Markets Weekly December 21, 2024

hello my friends today is December 21st and this is Market weekly so this past week was a really volatile week in markets we saw some notable selling after the fomc though we did rebound a bit on Friday now as we've discussed before these last two weeks of December are seasonally very positive however at the same time Santa Powell did put some coal in our stockings so it looks like the remaining days of the year are going to be a struggle between seasonally positive flow and higher interest rates so let's see what happens in any case

today let's talk about three things first let's take a look at what's happening in Brazil as it seems to be embroiled in a fiscal crisis and something like this should be a sign of things to come across the world secondly now many people were expecting housing to rebound after the FED began to cut rates but even after 100 basis point cuts of rates we see more mortgage rates still pretty elevated and housing market not doing so well let's listen to the earnings calls of two Builders to try to figure out what's going on and lastly

this past week we also got meetings from the boj and the bank of England let's briefly review what happened over there okay starting with Brazil now looking at this graph of the Brazilian real over the past couple months you notice that everything began to go south sometime in November when they unveiled their latest budget since then the bra the Brazilian real has been depreciating gets the dollar in a big way so what is it about the budget that spooked markets well it's taking a step back it looks like President Lula over there has been learning

from the Magic Money Tree people and just spending a lot of money now Brazil's economy is doing okay their unemployment rate is low wages are rising but at the same time they're really spending a lot of money looking at this chart here they're FIS deficit is about 10% which of course is very high in the US we have a 6% fiscal deficit and that's way too high 10% much much higher now typically what happens and we of government spending too much money is something we see over and over again throughout history it's really super common

and I would say inevitable for uh any group of elected people because at the end of the day you're spending money that's not your own in order to benefit yourself and your lobbyists right if you promise to spend more money you can get elected and then you can spend money to uh support your donors and so forth and that's not your money so who cares so it's something that happens basically all the time now the classic signs of a fiscal crisis are obviously first your currency depreciates because you're the government when it spends money doesn't

have it does so by uh printing debt now some people think if this is borrowing but I think of this as I think of more accurately in the financial system as buying goods and services and paying with a newly printed debt which is really just money that pays interest in a Fiat system and so when you do this in a big way obviously your currency will depreciate now the corollary to this is of course when you're doing tremendous fiscal deficit spending you it's inflationary so you would see interest rates shoot up and often times you

would also see stock markets sell off although in extremes of course uh the stock market crashes up as we see in countries like Argentina but in any case at the moment right now we do see the Brazilian real depreciate significantly against the dollar now the central bank over there has been trying to stop this massive depreciation and they do this by offering dollar auctions what they do is they sell dollars and buy real again selling dollars buy real mechanically uh strengthens the real but that's not enough because they keep doing it and again these this

buy some temporary reprive but at the end of the day it doesn't solve the root problem of too much fiscal spending and so the real just keeps selling off now in in line with the debuting currency looking at the local currency denominated government bonds over there well they're yielding 14% And obviously that that's very high and so that does show a lot of concern about the fiscal situation looking at their stock market these higher interest rates this Panic uh in the real has really seemingly led to some degree of capital flight where people are just

you know selling everything and taking money out so their stock market has done very poorly but the good news is of course their Central Bank is trying to do something not just offering dollar auctions but also hiking interest rates that are around 12% now so um it does seem like there is some degree of indep monetary policy atw work trying to trying to fix the problems now over the past few days uh president Lula who recently had was in brain surgery so he wasn't able to respond to this crisis is now coming out and saying

more positive things being more Market positive saying that he's going to try to reain in some of this fiscal spending and that's been getting giving some reprive in the market so we'll have to see if he actually follows through with his pledges uh in order to restore some degree of financial stability but this incident I think should sound familiar to people because not too long ago we were also talking about something similar unfolding in France of course not to the same degree as we all know uh France is in some sort of a mini fiscal

