- Oh, Mr. Market, You Crazy.
- Denver is still moving.
- Thank you, 271 families.
Thank you to everyone who gave us feedback on the last Market Insights report and also to those who have reached out in the last several weeks with questions. Our group’s mission is to improve the community by promoting healthy homeownership, so please, don’t hesitate to use our team as a resource to get the information you need.
This is definitely the weirdest Market Insights report I’ve written to date; and no, I’m not planning on slamming another Michigan rival in this one. Normally, my days are full of phone calls, meetings, coffee appointments, and happy hours (I know, it’s tough) and I’m able to get a pretty good sense of the tone of the Denver business landscape through those interactions. Heading into our fifth week of shelter-in-place, the most difficult thing for me, personally, is trying to deal with the feelings of being “uncalibrated” or “without feedback” in the absence of those appointments. While I’m trying my best to get those data points from increased phone activity and Zoom calls, it just doesn’t feel the same, and I’m going to assume that most people are likely in the same boat.
Oh, Mr. Market, You Crazy.
Weeks have passed since the initial shelter-in-place orders were issued and things are slowly getting straightened out. I will say that my initial understanding of this situation drastically underestimated the complexity of the issues we’re now facing and the systems we will employ to solve problems. In light of these realizations, the action in the US equity markets has been nothing short of impressive these last two weeks and I want to use this opportunity to share some of the things on my radar. The rally in the market from the lows in March feels a little too easy and I think calls like this one from Goldman (Nothing to see here!) are unable to contemplate the full scope of the disinflationary pressure put on the US economy by COVID-19.
Before we get into that, you know I’m going to give you a disclaimer before I write about the stock market. I really try not to focus on equity market discussions because I don’t feel that I have a ton of value to add when things are “normal.” In fact, I’d argue that my investing call sign should be “Top Tick.” My first days trading at Credit Suisse were just days before the S&P 500 hit its all-time high in October of 2007; my bosses made major bets in my correlation business in 2011 right before the highest covariance market move (prior to 2020) going back to 1929; I left Wall St. in 2014 to join a Mexican real estate development venture right before a major devaluation in the Peso. The purpose of this disclaimer: you should consult with someone who knows more about your financial situation before acting on any of market commentary I offer.
I say that I don’t have a ton to offer on the equity markets in “normal” times because that’s when fundamentals matter. Earnings, profits, P/E ratios, PEG, blah, blah, blah. From my seat in Denver, there’s nothing I can offer that’s differentiated from the biggest and most agile investors. However, we are NOT in a “normal” market and fundamentals are probably the last thing to matter right now. Governments around the world are printing TRILLIONS of Dollars to support the global economy, over 15 million people have applied for unemployment benefits in the last three weeks, the unemployment rate in the US now stands at 13% (the highest since the Great Depression), and stress indicators around the globe are still flashing red suggesting that we are not out of the financial woods, yet. Even IF the US economy were to say “Open for Business” right now, there is no way we would just bounce back to where we were just two months ago. When the market is not being governed by fundamentals, you need to look at the market through a different filter: technical analysis. I’m sorry, Eugene Fama, this stuff works (sometimes).
Technical analysis is the study of using historical price charts to determine future price behavior. In theory, this shouldn’t work, ever. Why not? Well, price data is available to everyone, so there is no information advantage; without information advantages, it’s really hard to create risk-adjusted returns in the long run. Technical analysis is extremely helpful in that it offers a toolkit in which we can uncover patterns in the market and one of my favorite tools is Fibonacci sequences to predict market behavior. Fibonacci numbers and sequences show up in all sorts of strange ways in nature; at this point, it’s almost impossible to avoid Fibonacci analysis when reading books on evolutionary biology or chaos theory. You can also apply Fibonacci analysis to financial assets and I’m including a study of a basic Fibonacci Retracement applied to the S&P 500.
