Mortgage Rates Are Lower Than Inflation

Interesting take in this article by Jonathan Lansner, longtime business columnist of the Orange County Register. Lansner uses data from the Federal Reserve and from Freddie Mac to show that April’s average 30-Year Mortgage rate of 3.1% was lower than April’s 4.2% annualized inflation rate. That’s not just a tad bit lower; that’s a lot lower, 1.1 percentage points lower. First time this has happened in over 40 years – August 1980, to be exact. Let me give you my thoughts on why this has occurred and what might happen in the future.

10 Year US Treasury Yield from Stockcharts.com

Why Mortgage Rates Remain Low

Mortgage rates are still in the low 3% range because US Treasury rates remain steadfastly low despite the uptick in inflation. Rates of 30 year mortgages are closely linked to 10 Year US Treasury yields because the average duration of 30 year mortgages is about 10 years (a little less, actually). Check out the chart of the 10 Year US Treasury. After rising from below 1% at the beginning of 2021 through mid-March, the yield on the 10 Year topped out at just over 1.7% during the 3rd week of March (coincidentally the 1 year anniversary of the nadir of the stock market in 2020). Since mid-March, however, Treasury buyers have rushed in and have kept yields below 1.7%. Why is this? Because 1.7% on “risk-free” US Treasuries looks like a great return to investors both in the US and in the rest of the world. As low as they are, rates on government debt in the US are higher and hence more attractive to international investors than are rates from other countries. As long as that remains the case, look for 10 Year rates and therefore mortgage rates to remain low. Unless inflation gets out of hand, which it might.

Inflation Risk

Is April’s 4.2% annualized inflation rate just an anomaly, or is it just the tip of the iceberg? Last week I wrote about the quadrupling of the price of lumber, which certainly contributed to April’s inflation in some way. Since I posted that article on lumber, its price has headed south, from $1,700 to just over $1,300, a drop of about 23% in a week. If lumber’s price remains subdued, so to speak, it speaks to the anomaly theory rather than the runaway inflation theory of the future. Supply chain disruption was and remains a big part of the world economy. The US economy seems to be recovering well but that’s not true of other geographies which export essential components so that the US economy can continue to roar forward. Perhaps the theory of a temporary period of disruption is another reason why US Treasury rates remain benign despite higher inflation numbers. The Federal Reserve itself believes inflation remains under control and that an annual rate of 2% or even slightly higher is acceptable, April’s figure notwithstanding. Do you believe or trust the Fed? If you don’t, proceed at your own peril because the Fed usually gets what it wants.

IMO

I believe the phenomenon of inflation rates greater than mortgage rates could remain a thing for several months hereafter. Anecdotally, gasoline is higher, the cost of going out to eat is higher, housing is higher, and so it stands to reason that we should get used to inflation rates of in excess of 2%. If supply chain disruptions are to blame, then I believe such disruptions will remain with us for at least a year, maybe more. Meanwhile, unless inflation really gets out of hand – say in excess of 5% for a sustained period, along with the perception that the Fed is out of touch and fighting the wrong battles – the demand for US Treasuries will remain strong and therefore Treasury rates will remain low. What does this mean for your investment outlook? Buy stocks, including and especially funds and/or ETFs that track stock performance.

Lumber And Inflation

If you believe, as the Federal Reserve does, that inflation is under control and will likely remain so for several quarters at least, then you might want to reconsider your belief after taking a look at the chart of Lumber Futures. Presented here is a Weekly chart of Lumber Futures that goes back to January 2019. You can see that it has gone almost straight up since October 2020.

Why?

