Trapped by Your Mortgage
I was watching NBC Nightly News the other night, and they ran a story about how there is no housing inventory because people are trapped in their mortgages.
They got a 2.5% mortgage during our prolonged period of zero interest rates, and now that interest rates have risen, getting a new house would be prohibitively expensive, even when taking their home equity into account.
This is why I love markets—you never know what is going to happen next. When interest rates rose, there were quite a few housing doomers online pointing to the fact that the typical mortgage payment had risen from $1,000 to $1,800 or so. Looking at this situation strictly in terms of housing affordability, that would seem to be correct—nobody would be able to afford a house, and prices would crash.
I want to point out that nobody predicted this. I expressed skepticism that the housing market was going to crash, but I didn’t really understand the mechanics behind it. Nobody did. It caught everyone off guard.
This is why making predictions about asset prices is fraught with danger. Everyone looks at things linearly, and nobody considers the second-order effects. The one thing that I have learned from years in the markets is that when you are looking at things linearly, you are probably going to get in trouble. Economics is full of surprises.
I can tell you that there have only been two home sales in my neighborhood in the last few months, and both were at nosebleed levels.
Sum of the Parts
There are a lot of ways to value a house, but one way to value it is as a sum-of-the-parts valuation. It’s the value of all the lumber, nails, copper, ductwork, and cement that goes into it. When you consider that the prices of all these commodities have skyrocketed in the last two years, then it would make sense that houses are more expensive. Since I am building a house, I can tell you that the inputs to a house are very expensive.
So I am not terribly concerned about housing valuations at the moment. Yes, they are at all-time highs. But so are incomes. And there are trillions in cash sloshing around the system in the form of CDs, money market funds, and other short-term instruments. I don’t have the statistics at my command, but a lot of the transactions that are happening in the housing market these days are all-cash deals.
One thing I have said pretty consistently is that out of a range of possible assets you could buy in an inflationary environment, real estate is pretty close to the top—land, in particular.
Now, if 10-year interest rates were to rise to 6% or more, then sure, you would probably see a decline in housing values. But we are actually in something of a sweet spot.
I am a little bit of a bond bull these days. The economic data has been deteriorating for a while, ex labor market, and now we have two punk claims numbers in a row. It could be that the labor market is slowing very gradually. Seeing as how the Fed’s entire universe revolves around the labor market, this would be a welcome development for those wishing that interest rates would go lower. Payrolls have beaten expectations for a record 14 months in a row, and the first time they don’t, you’re probably going to see the biggest one-day change in interest rates in years.
This market is starved for dovish economic data. As a trader, I look for asymmetries, and I noticed that bonds go up more on dovish data than they go down on hawkish data. There is a huge amount of asymmetry here. Stocks seem to be ignoring everything and going higher no matter what, but I assure you that if July’s payroll number is terrible, then stocks are going to have a pretty gosh darn good day.
The next time you see someone making a prediction about the market, you should ask them, “Have you thought this through?” Because the easy, straightforward predictions are always the wrong predictions. And nobody has a high enough IQ to predict the second-order effects.
Usually, if you just do the opposite, everything will work out fine, which has been my investment philosophy since the beginning of time.
Jared Dillian, MFA
But the opposite happened. Since everyone is trapped in their low-interest mortgages, nobody is moving, there is no inventory, and prices are going even higher. And here’s the amazing thing: This will probably continue until interest rates decline, which will release a flood of houses back on the market.
Who on Planet Earth would have guessed that high-interest rates would be good for the housing market and low-interest rates would be bad for the housing market?
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