The graph above shows the S&P 500 going back to last summer. The region of the graph in which we are most interested is the area with different shaded regions on the left side of the picture. Those shaded regions are developed by applying Fibonacci sequences to prices from the high in February to the lows in March. The lines that border the shaded regions are the key pieces of info here; these are the price levels at which we would expect support or resistance for the S&P 500 on its rally back to the top.
The first interesting piece of information we can draw from this analysis is how Fibonacci sequences accurately predicted resistance at 2,662, support around 2,490, and now we’re approaching what should be resistance at 2,800 and 2,950. That resistance at 2,950 is significant to me because it was a tested area of support on the initial selloff. Technical analysis suggests that prior support levels should become solid resistance on the way back up. This PURELY TECHNICAL (non-fundamental) analysis suggests that upside is limited while the door is open to significant downside again.
The other reason why I’m advising caution as it relates to the equity markets is that this rebound is not driven by any fundamental projection or change in trend and is a positional rebound, in my opinion. With the 50-day moving average of the S&P falling below the 200-day moving average, the long-term trend for the S&P 500 is now bearish. Until the 50-day goes back above the 200-day, we need to see the world through our bear market lenses and not get sucked back into the market too early. One way to avoid getting sucked into the market is using another technical analysis tool called MACD or moving average convergence divergence. Those are really big words that are very easy to interpret: when the blue line (on the bottom of the picture above) crosses the orange line then do something. The velocity of the selloff was SO aggressive in March that this momentum indicator had been suggesting a reversal for some time. We’ve now gotten the positional bounce and the momentum indicators appear to be losing some steam while approaching major resistance levels and an earnings season with a lot of unknowns.
The discontinuity in the economic data is so significant and there are still so many unknowns about the path to recovery that very few can make a legitimate estimate of price levels and it’s very hard for me to accept that this will be a “v” shaped recovery. There are sectors of the old economy that will never recover, reopening the economy will not happen in a way that will re-employ all 15+ million people who were furloughed or fired immediately, and there will be psychological impacts that change our financial behaviors forever. Additionally, and this is something that really, really scares me, the biggest losers in the COVID-19 recession are the pension funds… Major owners of commercial real estate, major owners of public equities, materially underfunded liabilities heading into the recession… Unfortunately, I don’t think modern monetary theory works as well when we will have to bail out the pensions because the beneficiaries of those bailouts will never be going back into the workforce to generate the taxes we’d need to pay off the increased national debt. Anyway, we can kick that can down the road a bit longer… Let’s just say that I think caution in the public markets is still warranted.
Denver is Still Moving
Last month, we stated our operating assumption is the Denver residential market will be benefitted by lower borrowing rates as long as those rates are not accompanied by a major, national economic dislocation. And, well, yeah, this does count as a pretty big national economic dislocation. So far, the impacts on the housing market are muted because policymakers are doing the right things to keep people in their homes. Additionally, the timing takes a few months for financial hardships to cause activity in the real estate market. The combination of babies, divorces, probates, and forced selling from COVID-19 foreclosures will start hitting Denver in July/August and continue for the next 18 months.
Here is our trusty table summarizing local market conditions:
Data summarized in this table was taken from RE Colorado and analyzes the housing market within a 10-mile radius of Union Station in Denver.
Four weeks into our shelter-in-place, the data is NOT suggesting a broad slowdown in the Denver residential market:
- Days on Market (DOM) Compressed – for the fourth month in a row, homes are selling more quickly than a year prior. Across all product types, the median listing was on the market for six days(!!!) before a contract was accepted. Back in January, we noted the housing market in Denver was setting up to look a lot like the market in 2018 and you have to go that far back to find the last month that DOM was as low as six days across the whole market. We do expect the velocity of the market to slow in April and May now that the Attorney General is limited in-person showings and expect the pace to pick back up once showings are allowed again. This statistic will be the first to reflect a slower market.
