The Dividend Cafe - The DC Today - Tuesday September 20, 2022

Episode Date: September 20, 2022

A volatile day to the downside in markets today as traders await comments from the Fed tomorrow and as bond yields bring down risk asset valuation. Dow: -313 points (-1.01%) S&P: -1.13% Nasdaq: -0.95% 10-Year Treasury Yield: 3.56% (+7 basis points) Top-performing sector: Technology (-0.51%) Bottom-performing sector: Real Estate (-2.57%) WTI Crude Oil: $84.16/barrel (-1.38%) Key Economic Point of the Day: Housing starts came in at 1.575 million annualized for the month of August, a whopping 125k above expectations. Nearly all of the excess vs. expectations were in multi-family, with single-family coming in the second lowest since mid-2020. Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, weekly market commentary focused on dividends in your portfolio and dividends in your understanding of economic life. Well, hello and welcome to the DC Today. We are giving you a daily market synopsis and I have a few other comments I want to make as well. I'm back in the California office. I didn't have a podcaster video yesterday because I was in transit leaving Atlanta, Georgia

from a conference I'd spoken at downtown and then just couldn't get a way to record from the airport. But you hopefully got your longer legacy written, DC, today. And we're back in our routine here today. Look, though, Dow opened this morning down 250 points, and then it got worse from there. Then it got better, but then it got a lot worse. At one point, it was down almost 600 points intraday. Then it came back up, if you will, to where we started, and it closed down about 300 points.

And so a lot of downside volatility, it never got into a positive situation, but a lot of the worst of the downside came back later in the day. I'm going to talk in a moment about what was going on today and what we're expecting into tomorrow. But there was another event that was Ford stock, the well-known U.S. automaker, down about 12% of the day. I think it's its worst day in over 10 years. And so anytime you have a big blue chip company with that kind of violent downside, it weighs on overall markets as well. And in fact, is probably the reason that the S&P was down, the Dow was down even more than the NASDAQ, obviously Ford not being a NASDAQ stock. But essentially today, as is always the case

going into an FOMC meeting, but more so right now because of the nature of Fed tightening, you had a fair amount of positioning for traders. There's just more sellers than buyers day before Fed Day. I don't see why tomorrow should be creating any particular market result because of my permanent belief that markets primarily respond to news they don't know, not news they do know. The Fed funds futures right now are pricing in an 84% chance of a 75 basis point rate hike. And that is what we're going to get tomorrow. That 16% chance of 100 basis point rate hike is just more speculators kind of throwing out. There's a pretty attractive risk reward. You don't have to bet a lot of money to

make a lot of money if you end up being right. But no, the market's telling you, you're going to get a three quarter point rate hike out of the Fed tomorrow. And so what you saw today was not only certain, you know, equity holders, particularly short term traders that don't want to go in to the aftermath of all of this with risk on. But you saw the bond market yields moving higher still. And so now the 10-year has officially made a new high on the cycle. I'm quite surprised by it. But what's interesting is the 30-year and the 10-year are now the exact same. And so you have total flatness from 10 to 30 on

the curve. And yet you have a 3 point, what did we close at today? 3.56% on the 10-year, which was up about seven basis points. The two-year is still at 3.94%. Okay. So you're roughly 40 basis points higher on a two-year than a 10-year. That's the inversion in the yield curve. And like I said, it's flat, the 356 from 10 all the way out to 30. The best performing sector of the day was technology. And by best performing, it was down 50 basis points. And then the worst was real estate, which was down 50 basis points. And then the worst was real estate, which was down 250 basis points, 2.5% plus change. Obviously, that being a rate sensitive sector and getting punished for these higher bond yields. A lot of inverse relationship between bond yields and the real estate sector in a moment like this. So look, I want to briefly talk on some

stuff with housing and public policy, but let's just put the market stuff and Fed stuff to bed. I think that the bigger issue that could move markets tomorrow, and I don't know that it will, I think it's very possible that the rate announcement could end up just being a dud. It's been so priced in for a few weeks. And that tighter posture is well known. I can't imagine there's any market actor expecting J-PAL to come out tomorrow and really say, hey, we're pretty close to a pivot. We're pretty close to changing our minds. I think everyone is expecting hawkish language. And so it's hard for me to understand how hawkish language should surprise markets.