Why has the price of lumber quadrupled, from about $400 per 1,000 board feet pre-Covid to over $1,600 per 1,000 board feet now? According to this article from Vox.com, there are are a number of factors involved, including the following:

  • Sawmills laid off workers when Covid hit.
  • Demand for lumber was forecasted to drop due to Covid. Instead, demand rose because people decided to work on their homes during the Covid shutdown.
  • Sawmills were slow to turn the switch back to On in the midst of the rise in demand.
  • Now sawmills are finding it hard to find workers, a labor shortage common to a number of industries that may have roots in the increased Covid relief and unemployment benefits paid to workers.
  • Beetle infestation in British Columbia is limiting the supply of lumber from that area.

Ramifications

Combined with sub-3% mortgage rates, the rising cost of lumber is causing the price of housing to increase. If you already own a home, then that doesn’t affect you. However, if you are a renter and/or you are in the market to purchase a home, then it will cost you more to do so. For sale home prices are not included in the Consumer Price Index measure of inflation, but “Owner’s equivalent rent of residence” is part of CPI. The rising cost of lumber will have an effect on CPI, whether directly or indirectly.

Another ramification is that people who may have been considering building a new home may reconsider once their project goes out to bid only to find out the cost of lumber has quadrupled. Same thing for homebuilders: how many tract home projects will no longer pencil with these much higher lumber costs? The result if that the already constrained supply of houses that are for sale will become even more constrained. With supply constrained while demand is increasing, home prices will likely continue to be strong, especially if mortgage rates continue to be low.

What To Do

Unless you live in a rent-controlled situation or other non-market factors are involved, then you don’t want to be a renter now. If you already own a house and plan to stay, then great! However, if you are looking to sell and move, then I advise that you make sure you have your new destination identified and under contract before listing your current house for sale. Buying the new home is the tougher of the two steps in this seller’s market. Don’t sell your current house and then have to move into a Residence Inn or other non-appealing temporary situation that will cost you a lot of money.

IMO

Home sales may not directly be a part of CPI, but if lumber remains high, the price of housing will reflect this new normal and will cause increased inflation, indirectly if not directly. If higher inflation numbers cause the Federal Reserve to rethink its stated positions on holding short-term interest rates low for at least a couple of years, then look for a rocky period in the stock market due to the prospect of higher interest rates.

Tilray

Tilray gets a lot of press because of the industry it plays in: Cannabis. i.e. Marajuana. Tilray’s mission is “to build the world’s most trusted and valued cannabis and hemp company.” Fair enough. It is getting more press this week because its merger with Aphria, another cannabis seller, closed, wherein the former CEO of Aphria (Irwin Simon) became the CEO of the combined company, which will continue to be known as Tilray. Despite all of this press, Canada-based Tilray has continued to lose boatloads of money. Although cannabis legalization is moving forward in the USA (it is already legal in Canada), I believe Tilray faces a steep uphill battle to reach profitability. I would not invest in Tilray stock, nor of the stock of most any other cannabis stock. Read on to see why I believe so.

From Stockcharts.com

Losses

Check out Tilray’s most recent 10K for 2020. The report is long on the future prospects of cannabis and therefore on the company, as well as on the risks of being in this business. However, the financial results are not a highlight. You have to scroll all the way to Page 64 of the report to find a summary of their financial results. Page 64 shows a gross profit of $24.7 million on sales of $210.5 million (gross margin of 11.7%). Good enough, but Tilray’s combined selling, general and administrative expenses (sg&a) totaled $140.5 million, or 67% of gross sales. Then Tilray shows a write-off of $61 million, which is 29% of gross sales, for “impairment of assets”. Cannabis is an organic product that can go bad. Tough way to do business. My take is that this is a low-margin business with product that easily can go bad in the warehouse, and that sg&a expenses are extraordinarily high for the company’s sales. Said another way, Tilray’s gross sales will have to increase enormously in order to justify what they are spending now for sg&a, let alone what they would be spending in sg&a if their sales were to increase. I don’t see Tilray reaching profitability any time soon, even with the merger with Aphria (Aphria’s financials are not part of Tilray’s 2020 10K).

