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House prices rise, homebuilders fall

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Welcome back. Best be careful out there today. England has defeated Germany in a major football tournament. Anything can happen now. Unhedged is playing it safe by sticking to familiar territory: housing, inflation and meme stocks. Email me: robert.armstrong@ft.com

House prices are no longer helping housebuilders

The headlines on Tuesday were dominated by the April reading for the Case-Shiller national home price index, which showed US home prices rising by an annual 14.6 per cent, the fastest pace in three decades. This is not too surprising. The April and May numbers from the National Association of Realtors, which I wrote about yesterday, were pretty sporty, too. But no one likes it when house prices do 2006-y things:

Line chart of S&P/Case-Shiller US National Home Price index (YoY %) showing US home prices jump most in more than 30 years

In the context of that chart, it is interesting that US homebuilders’ stocks peaked almost a month ago:

The homebuilders’ product is more valuable than ever. Input costs such as lumber are coming back into line. As I have written before, the US has a housing deficit of perhaps 2m or 3m homes, a result of a decade of under-building. Valuations of the likes of Toll Brothers, Pulte and Lennar are a little high, but still within their historical range of 1-2 times book value. Why has the group come off its highs?

The primary reason, as Truman Patterson of Wolfe Research pointed out to me, is memories of 2018. In that year, 30-year mortgage rates rose by about 100 basis points and, at a short lag, annual growth in unit sales of new homes went from 9 per cent in July to negative 14 per cent in November. Homebuilder stocks lost a third of their value that year. That’s what we call a rate-sensitive industry (data from the Federal Reserve):

This year mortgage rates are up only about 35 basis points from their lows, but this is enough to scare people. At the same time, as we discussed yesterday, some indicators of housing demand are coming off the boil. Finally, the KBW team points out, this autumn 2.1m mortgages that are still in forbearance will face the possibility of foreclosure and the rental eviction moratorium will end, meaning new inventory is likely to enter the market.

The short term set-up for homebuilders is pretty bad, in short, especially if you think rates are going up from here. 

But the long-term demand picture is good. Something must be done about the housing shortage. If you think the pandemic is going to deurbanise the country as more people work from home, and you think inflation concerns are overblown, don’t you want to buy this dip at some point?

It doesn’t have to be 1970s inflation to be painful inflation

Most recent discussions of inflation feature some reassuring soul pointing out the low probability that 1970s-style hyperinflation could recur today. Here for example is Bridgewater honcho Bob Prince in the FT a week or two ago: 

“If you go back to the 1970s . . . you didn’t have the printing of money back then but you had credit growth. You had very strong collective bargaining, labour unions,” he added. “You had deregulation of the commodities markets . . . so you had a spike in commodities, spike in oil prices. You had a lot of things there that don’t exist today.”

All true. But it is important to remember that inflation does not have to be hyper to make investors’ lives very difficult. 

Much has been written in recent months about how as inflation (or inflation fears) rises, the usual negative correlation between stock and bond prices turns positive. When no one is worried about inflation, when bond prices go down and bond yields go up, that is seen as an indicator of economic growth ahead. Stocks tend to rise. When people are worried about inflation, bonds down/yields up indicates inflation risk, and the possibility that central banks will tighten policy. Stocks go down. A portfolio of stocks and bonds is no longer automatically hedged, and investors are sad. 

But just how much does inflation have to rise to make the correlation turn positive? Sustained inflation of just 2.5 per cent will do the trick, according to Evan Brown, the head of multi-asset strategy at UBS asset management, who I spoke to on Monday. He points to this chart his team did earlier this year, comparing rolling 36-month core inflation and 36-month stock/bond correlations: 

Here is a UBS table of long US Treasury performance during the worst stock declines of the past 60 years or so:

Summing up:

  1. In the past 20 years, with very low inflation, bonds helped tremendously when stocks fell.

  2. In the 40 years before that, with inflation higher, bonds helped just a little or not at all when stocks fell.

  3. It seems that persistent inflation of just 2.5 per cent might be enough to flip the negative stock-bond correlation.

  4. Inflation does not have to go all 1970s to screw your life up. 

It is cheap to short meme stocks now 

Garrett DeSimone, who is head of quant research for OptionMetrics, an options market analytics firm, recently pointed out that the cost to borrow “meme” stocks (in order to sell them short) has fallen recently. Here for example is the implied cost to borrow AMC shares over 30 and 90 days, derived from markets makers’ cost to hedge the short position in the options market:

The cost to borrow AMC shares is down to about 5 per cent (meaning an annual rate of 5 per cent of the price of the stock), down from highs over 20 per cent. What this means, according to DeSimone, is that “short squeezes have become less of a factor in meme stock rallies during June”.

This could, in turn, mean that volatility of meme stocks will fall. It is short squeezes (along with option hedging) that provides the most dramatic price spikes. But it is the volatility of meme stocks that makes them fun to trade. If volatility falls, is the game no fun any more, and will everyone go home? 

One good read

My summer reading: Georges Simenon’s terrific little Inspector Maigret novels. Each can be read in a weekend. There are lots of them. Any good used bookstore will sell you one for five bucks. They remind you of Paris. And they have nothing whatsoever to do with markets. 

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