crisis as well with their fiscal deficit around 7% and with a government that doesn't seem to be able to uh change course now we've already seen sell-offs in French government bonds at the Euro it's really hard hard to say again France is just one country out part of a much bigger Union um but so most of the distress there seems to be reflected in their bond market but this is a situation that we really see across the world fiscal deficits rising and seemingly the Market's having less tolerance for it now one exception of course is

the US US very lucky it is the reserve currency so even as the US spends too much money even as interest rates rise it uh oddly enough leads to more financial inflows and a stronger dollar and of course um that may not always be the case but at the moment it is so looking forward let's be on a lookout for more types of fiscal crisis around the world because government spending too much that is a tale as old as time okay the second thing I want to talk about is the housing market now many people

were thinking that finally after the FED cut rates we would have a rebound in housing now the FED cut rates by 100 basis points but mortgage rates are still around six 7% the reason for this is not because of the market is concerned about inflation but because the market is less concerned about a recession and because the FED has guided with more hawkish communication so what's actually happened is that the market uh let's say earlier in the year was was pricing a lot of cuts for next year and then beyond but right now is only

pricing in two cuts next year so the market is taking out fed cuts out of the future because of course chair Paul did give a bit of a hawkish communication more recently but also it seems like the economy in the US is is doing okay so there's really no need for the recessionary cuts that were priced in and as a result longer data interest rates have been rising mortgage rates with them now this has been having a really negative impact on the housing market if you look at housing starts in the US again they surged

in 2022 when interest rates were very low but over the past year they've been pretty uh they've been you know uh coming down a lot and so that suggests that uh you know housing is not doing as well as you'd think now so far looking at construction employment you don't really see any layoffs construction employment remain strong but if mortgage rates were to remain this high you can easily see that you could have some problems for housing down the line now in order to better understand what's going on I listened to a couple earnings calls

from large home builders and surprisingly well not surprisingly it kind of mirrors what we see in the broader economy it is very much a k-shaped economy now first let's listen to what lenar has been doing lenar is one of the largest builders in the US so they target Target the mass market and for lenar their most recent earnings call is really downbeat now it looks like they missed their estimates uh by a large large number of units again selling much fewer units than they thought the profit margins also lower than they thought around 22% and

overall they were basically sounding a pretty downbeat note now they suggested that uh you know the people have jobs the wages are growing everything is okay but at the end of the day house prices are high and mortgage rates are high and so people haven't been able to afford the houses that they're building they've been trying to move inventory by offering concessions and that's been pushing out pushing their profit margins down so it was not a good quarter for them and unless mortgage rates come down it doesn't seem like it's going to improve now that

is a pretty downbeat note and if you look at the price of housing stock looking at this ETF you'll see that the market kind of already reflects that uh the home builder ETF has totally tanked in recent weeks however let's listen to another home builder Toll Brothers now Toll Brothers also a large publically traded home builder but not mass Market they s they tend to Target the luxury market so the average selling price for lenar about $400,000 now the average selling price for Toll Brothers about 9 900,000 so they do Target a marketly more affluent

consumer and what to Brothers is saying is that things have never been better they had their best year ever it's been a banner year and their margins again much higher than lard it's around 27.5 and what they're saying is that so yeah mortgage rates are higher but it doesn't really affect our home buyer in fact you know about a third of the people who buy homes from us paying all cash again all cash on a 900,000 home and the people who do have mortgages they're they're paying they putting down a pretty large down payment so

for them they're they're noticing something pretty interesting so the median first-time home buyer according to data is actually 38 years old and that share of uh so medium home buyer is around 38 years old but overall in the markets uh the share of the market that is firsttime home buyer is historically at a multi- deade low so what that means for them is that when people do buy homes for the first time because they're older they tend to be more affluent and they are more able to afford uh these pricer homes again looking beyond the

