@theMarket: Debt Deadline Hangs Over Markets
One week before the debt ceiling deadline, members of Congress have adjourned, while a handful of negotiators continue to search for a compromise solution to the impasse. Investors are holding their breath.
As many expected, myself included, the politicians are drawing out the drama and will continue to do so until the 11th hour. Both sides have stressed that there will be no default and the market has taken them at their word. Investors have bid up stocks this week in anticipation of a positive announcement.
This week, Fitch, one of the big three American credit agencies, has put the nation's debt on a negative credit watch. The agency warned that it may downgrade the U.S. AAA debt rating to AA+ over the debt ceiling fight. It cites the increased political partisanship that is hindering a resolution to the debt limit. In addition, they point to the failure of the U.S. to meaningfully tackle rising budget deficits and a ballooning debt burden.
This brings back to mind a similar situation in 2011. At the time, another big credit agency, Standard & Poor's, downgraded the nation's debt to AA+ for the same reasons, despite the two sides coming to a compromise and avoiding default.
Politicians from both sides denounced the move, as did the U.S. Treasury, to no avail. It still has not restored its' AAA rating. The agency said their downgrade reflected their view that the effectiveness, stability, and predictability of American policymaking and political institutions have weakened at a time of ongoing fiscal and economic challenges. That sounds about right to me, and if anything, the environment has worsened over the last 12 years.
Although I have never seen a published dollar amount of the cost to the nation and the taxpayer of that downgrade, I do know that the rating downgrade increased the U.S. government's cost of capital (interest, fees, and yields). The higher costs simply reflect the increased risk lenders are taking in buying our debt. Given the trillions of dollars we have borrowed over the last dozen years, we are talking billions and billions of dollars in extra costs. And here we are again in the same situation. Will Fitch follow Standard and Poor's lead and lower the rating? Time will tell.
Throughout the week, yields on bonds have risen in fear of default with the one-month, U.S. Treasury bills now yielding more than 6 percent. Three-, six- and nine-month U.S. Treasury bills are yielding between 5.31 percent to 5.39 percent. The U.S. dollar has shot up as well, and that combination has savaged precious metals and most other commodities.
Equities have fared much better — thanks to AI and 10 large-cap tech stocks. Artificial Intelligence (AI) has been around for many years, but the idea has caught fire among traders and investors. Reminiscent of the Dot.Com boom (and bust), any stock that has even a whiff of exposure to AI has exploded higher. Nvidia, a semiconductor company that is at the forefront of chips needed in the AI space, announced spectacular earnings and even better guidance this week. The stock rose 25 percent overnight and carried the technology sectors along with it.
But underneath this hyped-up area, most equity sectors of the overall market were at best marking time while the debt negotiations continue. As I predicted, traders are reacting to every word and headline, moving markets up and down. The latest word out of Washington is that President Joe Biden and GOP House Speaker Kevin McCarthy are closing in on a deal.
Their idea is to produce a simple agreement with a few key top-line numbers for spending, including defense spending, and let lawmakers hash out the details through the normal appropriations process in the months ahead. That would dispense with a weighty, thousand-page bill that would require legislators to write, read and vote on all in a matter of days.
My belief for months is that a deal will get done and the market agrees, otherwise, the market averages would be a lot lower than they are right now.
The question to ask is what will happen after a deal is done? I expect markets will spike higher in a relief rally, but then what? The U.S. Treasury is expected to need to raise a lot of money in the form of new government debt sales in the weeks after an agreement. That should send interest rate yields higher and probably put pressure on the stock market. But let's just get through the next week first.
The Retired Investor: Rents Rising as More Americans Priced Out of Housing Market
Nationwide, rents have been climbing since the pandemic, but it is still cheaper to rent than to buy in most of the country. As such, in some states, building houses-to-rent is becoming a trend.