Low Barriers to Entry

My fundamental problem with investing in Tilray or any other publicly-traded cannabis company is that the barriers to entry into the cannabis business are low, and that the hardcore cannabis users are already invested in the “alternative” growers and suppliers, or they just grow their own. Anyone can grow their own marijuana in their own backyard or even in a pot in their apartment. Just acquire some seeds from a buddy and off you go. In fact, growing one’s own is a primary aspiration of many hardcore users. My sense is that the Tilray’s of the world will attract new cannabis users, at least for a while. I believe the appeal of growing one’s own is part of the allure of cannabis, and this points to the issue of low barriers to entry in the cannabis industry. It is hard to establish a footing when literally anyone can get into the business of growing marijuana.

Demand Overstated

Despite the new applications for cannabis – CBD creams, oils, gummies, and the like – I believe the demand for cannabis and its derivative products will prove to be overstated. I have tried CBD cream on various body aches (hey, it’s legal), and it does work, but not substantially more than non-CBD topical products such as Emu oil or traditional Ben Gay, all of which I have also tried. Moreover, CBD creams are much more expensive. I believe people will try CBD creams just to check it out, but given its relative cost, I don’t believe sales will be sustainable. Yes, there will always be the traditional market for consumption of cannabis, but with its health benefits are clearly debatable at best, I don’t view its sales growth as something we should promote. In short, I don’t see cannabis demand exploding to the extent Tilray needs it to in order to become consistently profitable.

Health Benefits

The current advocates of cannabis products tout its health benefits. I agree that my CBD cream seems to work on my body aches. However, the problem is that all of these claims are word of mouth. Traditionally, if you have a substance or a chemical that you believe has health benefits, you test it with lab animals, then apply to the FDA to test it with humans, and then go through the FDA process to get the substance approved so you can sell it with the substantiated claims of health benefits. The problem is that cannabis is so widely available that it can’t be patented, and if it can’t be patented, a company such as Tilray cannot take it through the FDA approval process. As such, the health benefits of cannabis will always have to be word of mouth. Tilray will never be able to mark up the price of its cannabis because it doesn’t have an exclusive, patent-protected right to sell it or its health benefits. Consequently, the cannabis business will remain a relatively low-margin business, which will keep it a hard business to make money in.

IMO

As you can tell, I am not a proponent of Tilray or of any player in the cannabis business. The industry is a low-margin business with too may barriers to entry, with demand and health benefits I believe to be overstated. Tilray specifically has a bloated level of overhead that I don’t foresee it growing out of. Stay away.

Obsession

If you are a fan of audiobooks, as I am, then I highly recommend you purchase economist and podcaster Malcolm Gladwell’s new offering, “The Bomber Mafia“. This is a new audiobook that was conceived and designed to be an audiobook, and not just someone reading a print book into a microphone. In the audiobook there are sound effects (such as exploding bombs), music, and recordings from the World War II era that is the subject of the book. Even if you aren’t that interested in the subject – bombing during WW II – you should still buy the book just to listen to the production, if you like audiobooks.

Author Malcolm Gladwell

Obsession

At the outset of “The Bomber Mafia”, Gladwell says he has come to the realization that he likes to write about people who are Obsessives. Obsessive people, Gladwell says, are those who are able to block out all of the external noise and distractions in order to move forward with an idea or a goal that they believe will change the world in some way. While obsessive people may accomplish a great deal, their accomplishments will likely be at the expense of interpersonal relationships. Obsessives typically aren’t great managers of people or even life partners because even the people closest to them can get in the way of their obsessions. People who are obsessive typically aren’t fully healthy, either mentally or in some other way.

Are You Obsessive?

Most people aren’t obsessive, and that is probably a good thing for greater society. Can you imagine what our society would be like if most people were obsessed about something? And what if those obsessions came in conflict with one another? I guess that’s how wars start. So, if you are lacking an obsession, that’s ok. However, you may want to look at the concept of obsession as a way to invest your money.