I think he will reiterate their intention to stay where they are. And I think markets have had to price in over the last couple of weeks a higher terminal rate. And you're still in that same spot that people expect the Fed funds rate to end by the end of the year, just north of 350 basis points. They've moved quickly to get there. And then I think that your next rate hikes at 25 or 50 to kind of get to that 350 close you out. And so doing 75 and 75, the last couple just kind of accelerated the pace in getting there. But the thing that I would say is QE, quantitative easing, and more specifically now the quantitative tightening, which is the reduction of the balance sheet that the quantitative easing produced, it has a good chance of being the

main story tomorrow. They're in a very tough predicament. And I've talked about this a little bit before, but I'm curious if they address it tomorrow. They've said that they were at $47.5 billion that they were going to let roll off of their balance sheet over the last several months. And then in September, they were going to double that up to $95 billion a month. And that would be roughly half in mortgage-backed securities and half in treasuries. But they're having a very hard time getting the roll-off in mortgage-backed securities, that is mortgage-backed maturities that they can pay to cash, they redeem at par, and then they don't reinvest the proceeds. Because a lot of mortgage-backed securities

roll-off is not from maturities, but not from redemptions that come from maturing, but from prepayments. I don't think you're seeing a lot of prepayments right now. Very few people are prepaying a mortgage that was at 2% or 3% to walk into a mortgage at 5% or 6%. So you have a very limited redemption liquidity on the MBS side because of the total lack of prepays. Therefore, it makes it harder for the Fed to stay in that ratio of mortgage-back roll-off to treasury roll-off. So the question is, do they keep the $97 billion of quantitative tightening, but go heavier weighted on tightening of treasuries, which leaves them in a higher ratio of mortgage backed securities?

Or do they lower the amount of quantitative tightening they're going to do in total? I suspect what they're going to do is allow the ratio to go off for a little while. And then before it gets too off, actually have to slow down the level of quantitative tightening if indeed that's where they get. But they're in a bit of a pinch on their ability to see mortgage-backed securities come off the balance sheet. And they're in a bit of a pinch in that they really don't want to risk up the Fed balance sheet on a mark to market basis by having a higher proportion of mortgage backed securities than treasuries. A few months of this doesn't matter. But going on for some time at that almost $100 billion a month clip, it becomes a big deal. So we'll see if they

address it at all. We'll see if they address it at all. We'll see how they address it if they do. And then of course, how markets may respond. Ultimately, though, my belief is the cost of funding that you're seeing to some degree throughout credit markets, I don't think they care about how it's affecting residential real estate. And I've said before, I don't particularly think they should care about it. But there is a point at which the cost of funding government and the higher maturities that they're facing on a 10-year or 30-year represents an incentive for them to slow down on the quantitative tightening, which theoretically increases the potential for rates moving higher at the longer end of the curve.

We will be monitoring the impact in financial markets of quantitative tightening for how much liquidity comes out and potentially widens credit spreads. So there's a lot of things the Fed is having to watch. And there's a certain gamesmanship as to how they can and should say things. And that'll be on display tomorrow at the FOMC meeting. So the Fed will finish their deliberations in the morning. They've been going all day today. And then, as is the case, 11 a.m. pacific 2 p.m eastern they'll release their announcement we expect a 75 basis point rate hike and uh the fed funds rate which will bring it up to 300 basis points at three percent fed funds rate this will be um higher than the um high we saw in 2018 and the highest we've had going back in the Fed funds rate to 2007, 2008

period. And I think at this point now, we're beginning to get closer to those endings in which the Fed breaks something. And I think ultimately that leads to the point of policy pause and policy reversal. That's my view on where the Fed is. Quickly on public policy. Look, we can talk, and I've done it plenty, about is that GOP going to take the Senate? Is the Democrats going to keep the Senate? We talk about the House in terms of aggregate number of seats. And it's true. there's a 50-50 Senate. And so if you go to a Republican majority, there's one or two that go. And if the Democrats get to one or two lead, then it's just the math of the seats. But you have to talk about which seats. When you're talking about the House, it's 435 seats. And if one believes it's going to be

15 that switch hands and someone else believes it's going to be 15 that switch hands and someone else believes it's going to be 23 that switch hands, it's kind of hard to unpack 22 different individual races. And really there's, you know, 50 or so that's up for grabs. And so you're having to pick which 20 or 25 or whatever out of the 50 matter. With the Senate, it's easier to do. There's just certain battleground states that are a bit more contested. And what we're dealing with, I think, essentially, are three states that Republicans currently hold that are a fight to hold. And that is Pennsylvania with the retirement of Pat Toomey, Ohio with the retirement of Rob Portman, and what am I forgetting here, Rob Portman. And what am I forgetting here? Then Wisconsin with the reelection bid for Ron Johnson.