Home prices continue to soar with the median sale price of a U.S. home gaining 32 percent in the first quarter of this year from the same time in 2020. Throw in the climb in mortgage interest rates and there is no wonder that a record number of Americans believe it is a terrible time to buy a house, according to a Gallup survey. Renting seems to be the only alternative.
But the unfortunate fact is that rents are growing faster than incomes in the U.S. The trend began two years ago and is gaining steam. The reasons are simple. As the pandemic abated, the number of U.S. households grew by 1.48 million. Young adults, who had been sheltering with their parents at record numbers, began moving out and finding their places. Unfortunately, a soaring housing market locked out many of these would-be first-time home buyers.
That has forced many to rent while waiting for interest rates and housing prices to decline. At the same time, many local governments and management companies that had limited rent increases during the pandemic began lifting those rent controls. As a result, landlords are jacking up rents to make up for two-plus years of rent freezes just as the demand for rentals has increased.
In addition, the trend toward working from home opened opportunities for white-collar workers to move from pricey locations to more affordable areas. That wealthier demographic trend has driven rental prices higher in areas where there was not enough inventory to satisfy this influx of demand.
In the first quarter of 2023, the average renter, according to Moody's Analytics, needs to spend almost 30 percent of their monthly income on monthly rentals. That sounds like a lot, and it is, but that number is down from last year's historical peak when the rent-to-income ratio was higher than 30 percent.
Last year there were several urban centers where the burden of high rents was overwhelming incomes. As you might imagine, cities such as New York, Boston, Philadelphia, Houston, Palm Beach, Miami, Los Angles, and Northern New Jersey are experiencing rent increases that are above the typical mortgage payments.
Entrepreneurs in the building and construction industry are recognizing the opportunity in the rental markets. Their answer is build-to-rent (BTR) housing. BTR allows the renter to move into a brand-new home without the need for a huge down payment, or a long-term lease. In many cases, that rent includes amenities and professional property management.
In most cases, build-for-rent homes are clustered together and form a community like an apartment complex but not always. Depending on the locale, some communities consist of townhouses or cottages, or even detached family houses.
Builders like the concept, since the community projects can be put together in bulk and all at once. Construction can be accomplished faster and without checking in with the home buyer, who may have countless questions, changes, and thus delays. Potential landlords like them as well since each house is designed for efficiency, making repairs and maintenance easier.
There is a housing shortage in America. Experts believe the nation needs anywhere from 3 to 6 million more homes. Build-to-rent homes won't satisfy that demand overnight, if ever.
It is early days in the BTR market since there are only 115,000 units in the construction pipeline throughout the U.S. Arizona, North Carolina, and Texas lead the nation thus far in construction and many municipalities are still struggling with how to zone these communities. In 10 states there is no construction planned at all including Oregon, Massachusetts, and West Virginia, according to the National Rental Home Council. As rental prices continue to climb, however, so too will build-to-rent housing in my opinion and that is a good thing for both builders and renters.
@theMarket: Markets Signaling No Debt Default
The only thing that mattered to investors this week was the looming U.S. government debt default. Fortunately, the comments from major players in the debt talks have been largely encouraging. The devil, however, will be in the details.
The stated deadline for the passage of raising the debt ceiling is June 1, according to Janet Yellen of the U.S. Treasury Department. Some argue that it is a self-imposed deadline. Depending on several factors, including tax revenues, the U.S. might conceivably stretch its ability to pay its debt as far out as August, but that is no sure thing.
In any case, even if the two sides fail to agree on the details there is also the possibility of extending the debt ceiling limit a few weeks for the t's to be crossed and i's dotted. No one is talking about that yet, since Washington deadlines, artificial or otherwise, have the effect of galvanizing politicians to cross the finish line if at all possible.
House Speaker Kevin McCarthy said late last week that the House could vote on a debt ceiling deal as soon as this coming week. Both sides have gone out of their way to assure the public that a debt default is not on the table.
The discussions are continuing, and the negotiators are keeping the talking points close to the cuff and behind closed doors, which is another positive, in my opinion. The fact that McCarthy is talking directly to two of President Biden's most trusted negotiators is encouraging as well.