Entrepreneurs Are Obsessives

I would guess that many, but not all, successful companies are started and run by obsessive entrepreneurs who believe they can change the world and want to convince a pack of employees to engage in the quest to do so. Think about the mega-cap companies that are now the most valuable in the world. Do you agree that Bill Gates of Microsoft, Steve Jobs of Apple, Mark Zuckerberg of Facebook, Elon Musk of Tesla, and Bezos of Amazon are or were obsessives with their visions for their respective companies? Most, if not all, did not let interpersonal issues get in the way of their obsessions. Most were considered to be not very nice guys. However, the world wouldn’t be what it is today without any one of them, and our economy wouldn’t have gotten through the pandemic as well as it did without what they have contributed to our economy.

Look For Obsessives

With respect to your own investing, we have been taught by the Warren Buffetts of the world (another obsessive!) that we need to dig deep into the companies, their markets, and their financials in order to make a fundamental decision as to whether or not to invest in those companies. This is all well and good, but I would also add that you need also to look to see that the leadership of that company is obsessed about its mission. This is probably easier to do with larger companies because these larger companies tend to get more press coverage. However, if you like to dabble in mini-cap stocks or even in private equity or private companies, I would make sure that whoever is leading that company has a reasonable and healthy obsession with whatever that company is trying to accomplish. I would guess that most such entrepreneurs will be obsessed to some level. Now it is up to you, the investor, to determine if their obsession can be realized and monetized, and if that entrepreneur is the one who can lead that company to greatness. After all, there have been a lot of obsessed people who have failed either with their vision or their execution. You need to place your money not just with an obsessive, but with one who is able to bring their vision to fruition and make money for their investors in the process. This is what makes investing, or the allocation of capital, such an interesting endeavor.

IMO

You don’t have to be obsessive yourself in order to invest in people’s obsessions. If you look top-down at corporate management and determine whether their vision of their mission and their ability to execute it is within reason, then a good part of the battle for you as an investor is won. Building a successful company can be ugly at times but an intense focus on that building process is what is needed for that success. Look for those types of people when you invest your money.

Selling Your Home

Perhaps you are reading the news that single family home sales and prices are strong, and that is making you think that now may be a good time for you to sell your home. Maybe your children have finally moved out, or maybe you are concerned that your two-story home may not work for you as you get older. Maybe you are cash-poor and house-rich and want to monetize all you have built over the years and live a more simple life in a smaller home. All of these are good reasons to think about selling your home. The problem is, there are a lot of other issues that you need to consider before making the decision to list your home. Let’s consider some of these issues.

Home For Sale Real Estate Sign and Beautiful New House.

Where Are You Going To Live?

Most people need to sell their current home in order to buy another home. If your case is different, then hat’s off to you. In a seller’s market such as this, selling is the easier part. Buying a new home may be the harder part now, especially if you are looking to live in a desirable market with a paucity of housing supply. Stories abound now of listings receiving multiple offers including offers above asking price. Until you have experienced being outbid on a house you really want, you may not be battle-hardened enough to go the extra mile on a bid so that you win. You may find yourself in a situation wherein you have sold your house but have no place to move to because you weren’t successful in purchasing what you want. Keep in mind, if you are selling a less-expensive house and hoping to move to a more-expensive area or house, you are a net buyer, not a net seller, and so your focus should be on the purchase side rather than the sale side in a hot market such as this. If instead you are downsizing or moving away from the hot market, then your situation may be different. Nevertheless, consider whether the sale of your existing home or the purchase of the new home will be the tougher part of the transaction, and make sure you have the tougher side covered before addressing the easier side. Don’t find yourself having to bridge a gap by having to move in with your parents or your children or into rental housing because all of those add to the cost and to the annoyance factor of the move.