- Active Listings Lower – Active listings are still ~10% lower than a year ago even with new inventory starting to pop up a little bit faster. The fact that Denver hit the COVID-19 discontinuity with very low supply on the market is constructive for keeping the local housing market “on track” with respect to price trends. New listings added an incremental 200 active units to supply which only extends our supply runway by three days, big whoop.
- Purchase Power is Back – Median home prices were up 8.0% year-over-year at the end of March and this was the second highest annual appreciation by month going back a year. The highest monthly performance was last December when interest rates plummeted and there was very little supply on the market. That prices are materially higher, again, means there are buyers in the pool and they are ready to go.
We are hearing feedback from other real estate markets around the country that transaction volumes might be down 30-40% in 2020 vs. 2019. We do acknowledge that the pace of the market is likely to slow down with longer appraisal times, stricter credit conditions, and loan conditions that will take longer to clear. However, we do not see prices in the Denver housing market going down materially in the next 3-6 months.
Thank you, 271 families.
A huge “thank you” to the additional 271 households who chose to list their property in March 2020 as compared against the number of new listings in March 2019. While this 10% increase in new listings sounds like a material number, in reality, the Denver market is going to absorb those new deals in three or four days.
Based on the data above, the demand side of the Denver housing market appears to be healthy. If we assume that buyer demand isn’t going away materially, then we really need to look at the supply side to understand if and when a correction to the housing market might occur. Fresh supply of homes comes from the new construction, move-down buyers, divorces, probates (death), and financial hardships. We believe the current crisis is going to drive more supply in the medium term through an expected increase in divorce rates, a few more probates, and a number of listings from homeowners who are now experiencing financial hardships and will be unable to carry their mortgage. I do not believe the amount of additional supply we will see as a result of COVID-19 hardships will lead to a price correction by itself, we would need to see weakening demand in combination with additional supply for prices to go lower.
Banks and servicers are working with homeowners to try and keep them in their homes by looking into refinancings or doing workouts like forbearances. A forbearance just means that a lender will refrain from exercising their legal right to foreclose in favor of restructuring the mortgage so the borrower can pay. Typically, we’ve seen lenders allow borrowers to not pay their mortgage for the next 3-6 months and they will either force a balloon payment at the end of the forbearance or add on those months to the term of the mortgage. There is no standard way that lenders and services are entering into these forbearances, so our analysis is going to serve as a back-of-the-envelope thought experiment instead of a rigorous analysis.
Let’s say you lost your job during the first week of March and had enough cash/savings to make your April 1st mortgage payment; however, you know you will not be able to pay your mortgage payments after that without a new job. You anticipate your inability to pay your loan and call your lender to work out a forbearance in which they will allow you to skip the May, June, and July payment as long as you are current on your mortgage by August. If we assume your mortgage payment is $2,000/mo, then you will need to pay a total of $8,000 by August 1st. You accept those terms because you are convinced you will be able to return to work and stay in your home. Do you see where there might be problems for certain homeowners in this scenario? Some homeowners will be proactive about working out loan modifications with their banks and some will not. Some borrows will be able to restructure their mortgages and some will not. Some borrowers will be able to replace lost income, and some will not.
For our example, let’s fast forward to July and we know we’re in trouble. We weren’t able to find a job quickly enough and we won’t be able to make our $8,000 balloon payment on August 1st, so what are our options? We have three of them: (1) sell the home to pay off your mortgage and take your equity into your new housing situation or (2) try to restructure again or (3) go into foreclosure. Either way, if you are unable to make that August payment, the most likely scenario is that you will need to start selling your property in a normal transaction or through the foreclosure process.
This is why we believe an increase in new listings will hit the market starting in August and likely continue for the next 12-18 months. The financial hardships that our neighbors are experiencing take time to resolve themselves and we don’t want to be surprised when supply starts hitting the market.
Thank you for your time, and please, call us at 720-526-2583 when you need help buying or selling a home!