Prepping for Purgatory

“The President is headed towards formally dumping Phase 1 [China Trade Deal] next month”
- Derek Scissors, China scholar (Hedgeye Macro Policy call yesterday)

The Trade Deal is probably dead before arrival.  The first real salvo in the autocratic regulatory assault against twitter and Big Tech more broadly has been launched … via twitter nonetheless.  History suggests upwards of 42% of “temporary” job loss may prove permanent. 

Housing, meanwhile, officially struck the v-shaped virus dismount. 

The news cycle, like investor disposition, is finicky and susceptible to both subtle vagaries and more discrete shiftings in the ebb and flow of collective sentiment. 

The last 24 hours was more of the non-subtle, flow-ing variety. Even if many haven’t really internalized it yet.

Back to the Global Macro Grind ….

While the Housing Purchase Party has successfully transitioned from quant afternoon gathering to happy hour dance party, the structural reality police will invariably deploy crowd-control and euphoria prohibition tactics (depression level unemployment, all-time tight supply constraints, tighter underwriting, etc) in an effort to short circuit any further transition to raging, late-night kegger. 

That’s how we capped the contextualization of yesterday’s Mortgage Purchase Application data which saw Purchase demand rise +8.6% W/W while accelerating to +8.4% Y/Y - marking a 6^th consecutive week of gains, the strongest level of demand since the end of January and fully retracing April’s COVID demand Cliff.

Price performance across the housing complex remained similarly epic. 

Now let me move this discussion forward by quickly taking a step back.

What I’d like to do here is weave parallel narratives for the housing market, the broader economy and financial markets in a way that lets us arrive at a temporal nexus where all three are likely to converge.

That’s an admittedly tall order and a lot to unpack in ~40 mins and ~900 words, so I’ll strive for “sufficient” not “exhaustive” in framing the setup.

The evolution in Housing fundamentals serves as an apt microcosm and detailing the dynamics in housing will serve as our vehicle for describing some broader underlying realities domestically.

We’ve detailed the internal push-pull of countervailing fundamental dynamics within the housing market previously but to quickly recap:

• Positive: Unprecedented policy support, all-time lows in rates alongside a “lower forever” policy outlook with little risk for a negative affordability shock, and realized job loss that has disproportionately impacted workers who were least likely to be able to own/purchase homes in the first place has served as the predominate impetus off the lows. 

• Negative: With credit tightening, application rejection rates rising (the flow-through from Purchase Application to approvals and closed transactions declining), more than 4.5 million loans in forbearance, delinquency rates doubling and continuing to rise, already acute supply conditions tightening further, catastrophic job loss that will only worsen further nearer-term, declining international demand and a progressively harder base effect setup in 2H, underlying conditions will ultimately constrain both the period and amplitude of any upside rebound.   

Again, you can harvest as much nuance as you want out of the various housing indicators, but the points above sufficiently capture the prevailing condition set. 

Now, I could delve into why Existing Home Sales are likely to collapse next month, or why NHS were resilient in April while Housing Starts weren’t but why both are likely to accelerate meaningfully in May, but that detail would probably just serve to dilute the larger point.   

That is, investors will be forced to navigate conflicting data headlines reflecting different measurement periods over the coming month(s) while balancing the reality that, while the demand rebound has been encouraging, any further improvement will be increasingly constrained by the gravity of job loss, tight and tightening underwriting and severely tight inventory conditions.   

As we push towards 2H20 and with Housing equities (ITB) up +88% off the March lows and just -10% of the pre-outbreak cycle highs, a kind of near-term, purgatorial stasis is likely to characterize the collective psyche as housing investors weigh emergent (and already discounted) improvement against capped fundamental upside and a more careful consideration of the prospects for derivative and structural damage to the labor market and the consumption and housing economies by extension.

2H20, a rising probability for a purgatorial divide and the dynamics surrounding the housing outlook, is what tethers us back to the broader macro and market outlook.

While we’ve touched on the impending Fiscal Cliffs previously, they deserve proper emphasis -  particularly as the marginal shift in the appetite for fiscal stimulus has been away from proactivity and towards wait-and-react.  

Consider the following timeline as it exists currently:

• June/July = The first and second rounds of PPP loan disbursements expire.  To the extent demand hasn’t (fully) re-materialized by the time payroll and cost subsidization ends, job cuts and business solvency re-become more acute risks. 
• July 15^th = Tax filing deadline.  This is not a major catalyst but to the extent this remains in place, it’s an outflow and liquidity drain.
• July 31^st = end of Enhanced Unemployment Benefits.  The reality that many are receiving more under enhanced UI benefits than they would be working full-time has been well covered.  That factual reality, however, doesn’t dilute the significance.  The program will have supported hundreds of billions in household spending (probably north of $450B … pushing towards 10% of GDP) by the time the current program expires.  
• October 31^st = Expiration of Forbearance programs.  Approximately 6% of loans are now delinquent and roughly 8.8% (approximately 4.7 million loans) of loans are in Forbearance.  Think about that.  Almost 5 million households are currently not making mortgage payments. Most of the programs allows the missed payments to be added to the end of the term.  Many (however nonsensical) require a balloon payment at the end of the forbearance term totally all of the missed payments.  In any case, the primary point is that 5 million households will be going from spending $0 on housing back to full mortgage payments when the program expires.  That’s roughly $6B/month (5 million households at ~$1200/mo mortgage pmt) that will either not get paid or be re-diverted back from other (already depressed) discretionary consumption.

There are a few straightforward implications.   

1. The expectation for the recovery to take fuller shape and the income & consumption cliff associated with benefit roll offs and the end of mortgage forbearance terms are all coalescing around a similar timeline. A timeline which also happens to coincide with 2^nd wave risk. 
2. To the extent policy doesn’t step back up to mitigate the fallout associated with income cliffs above, it risks further entrenching the labor/investment/consumption hysteresis that invariably accompany shocks of the current magnitude.    
3. The precarious and trudging recovery in the labor and consumption economies will be occurring against a backdrop of slower credit expansion and depressed Capex and external demand.  In other words, with retrenchment defining the corporate ethos, global commerce and Trade continuing to decline from already negative pre-virus growth, Sino-U.S. tensions re-percolating and defaults and bankruptcies set to spike on a lag, Investment and Net Exports will not be the foundational basis supporting a durable growth acceleration.  

“If everyone is wrong, no one is wrong” has been a long-standing CYA finance mantra.  Substituting “purgatory” for “wrong” doesn’t carry the same ring.

Fortunately, purgatory is, by definition, temporary.  And identifying and mapping the rising probability for it probably allows you to avert it’s trappings in the first place.

Immediate-term @Hedgeye Risk Range with TREND signal in brackets:

UST 10yr Yield 0.61-0.73% (bearish)
SPX 2 (bearish)
RUT 1 (bearish)
NASDAQ 8 (bullish)
Healthcare (XLV) 98.70-101.38 (bullish)
Tech (XLK) 92.55-98.55 (bullish)
Consumer Staples (XLP) 56.50-58.91 (neutral)
Financials (XLF) 20.26-24.76 (bearish)
Industrials (XLI) 57.90-69.16 (bearish)
Shanghai Comp 2 (bearish)
Nikkei 20187-21998 (neutral)
DAX 101 (bearish)
USD 98.50-100.80 (bullish)
Oil (WTI) 27.38-36.04 (bearish)
Nat Gas 1.57-2.03 (bearish)
Gold 1 (bullish)
Copper 2.30-2.45 (bearish)

Best of luck out there today,

Christian B. Drake
Macro Analyst