first home buyer Market a lot of the customers for Toll Brothers are move up people move up home buyers so people on their second or third homes now trying to upgrade and get a Burg Home and these people obviously older more affluent and they're finding it just fine to go and move on to these more luxury homes and I would suggest that this is largely due uh to the asset price uh inflation we're seeing where is a certain segment of the population has been exposed to the equity Market to crypto or whatnot and they've been

doing very well and they continue to convert their wealth in into fancier housing but for the vast majority of people uh it's seems like they really are struggling because they don't have as many assets do not benefit from appreciation so it really seems that the housing market is another reflection of the kshap recovery now the interesting implication of this is that if we do uh for whatever reason have some kind of recession on the one hand all these aom buyers will have fewer stock market gains on the other hand it seems like mortgage rates would

come down I would expect that that would probably benefit the common Builders more since their clients you know don't have that much assets to begin with although uh they would have uh their jobs at risk potentially depending on their occupation okay the last thing I want to talk about is what happened in Central Banking world the past week so the past week we have meetings from the bank of Japan and the bank of England now in Japan as we've you been talking about they've been discussing hiking rates now B Japan has is coming out of

a multi- deade prong in in deflation so you know they want they don't want to hike rates too quickly and kill off inflation which they've been praying for for years and years and years now this past week they did not hike rates and it was perceived to be more doish because the Central Bank there uh Bank uh Governor way over there did not guide strongly for additional hike in January so again they were thinking Mark was thinking potentially a hike last week didn't happen now the market would be thinking about January but they also didn't

receive strong guidance towards that as well now the market widely perceives that this is going to happen in January or March it's going to happen eventually looking at the data inflation in Japan has been seemingly uh pretty stable around slightly above their 2% Target so it seems like the Central Bank there would feel more comfortable about hiking rates although they did not now this past week they also had a very interesting policy review come out and the cliffnotes from their over 200 Page policy review seems to be that Governor Gua would like to normalize policy

uh he gives himself a big pat on the back for his unconventional policy stimulating the Japanese economy but he would seemingly want to prefer to be able to normalize interest rates that is to say get interest rates comfortably above zero so that in the future when we have a when they have a downturn again they can cut rates and ease policy through conventional measures rather than doing all this massive QE in the bond market in ETFs and so forth but so far though it doesn't seem like he's strongly signaling uh a rate hike though the

market really believes that he's going to hike very soon now the reaction to the bank of Japan's meeting was a pretty strong de appreciation of the Japanese Yen again this is coming right after a Fed meeting that's perceived as hawkish so together we had a massive massive depreciation of the Japanese Yen D boj hakos Fed so much so that on Friday we actually got uh some verbal intervention from government officials in Japan know warning that they don't like seeing the Yen depreciate disorderly and you know they they could potentially intervene which they've done a couple

times in recent years so it seems like um it seems like we are approaching that red line where Japanese authorities don't like to see uh such a big disorderly depreciation of the Yen and of course with President Trump waiting in the wings and he's been very vocal about not liking other countries to um have the appearance of unfairly manipulating their currency that's something to watch uh it seems unlikely that Japan would be able to tolerate uh further depreciation of the Yen so maybe that will prompt Bank of Japan do something soon okay the second thing

that happened was of course the bank of England meeting now the bank of England did not cut rates they were paused but it was perceived to be somewhat of a doish meeting because there were three people on the rates Hing committee that actually dissented and wanted to cut now taking a step back the market you know was kind of thinking that the bank of England would be a bit hawkish because just before the meeting the most recent inflation data was a bit hotter than expected and wage data had been hotter than expected but it seems

like the bank of England is going to dismiss those data prints especially the wage one as just volatile data and wants to continue to cut uh it seems like they're becoming more concerned about growth which was revised lower at the meeting um than inflation so the market is widely thinking that the bank of England is is going to cut a few times next year um okay so that's all I prepared for today thanks so much for tuning in next week I will put my markets outlook for 2025 and we'll go back to a regularly scheduled

Markets weekly uh the week after um all right thanks for tuning in for this year it's been a wonderful year and Merry Christmas to everyone