Those are three held by Republicans that are tighter races. And then you have three that the Republicans are looking to pick up a seat in, and that is Georgia, Nevada, Arizona. I understand some also want to throw in to the discussion overall, New Hampshire and some other states. I think the six I've highlighted are the six that matter. If there ends up being another surprise somewhere where the Democrats pick up a seat they weren't expected to, or the Republicans pick up a seat they weren't expected to do, then I'll admit I must have missed something. But I think these six from my political calculus are the ones that are going to make or break the state of the Senate. The three, by the way, that I were referring to are Georgia, Nevada, Arizona, with the Republicans trying to gain a

seat. Why Georgia? Because they've traditionally held it. They had it, in fact, even going into 2020, but then in a runoff, lost both seats. And so now there's a chance for Hershel Walker to take that seat back from Raphael Warnock, who just was put in a special election in 2020. Then you have Nevada, where Adam Laxalt is running for the Senate seat in Nevada. That would be a take for the Republicans if they were to win. And then Arizona, where Mark Kelly is in office now as a Democrat, faces a general election contest against Blake Masters. So here's the thing where I said before, I thought that the best case scenario for Republicans now was a 50-50 tie and that you could see a plus one or plus two Democrats. And I was based on polling and analysis

and other calculus. What is the scenario by which the Republicans get to plus one? I think the most scenario, the most likely scenario, if they were to do that, is by winning two of the three they have to hold and then two of the three they have to get a pickup. Could they run six out of six? Of course. Could the Democrats run six out of six? Of course. But I don't think the Republicans are going to lose the Ohio seat. They have a better chance of losing the Wisconsin seat than Ohio, but I think that's more likely for Republicans to hold. And then I think the Pennsylvania seat is going to be very difficult for Republicans to win for a variety of reasons. So again, if they win, if they hold all three there, they're likely going to do fine at the

pickup seats as well. But if you say they're going to win Ohio and Wisconsin and then lose Pennsylvania, that puts the Republicans now down one. And so that's why then you have to look at two of three to get a pickup to get to a plus one Republican majority and vice versa. I'm only phrasing it this way because of a net move the other way. For Democrats to hold, you're looking at the exact same math inversely. So this isn't partisanship, this is math. The Democrats, I think, are very likely to hold the Arizona seat. And I think that Georgia and Nevada are looking much more favorable for the Republicans than they were two weeks ago, not only from a variety of polling, but local dynamics.

I'm doing my best right now to get no information, if at all possible, from national sources. There's a national narrative. There's a national agenda that media outlets on the right, media outlets on the left may have. I'm trying my best to get really granular, on the ground expertise with folks following the election circuit in Pennsylvania or in Georgia, in Ohio, et cetera. People I'm talking to, some of which have a left-leaning bias, some of which have a right-leaning bias. Right now, I tend to agree on my analysis that the most likely path to a Republican plus one Republican Senate would be to hold Ohio, Wisconsin, lose Pennsylvania, to hold Nevada, Georgia, lose Arizona. That will be a fight. Getting anything more than that will be a real fight.

And then the opposite as well for the Democrats. There's a real fight. And then the opposite as well for the Democrats, there's a fight there. So this is going to be a close November, I think, for where the Senate ends up going. And I just wanted to mention some of that to you by way of public policy coverage. Real quickly, housing starts, and then I'm going to let you go. They were substantially higher new housing starts in August than were expected. It was still only 1.57 million annualized, which isn't great, but it was quite a bit higher than had been expected. I think about 150,000 more than consensus. But the problem is all that excess was in multifamily.

was in multifamily. Single family new housing starts were still the second lowest level they've been on a month in over two years, in about, I think, close to 30 months. So you still just simply don't see a lot of new supply coming online in single family. And a lot of that just has to do with the economics right now are very tough with rates so high. And so that's the state of the housing market. Okay, we've covered the basics today. I'll leave you on there. Thanks for watching the video. Thanks for listening to the podcast. Clients, you will receive your weekly portfolio holdings report in your inbox bright and early in the morning as always on Wednesday mornings. And then we'll see what happens out of Fed Day. I always say Fed Day is the best day. Maybe it will be. But that could mean a couple of things. For buyers, it could mean a dip. And for others that just like seeing prices go higher, maybe there's a rally.

It could mean total boredom tomorrow. Who knows? But in any time, have a good Tuesday night. We'll see you tomorrow, Wednesday. Thanks for listening to and watching the DC Today. night. We'll see you tomorrow, Wednesday. Thanks for listening to and watching the DC Today. Thank you. All data and information referenced herein are from sources believed to be reliable. Any opinions, news, research, analyses, prices, or other information contained in this research is provided as general market commentary and does not constitute investment advice. The Bonser Group and Hightower shall not in any way be liable for claims and make no expressed or implied representations or warranties as to the accuracy or completeness of the data and other information, or for statements or errors contained in or omissions from the obtained data and information referenced herein. The data and information are provided as of the date referenced. Such data and information are subject to change without notice.

This document was created for informational purposes only. The opinions expressed are solely those of the Bonson Group and do not represent those of Hightower Advisors LLC or any of its affiliates. Hightower Advisors do not provide tax or legal advice. Thank you.