Keith McCullough put it yesterday:  “The free money’s gone, the crap that consumers bought has gone down, and their favorite stocks are going down.”

The Economist offers an insightful big picture overview this week in What would happen if financial markets crashed?:

Today America’s financial system looks nothing like it did before the crashes of 2001 and 2008, yet lately there have been some familiar signs of froth and fear on Wall Street: wild trading days on no real news, sudden price swings and a queasy feeling among many investors that they have overdosed on techno-optimism. Having soared in 2021, shares on Wall Street had their worst January since 2009, falling by 5.3%. The prices of assets favoured by retail investors, like tech stocks, cryptocurrencies and shares in electric-car makers, have plunged. The once-giddy mood on r/wallstreetbets, a forum for digital day-traders, is now mournful.

It is tempting to think that the January sell-off was exactly what was needed, purging the stock market of its speculative excesses. But America’s new-look financial system is still loaded with risks. Asset prices are high: the last time shares were so pricey relative to long-run profits was before the slumps of 1929 and 2001, and the extra return for owning risky bonds is near its lowest level for a quarter of a century. Many portfolios have loaded up on “long-duration” assets that yield profits only in the distant future. And central banks are raising interest rates to tame inflation.