Capital Gains Taxes

If you sell your house for more than you paid for it plus what you have put into it, then you incur a capital gain, which is taxable. Therefore, all of the equity that you pull out of your current house may not be available to you for a down payment on the new house. Fortunately, the IRS does provide relief for this. When you sell your house, you can exclude up to $250,000 of capital gains from being subject to capital gains tax – and up to $500,000 if you are married filing jointly. You need to have lived in your house as your primary residence for at least 2 of the 5 years prior to selling the house to qualify for the capital gains exclusion, and you can still qualify for at least a partial exclusion if you have extenuating circumstances such as death, divorce, military service, or job relocation. For most people in most housing markets, these exclusions are sufficient to cover their capital gains, but in some markets and where people have owned their current house for a long time, they may not be able to exclude all of their capital gains. Consult your tax expert with your specific situation before moving forward under any assumption that you can exclude part or all of your capital gains. Make sure you have a record of money you have put into your house that might have added to its basis and therefore would work to minimize any capital gains taxes.

New Property Taxes

Some states, such as California with Proposition 13, have caps on how much their property taxes can be raised each year. If you live in such a state and your home has appreciated in value during the years you have lived there, your current property taxes may be artificially low. If so, when you buy your new house, your new property tax bill will be based on what you paid for the new house, meaning you could pay a lot more in property taxes on the new house than you did on the prior house. Now, California also has a law that allows some people (Seniors) to purchase a new property within their current County (plus some but not all other Counties) and retain their old tax basis. However, absent such a provision in your state, you may be faced with a much higher property tax bill when you buy a new house.

Other Issues

Do you really want to move into a new house and start again from Square One with respect to your social and community life? Are there so many memories tied up in your existing house that you can’t bear to leave? Does the thought of moving horrify you? It may be too much for some people, but for others, perhaps those seeking to be closer to medical care or to grandchildren or other family members, such change may be desirable. Such non-financial issues are certainly valid issues related to the decision of whether or not to sell your home.

IMO

A lot of people look at these and other issues and decide it isn’t worth it to sell their current home, even in such a hot seller’s market. This is one of the reasons that demand far outstrips supply and that you have multiple offer situations with some listings. Yet, the hot market is tempting, and the market should remain strong as long as the supply/demand equation remains tilted as it currently is and as long as mortgage rates remain relatively low. Talk with tax experts and consider your own situation before making the big decision of whether to sell your house now or not.

Breadth

For most of the past 13 months of stock market rally, I and others have written about our concern that the rally is being propelled by a very few number of stocks, particularly by those mega-cap companies that have benefitted through the economic shutdown caused by the Pandemic. In short, the rally has been strong but not very broad. According to this article in Monday’s Wall Street Journal, that seems to be changing. More and more stocks are participating in the current rally, and that is a good thing if you are looking for a sign that the current rally has legs. (Today’s down action notwithstanding).

200-Day Moving Average

The WSJ article says that the current rally is broad because 95% of all stocks are trading above their 200-Day moving average, a situation that hasn’t happened since 2009, also the first year after a market correction. 200 days is about 40 weeks of trading, and if 95% of stocks are on a 40 week uptrend, then that is indeed evidence of a broad market rally. The 200-Day is considered to be more indicative of a stock’s long-term direction as has more data points than shorter-term indicators such as the 50-Day.

Stay At Home Stocks

This has not been a straight-up rally for the entire breadth of the stock market, and it remains lopsided with the mega-cap stocks carrying the bulk of the load. However, as more people get vaccinated and more aspects of the economy reopen, companies and stocks that had trouble during the worst of the pandemic begin to show life again and investors continue to look for opportunity. Interest rates remain low and therefore returns in the fixed income sector still aren’t there, and so investors continue to invest in stocks rather than bonds. It seems like a situation wherein the mega-caps have led the way and the rest of the stock market universe is now following along.

IMO

I have been very concerned for the past year about the lack of market breadth. We’re not out of the woods yet, but if 95% of stocks are above their 200 Day MA, then that is a good sign that there is true breadth, and that an issue with one of the mega-cap stocks won’t cause the entire house of cards to tumble down.