But every time one side or the other expresses something negative, markets react as they did on Friday when GOP Representative Garret Graves, who is leading negotiations for McCarthy, said "It’s time to press pause because it's just not productive." Market gains evaporated in seconds. Investors should expect more of this volatility next week.
Complicating the picture, however, is that both the House and Senate left town on Thursday and the Senate is not expected to be back in session until the last few days of May. There is also a danger that the hardline radical group of Republicans in the House could balk at any compromise hammered out by both sides.
In sum, while the markets are betting that a deal will be done on time, the danger is that it won't. If that were to occur, the downside in stocks could be considerable.
The stock market, which has been stuck in a tight trading range for weeks (4,050-4,160), broke above that range and the S&P 500 Index vaulted above the 4,200 level this week. My upside target is still 4,325. Technology, semiconductors, and anything that remotely had something to do with artificial intelligence (AI) continued to lead the markets.
Sectors that had been held back due to the risks associated with the debt ceiling found some strength while your typical safety trade areas such as precious metals, utilities, consumer staples, health care, etc. lost ground.
On the Fed front, there seems to be a crack in the monetary mantra that more interest rate hikes are on the way. Several Fed members seem to be advocating for a pause in the rate hikes, while others thought that we still needed at least one more hike. But none of them suggested that a rate cut was on the table any time soon.
In the coming week, all eyes will remain focused on Washington. President Biden plans to fly home early from the G7 meeting to shepherd the talks as the clock ticks closer to the deadline. If the politicians can keep control of the narrative and come to a deal, we could see my target met before the end of the month. If not, look out below.
The Retired Investor: Food Prices May Be Moderating in Some Cases
For more than a year, consumers have been contending with higher food prices. The latest read of April's Consumer Price Index, however, gave some hope that relief may be around the corner.
Headline inflation rose 0.4 percent last month but a look under the hood revealed that the "food at home index" declined. This was the second month in a row that prices for fruit, vegetables, meat, and eggs among other items, fell.
That may be so, but I certainly am not seeing those price declines in my shopping bill. Let's take eggs for example. You may remember that in December 2022, we were paying as much as $5.46 on average for a dozen eggs. The culprit behind those soaring prices was a historic outbreak of avian influenza or bird flu that coincided with the winter holidays. The epidemic killed millions of egg-laying hens. Since then, influenza has subsided and there have been no new cases detected at commercial farms since December 2022.
The industry has bounced back since then and as it has the price of wholesale eggs has fallen. At the end of April, the benchmark Midwest Large White Egg price has fallen to $1.22 per dozen. That is a 78 percent decrease in five months. Some produce analysts expect we could soon see egg prices dip further to below $1 a dozen.
The average consumer paid $3.45 for a dozen large Grade A eggs last quarter, according to government data. That is down from January's $4.82, but still more than double the $2.05 the prior year.
While this may be good news for some consumers, a trip to my local supermarket tells me retailers have certainly not passed on those price savings to customers. Retailers can sell their eggs at whatever the market will bear. Here in the Berkshires, we are way above the so-called "average" egg prices. At Price Chopper, for example, a dozen cage-free Grade A large eggs are going for $5.39 a dozen, while organic eggs are $8.99. That is a markup of 441 percent and 736 percent.
I know there are other costs that retailers need to cover — transportation, labor, etc. — and there is always a lag effect between a decline in wholesale prices and the price we pay at the check-out counter. We could see price cuts in the months ahead for eggs and other products but the jury is still out when it comes to beef.
Beef prices remain in the stratosphere. There are reasons for this situation. A continuous and extreme series of droughts in the U.S. in recent years has made maintaining cattle herds expensive or, in many cases, impossible to maintain. Herds (including breeding cows) were slaughtered, which has resulted in a growing scarcity of beef products. This year will be the first significant drop in beef production since 2015. Less beef supply usually means higher prices if demand remains the same.
