As a follow-up to his recent note on the “7 reasons investors are complacent” David Rosenberg brings us his 3 biggest risks to the market:
- Energy prices: Gasoline prices have surged $1 a gallon from a year ago and stand at a 15-month high of over $2.70/gallon and many market participants are calling for $3+ by the spring. The rule of thumb is that every penny increase at the gas pumps drains the equivalent of $1.3 billion from household cash flow, so this is equivalent to a $130 billion drag on discretionary spending or over a 1% pay cut to the average worker. Tack on what the cold snap is going to do to the home heating bill (most regions of the U.S.A. are 10% colder than normal). We are already seeing that retailers are planning for this surge in natural gas and heating oil to divert 4% more of the household budget towards energy needs through the winter months.
- Mortgage rates: They are already up a quarter-point in the past month and are at a four-month high. Part of this reflects the rise in Treasury yields and part of the rise is due to growing concern over the Fed’s exit strategy in March when it plans to stop being a buyer for mortgage-backed securities. The Fed now holds an unbelievable $909 billion of mortgage paper on its balance sheet; in the past year, it has purchased 73% of the mortgages that government-backed Ginnie Mae, Fannie Mae and Freddie Mac have turned into securities. When you count in what the Treasury has done, the government has bought over $1 trillion of mortgages or basically has nationalized the housing market. So the Fed is basically three-quarters done its quantitative easing (QE) program if things go as planned — the impact of any withdrawal could result in a further increase in mortgage rates of between 50bps and 100bps.
- Home prices: There remains a glut of at least two years supply on the market when the ‘shadow’ foreclosed housing inventory data are included in the calculation and home prices on average have 10-15% downside before fully mean reverting with respect to residential rents and wage income. This is the canary in the coalmine when it comes to wealth, confidence, spending — and writedowns (the market is expecting write-ups this year) in the banking sector. The big surprise will be the renewed turndown in the closely-watched Case-Shiller (CS) index of home prices, which in the past two months has slowed to an average gain of +0.25% after 1%+ advances in July-August, which gave beta-hungry investors more reason to add risk to their portfolios. But the CS series is a three-month average and for all we know, the renewed price declines we expect to see may already be occurring now. Note that two home price series are already back in decline for two straight months — LoanPerformance and Radar Logic. This is key for any sector that remotely touches the housing industry from the homebuilders, to the financials, to the consumer discretionary group.