For Yourselves or For Your Children?

Is one of your financial objectives to leave some inheritance for your children and/or your remaining family? Or are you hoping to spend it all during your own lifetime, enjoy the fruits of your labor and your personal planning, and die with $0 in the bank but owing nothing to anyone? The answer to that may depend on how much money you have to begin with. It is a nice, generous thought to believe that you can leave an estate to your children, but most people don’t have that luxury because they are living paycheck to paycheck and fighting to keep afloat during their own lifetimes. For most people, the legacy they leave to their children is the love that they give them and the money that they spend to feed, raise, and educate them when they are still children. They couldn’t afford to do much else when their children are younger, and they likely won’t be able to afford to provide more for their children upon their death. For most people, Social Security is a very important part of their retirement income, and whatever personal savings they might have they spend themselves, hopefully in some orderly fashion that will leave them still with some money even if they live to a very old age.

Planning to Leave an Inheritance

However, if you are lucky enough to be among the few who already have enough money to live comfortably during retirement and will likely have something left over to leave to their children, you will likely have a different plan both for investing and for your rate of spending your savings during retirement. For instance, if you are not planning to leave an inheritance, something like the 4% Rule should be part of your plan. Withdraw 4% +/- of your net worth every year and hope your money lasts long enough. If you instead are trying to leave something to your kids, then you shouldn’t think about how much of your net worth you can withdraw each year. Instead, you should invest such that you can generate enough current income from your portfolio to live on comfortably during retirement without having to draw on the principal. Easier said than done in this day and age because current income is hard to come by with interest rates as low as they are. It may mean you consider investing in alternative asset classes that pay current income, such as real estate or oil and gas partnerships. You should invest also in traditional income-generating assets such as stocks that pay dividends, preferred stocks, or corporate or mortgage-backed bonds or mortgage REIT’s. All of these pay current interest or dividends but are further out on the risk spectrum than are traditional bonds.

Step-Up In Basis

Another part of the “Inheritance” plan is to own assets for a long time, preferably several years. Hopefully these assets will appreciate in value during that time. If they do, when you pass away, your heirs receive a step-up in basis. This means that your heirs’ tax basis in these assets will be the market value of those assets at the time the heirs became the owners. This is a significant tax advantage to them because they could sell these assets for whatever reason and not incur a capital gains liability. Direct ownership of real estate works well in this regard.

Another Option

Another option to consider is my strategy to own index funds and to write call options against them for current income. Depending on how much you have and are willing to dedicate to this strategy, if you just withdraw the amount of income that you generate from the call option writing (or less), then you may be able to live comfortably during retirement without having to withdraw any of your principal, and therefore you should be able to leave something to your children. This strategy doesn’t work as well if you are trying to leave your heirs with assets at a low basis because of the likelihood that your assets will be called away from you from time to time, necessitating that you re-buy them in order to keep the strategy going. Please contact me with further questions about this option.

IMO

What you want to have done with your assets when you pass away, assuming you have any assets at that time, will dictate how you invest those assets during your lifetime. If you have enough money to live comfortably during retirement and you have a desire to leave something to your heirs, then you should think about investing long-term and about making sure your assets generate current income for your own needs. Otherwise you may die with $0 in the bank even if that wasn’t your intent.

Beware Of Their Agenda

While scrolling through LinkedIn, I saw a recent quote by billionaire Sam Zell to the effect that working in a traditional office will make a comeback because creativity and motivation are not easily fostered by working remotely through Zoom. Of course Sam Zell would say that, I thought. Sam Zell is the head of Equity Office Properties, one of the largest developers and owners of office towers in the US. It’s not news that Sam Zell said he believes offices will make a comeback; it would have been news had he made the opposite statement.