There is some evidence, however, that beef prices may have reached a level where consumers are beginning to cut back on their beef purchases. Tyson Foods, which processes 20 percent of the nation's beef, poultry, and pork, saw its first fiscal quarter net income drop more than 70 percent based on weaker results in all three of those product areas. Analysts believe some consumers are substituting more chicken and pork for beef in their diets. Tyson was caught between higher live cattle prices and less consumer demand and was forced to reduce prices somewhat. Will this trend continue?
That remains to be seen. Demand for beef usually picks up about now (during the grilling season), so this summer will be key to determining the consumers' appetite for continued purchases of high-priced hamburgers and steak. If so, we can expect meat processors and retailers to charge even higher prices in the fall and winter for meat. However, if the economy begins to slow, consumers might cut back even more on their spending across the board and that could keep beef prices flat or even slightly lower.
@theMarket: Stocks Playing a Game of Inches
Bears and bulls are battling for supremacy, which is keeping stocks moving in a tight range. The question is which way will the markets break?
On the plus side, inflation does appear to be falling, or at least not going higher. Both the Consumer Price Index and the Producer Price Index came in as expected for April. Investors interpreted the data as a bit of a positive in the fight to control inflation. The trend is definitely down compared to last year's numbers.
Bears, on the other hand, were encouraged by the rising fears of a default on the nation's debt in less than three weeks. In addition, the ongoing regional bank contagion is alive and well. Pacific West Bank, a regional bank, reported that almost 10 percent of deposits flowed out of the bank's doors last week.
The focus on corporate earnings has taken a step back now that the mega stocks have been reported. Results are still coming in better than expected overall, but guidance is checkered. Companies in some sectors are seeing a troubled future, while others claim it is business as usual.
Just a handful of stocks (FANG+) have been supporting the equity market for months and that still seems to be the trend. For the markets to move higher, we would need to see both an expansion of the number of stocks that are participating in an up move (breath) and overall market volume must increase as well.
Early last month, in a separate column on the debt ceiling, I warned that readers could expect the debt ceiling would begin to concern Washington, the media, and the financial markets. This week was the first meeting of the key players: the president, and leaders of both parties in Congress. I expect the rhetoric to escalate, and fear-mongering will move to center stage. The beginning of the horse-trading process is expected to occur early next week when both sides meet again.
For the politicians, it is a huge opportunity to shine among their partisan voters, to appear strong, dedicated to principles, and concerned about the country's future. They won't give up that chance until they absolutely must. That's why this bickering will drag on up to the eleventh hour or even beyond.
Underneath this farce is a simple truth. Imagine a credit card bill, or mortgage payment that is due on June 1. Most people would not even blink in considering whether to pay at least the minimum amount due. Sure, you may have a discussion afterward on how to reduce your spending or refinance a mortgage, but you won't skip a payment. But in Washington politics, that argument is beside the point because it is not about the debt, it is about them and their political future.
The sad, sad truth is that without turmoil in financial markets, the politicians on both sides have no incentive to agree. That could mean by next week, or the week after, we can expect to see a period of downside in the markets, punctuated by spikes higher as market participants hang on every word uttered in this increasingly acrimonious debate. That could mean a 10-15 percent decline in the markets between the last weeks of May into June.
I am already getting calls from concerned investors on how to manage through this volatile couple of weeks. For long-term investors, my advice is to do nothing. In the end, the debt ceiling will be passed. Those most against it now will vote for it in the end and then try and hide their vote from their constituents.
If you feel you will need some cash in the short term, a three-month CD could be a safe bet. The yield on those instruments is almost 5.25 percent, the last I looked, which is a great rate. U.S. Treasury bills, notes, and bonds are also an alternative, although, with the risk of government default, some investors are shunning these instruments despite yields on the short end that are 5 percent or more. In any case, prepare for an uncomfortable few weeks, but we will come out the other side just fine.