Green light / red light

Stocks had a mixed close yesterday as investors tried to make sense of some wild-in-both-directions economic releases. Longer maturity bond yields marched higher leaving stock investors of all types concerned, causing higher yielding stocks to pull back.

Hey Fed, it’s working. My regular readers are accustomed to my occasional “it’s just math, stupid” submissions from time to time. I like those, because, as we have learned, once we strip away some of the mystique around what is going on in the markets, sometimes, ominous developments don’t seem so ominous after all… and vice versa. This morning I want to submit a new type of analysis: “it’s just physics, stupid.” Let us begin with the term velocity. Velocity is just a fancy word for speed of motion. The formula is velocity = displacement / time. A simple, everyday example is driving a car in which your speed, in common terms, is your velocity. That is how we get miles per hour, or kilometers per hour. You get it, right?

Now, let’s apply it to the economy. We can use the formula to track the rise of prices. Specifically, let us look at housing prices. We all know that housing prices have been one of the biggest drivers of general inflation over the past 1½ years. Forget about why, but the effects have been devastating if you are seeking to buy a new house, or worse yet, if you’re a renter with a short-term lease which adjusts to the market. Now, technically growth, itself, is a change in value, but keep up with me for a bit and you will see where I am going with this. Using thepopular Case-Shiller National Home Price Index, we can see that home prices, while still growing annually, were slowing prior to the pandemic. In December of 2019 home prices were growing at around +3.1% per year. That would all change in 2020 as demand spiked in a low supply environment which caused annual growth rates to take off, and by the end of 2020, home prices rose by +10.43% from a year earlier. The trend continued into 2021 and by August the index was nearly +20% higher than a year earlier. By late 2021 the Fed decided to act on the runaway prices with earnest moves starting earlier this year. But that didn’t slow progress, and the yearly change topped off at around +21% in March. Think about it, housing prices earlier this year were +21% more than a year ago. No matter how you look at it, that is fast, and that can’t be good for monthly budgets.

Now on to some more physics. Now that we know velocity means speed, we can wow our friends by saying something like, “the velocity of housing cost growth is so much greater than it has been in years, it must surely be impacting household budgets.” Simultaneously, you are thinking “this can’t go on forever, it will eventually slow down as mortgage rates continue to climb.” You are correct, we know that the speed… er, velocity at which housing prices are rising will eventually slow down as demand pulls back. The next physics terminology I want to introduce is acceleration/deceleration. That is defined as the rate of change of velocity. Don’t panic, just think about it for a few seconds. It measures how quickly something speeds up or slows down. Let’s go back to our car analogy. When you get onto a freeway you press on the gas until your car reaches the speed limit. If you slam on the gas pedal, you will get up to speed faster than if you depress the pedal calmly. In physics terminology you would have accelerated at a slower pace if you pressed on the gas pedal calmly. Side note: my wife is surely shaking her head right now as she often notes my ambitious acceleration when driving. So, the housing market is not only growing fast, but it accelerated so quickly. Think of your head being pressed back into the headrest as housing prices did not only grow quickly but they got to that growth rate in such a short period of time. Now, let’s think about the opposite, deceleration. When you press on the brakes, you can do it slowly and allow your vehicle to come to a stop over an extended time period, or… you can slam on the brakes so that everything in the back seat ends up in the front seat (hopefully pets and passengers are buckled in).

Now back to housing. The Fed has just essentially slammed on the brakes over the past several months by raising interest rates at an unprecedented rate. The move was designed to slow down the speed, or velocity of prices, notably, housing prices. Mortgage rates have risen in response; they are now at 6.86% while they were at just around 3% a year ago. By June, the growth of home prices slowed to +18% in response. That is still high, but it is a sign that the brakes are beginning to slow the vehicle down. Yesterday, S&P CoreLogic, who maintains the index, released the number for July, which further slowed to +15.77%. That is further proof that the Fed’s maneuvers are working. On the surface, that all looks fine, as we would all like to see housing price growth moderate. However, if we looked at the deceleration, we would see that the 2.23-percentage point difference is not only fast, but it is the fastest deceleration of the growth rate in the history of the index. Back to my earlier analogy, people don’t get injured when cars slow down, only when they decelerate too fast. That is a problem that the Fed is very much hoping to avoid, and in coming weeks it will have to decide if it wants to mash harder on the brakes, ease up a bit, or maintain its current pressure. It is a good sign that progress is being made. Hopefully, no one gets hurt… make sure your seatbelts are buckled.

YESTERDAY’S MARKETS

Stocks had a mixed close as topsy turvy Treasury yields spooked high dividend stocks but left growth stocks mostly unscathed. The S&P500 fell by -0.21%, the Dow Jones Industrial Average dropped by -0.43%, the Nasdaq Composite Index gained +0.25%, and the Russell 2000 Index advanced by +0.40%. Bonds fell and 10-year Treasury Note yields, gained +3 basis points to 3.94%. Cryptos slipped by -0.90% and Bitcoin lost -0.21%.

NEXT UP

• MBA Mortgage Applications (Sept 23) declined by -3.7% after gaining +3.8% in the prior week.
• Pending Home Sales (August) may have pulled back by -1.5% after falling by -1.0% in July.
• Fed speakers today: Bostic, Bullard, Powell, Bowman, Barkin, and Evans.