Sam Zell, CEO of Equity Office Propertis

They All Have An Agenda

Sam Zell’s statement is self-serving. More people in offices means more tenants which means higher office rents which means more money in Sam’s pocket. Yet Sam’s statement is consistent with what you see and hear from the talking heads in financial and social media. All of these people are self-promoters with an agenda, which is to put more money into their own pockets. Not that there is anything wrong with that. Every business person is trying to make more money and their statements and actions reflect that motivation.

Think Critically

You can think of all forms of media and sources of information as a forum for conflicting ideas, and it is up to each person to think critically and decide who to believe and who not to believe. The ability to think critically is the key. Just as Sam Zell promotes a return to traditional offices, I’m sure that a statement from the CEO of Zoom (Eric Yuan) would be to the effect that the era of traditional offices is over and that business henceforth will be conducted primarily remotely using platforms such as Zoom. Which statement do you believe? You have to decide for yourself by looking at the data. Same for any situation where you have competing points of view. All of these people are in the game to make more money for themselves, and so are you. Use your best judgement, make your choice, and hope for the best. That is our gift as human beings.

IMO

I am not picking on Sam Zell here. I read his quote and thought there was something universal about it and its context, so I thought I would write about it. My point is to be skeptical about self-promoters; i.e., almost everyone who is quoted in any form of media. Skeptical not in a bad way or that they are bad people, but to understand that they have an agenda to promote which is probably different than your own agenda. Understand this and it will give you perspective on what you need to do to achieve your own goals.

Are Investors Getting Complacent?

As of this morning, the VIX Index, aka the Fear Index, is hovering at around 18, which is the lowest it has been since pre-Covid. The Equity Put/Call Ratio is low, at around 0.74, which is below its 200 Day moving average of about 0.8. The stock market is “melting up”, with the S&P 500 at an all-time record high and the Nasdaq 100 Index up over 1% today and only about 5% off its record high after a sell-off from mid-February into early March. The $1.9 Trillion American Rescue Plan stimulus bill has been signed, and now President Biden has proposed another $2.3 Trillion to be spent on “infrastructure”, although details of the bill suggest otherwise. The rising stock market suggests that investors believe the upsides of all of this government spending will outweigh the downsides and that corporate earnings will rise, and so investors are buying stocks. Do you believe investors are showing their complacency in this view?

Inflation: The Danger

The big risk with all of this government spending is that inflation will rise and that the dollars that people have will be worth less in the future due to this inflation. Higher inflation means higher interest rates, and though the Treasury market has stabilized for the time being, rates will rise if indicators show that the inflation risk is elevated. It was a rise in rates across the yield curve that caused the mini-correction that we had, especially in the Nasdaq 100 Index, during February and early March. Look for another mini-correction in the stock market if rates move up again, even by another 10 basis points. For instance, if the 10 Year US Treasury Yield rises from its current level of about 1.68% to 1.8%, a rate that it hasn’t hit since pre-Covid, look for stocks to sell off again, with high-multiple Nasdaq 100 stocks being the most vulnerable.

Are Investors Really Complacent?

Though the readings on the VIX, Put/Call Ratio, and the record or near-record levels of the big stock indexes might suggest that investors may be complacent and may not be heeding the risks of higher inflation and higher interest rates, I’m not so sure that the readings show complacency. True, the VIX Index is lower than it has been in over a year, but before Covid, the VIX seldom broke above 20 for the prior 4 years. True, the 10 Year Treasury Yield is up, but its yield was north of 2% as recently as July 2019 and for most of the 3 years prior to then as well. Perhaps the low Put/Call ratio and the “melt-up” in stock prices doesn’t reflect complacency as much as it reflects investor optimism that our nation and our economy are finally returning to “normal” after the Covid period.

IMO

I believe the key will be the rate at which inflation will rise. Watch things closely here. If most of the supply chain issues can be addressed and the rise in inflation can be kept in check, then current investor optimism will have been justified. However, if the stimulus spending coincides with an economy that struggles to emerge from supply chain bottlenecks and other international issues, then the bet may have been misplaced. My guess is that inflation will rise to perhaps the mid-2%’s, but that will be manageable and we will make it work. “Be skeptical when others are greedy” is a good thought to keep in mind at this point.

Last Chance to Refinance

Not really – you can refinance at any time if you aren’t looking for the lowest possible mortgage rate. However, mortgage rates are up and there is better chance they will continue to rise than fall over the next year, as all longer-term interest rates are projected to rise. So, if you haven’t yet refinanced and taken advantage of low mortgage rates, now is the time to do it.

Mortgage Bankers Association

According to this article from Calculated Risk, the Mortgage Bankers Association (MBA)’s Weekly Survey from last week shows that average 30 Year Fixed rates have risen 50 basis points since the beginning of this year and now average 3.36%. Not bad, but not as appealing as the sub-3% rates we saw during Q4 2020. As a result, the article goes on, their “refinance index” is down 5% from the prior week’s survey, meaning that fewer applications for refinance are being submitted. This doesn’t mean the housing market is weak. On the contrary, it is significantly stronger and is expected to remain so due to, as the article says, inadequate housing inventory.

Human Nature

If you think about it, it makes sense that refinances will decline as mortgage rates go up. As with any purchase decision – and I consider a mortgage refinance to be a purchase decision because the borrower likely doesn’t need to refinance – if the price is going down, the buyer/borrower will wait to see if the price might go down some more before committing to the transaction. This is called bottom-fishing, and it is also indicative of why deflation is such a bad economic thing: people refrain from economic activity if the price is going down. Then, once rates bottom out or even rise a bit, borrowers will put their chips on the table and commit. They will continue to refinance as rates go up slightly – I am speaking in a macro sense here – until it no longer makes economic sense to refinance. This could take a long time if the borrower hasn’t refinanced in a while, or it could be a short time for serial refinancers.

Pros and Cons of Refinancing

The obvious pro of refinancing is that you have a lower interest rate and a lower monthly payment, especially if you don’t take any “cash out” in the process of your refinance. Another pro is that you might be able to pull some cash out if your home has appreciated significantly since your prior loan and you need a lump sum of money for some reason. Some families finance their children’s college educations through cash-out refinances, which is a very good way to do it because it is better to pay for college by borrowing in the low-3%’s and paying it back over 30 years than it is to borrow at the higher rates of some student loan programs.

The cons of refinancing include the following:

  • You may have to pay points and/or fees for your refinance loan, which means comparing your current mortgage rate to the new proposed mortgage rate is not an apples-to-apples comparison. You have to factor in the cost of these fees and points, which the lender should provide to you when it quotes you the Annual Percentage Rate (APR) of the new loan.
  • One of the reasons your monthly payment goes down is because, with the new mortgage, you now have a new 30 year timetable for paying off your loan. Let’s say you were 10 years into your prior loan: that means you would have your house paid off in 20 years at the current payment. Now, although you are paying less per month with the new loan, you won’t pay off your house for another 30 years. Of course, you can always make extra principal payments that will speed up the payoff process – typically with no penalty payable to the lender. Or you can refinance into a 15 year fixed rate loan, and get the lower rate (and potentially lower payment) and still own your home free and clear in 15 years.
  • If you take cash out as part of a refinance, now you owe more. No problem, you may say, as long as your loan is 80% loan-to-value or lower, meaning that you have at least a 20% equity cushion if you have to sell your house. And, you may be right if you feel like you are in a growing area with a strong housing market. However, don’t take the decision lightly if you are considering a cash-out refinance. It could get you into a financial bind down the road.

IMO

I believe you should act now if you are considering a mortgage refinance if you want a good rate. I believe mortgage rates will rise over the next year, so don’t wait. With the for-sale housing market as strong as it is, there is a better possibility that your house will appraise out at a value that will justify the loan amount that you want, especially if you are looking to take cash out of the transaction.