Written by: Samira Fatehyar
Synopsis
Listen to the podcast here.
I know it’s already been a rollercoaster of the first couple of weeks of the new year. I know everyone is talking about the Capital Riots that took place on January 6th and the 2nd impeachment of President Trump. 2 unprecedented events in a matter of a week. I’ve been wondering if there truly is a way to find unity, again. I hope we do, because I know we are stronger, together. Covid and its impacts will most likely be our new normal for a few years. Unfortunately, or fortunately, my fellow Americans, we are not alone in this disarray of our current political and economic climate. All across the world, there are many countries facing similar things. As you know in this blog, I have a segment dedicated to Europe and as such we will be exploring Europe and how they are faring in the first few weeks of the New Year as well.
There’s been quite a lot of economic news to sift through in the last few weeks and I want to touch on as many as I can. I’ve received countless questions about the unemployment report that came out, so I will discuss that. But I also want to spend a bit of time talking about the current state of our market in the US while also reviewing major asset classes that have ballooned over the past year. I’ve seen many forecasts for the year ahead and want to share some of them with you. Lastly, I will talk about some interesting real estate trends in Europe.
Economic Update
Unemployment Report
There’s been lots of talk about the unemployment report that came out during the first week of January. According to the Bureau of Labor Statistics (BLS), the US lost roughly 140,000 jobs in the month of December. One thing that stuck out to me is that November and December are usually known as high seasonal employment months; meaning that usually there should always be a gain because of the holiday season. But here we are, losing 140,000 jobs since the first initial shocks of the pandemic. Let’s look at it further.
Graph 1
Nonfarm payroll employment over month change, SA, December 2018-2020
https://www.bls.gov/news.release/pdf/empsit.pdf
When we look at Graph 1, above, we see that this decrease is extremely small compared to what we experienced in March and April of 2020. This is good, but as you can see we are not anywhere near having recovered all those lost jobs. As I pointed out earlier, it’s strange to see a job loss during one of the months you’d usually see job gains because of the holiday shopping season.
It should also be noted that the unemployment rate of 6.7% remained unchanged for the month of December, along with the number of those who remained unemployed.
If we look further to see what sectors had job losses and gains, we are able to see a clearer picture of what is truly occurring in the economy. According the report,
In December, job losses in leisure and hospitality and in private education were partially offset by gains in professional and business services, retail trade, and construction.
More specifically, employment in leisure and hospitality decreased by 498,000 jobs. Overall, leisure and hospitality is down 3.9 million from February. Private education employment decreased by 63,000 jobs. Overall, private education is down 450,000 from February. Professional and business services increased by 161,000 with 68,000 of it in temporary help services. Retail trade increased by 121,000 jobs. Construction has also added 51,000 jobs.
A new section added to the report is in regards to pandemic related changes in employment, which I thought was quite interesting. The BLS reported that 23.7% of those employed teleworked due to the pandemic. Also in December, it was reported that 15.3 million were unable to work due to their employer closing or lost business due to the pandemic. Comparatively, in November it was 14.3 million. Though of the 15.3 million, 12.8% of them received some pay from their employer. The BLS went on to report that 4.6 million people, not in the labor force, were unable to look for work due to the pandemic. These people are not counted in the official unemployment numbers as the definition of being unemployed means that you must be actively looking for work or have been temporarily laid off.
As I have said in the past, there is a lot to the story that the data simply alone cannot tell us. The Supplemental section the BLS has now added to its report helps. But we can’t forget how many in our population are facing food insecurity as well as loss of work. I don’t expect the unemployment situation to get better soon, as many companies are seeing that they don’t need to hire all these people; they can save money without them. It’s the sad reality. One solution is to create more trade schools to help the influx of people looking for new skills. But can we as a society place the same level of importance on tradesmen as we do for those that have been college-educated? That will be a very important question for years to come.
The US Economy
Risks in the market place
The biggest questions on many Americans’ minds are what truly transpired on January 6th and should we expect to see more of this? There is no easy answer for either question. But I think we need to examine things a bit deeper. The country is more divided than it has ever been before. And it’s not just left vs right. It is old vs young, wealthy vs poor, and everything in between. My guess is that we are only now beginning to see the toll our division has taken over the last few decades. There’s a generational divide. So what does this mean for the markets? Is there truly a political risk taking shape?
The US government will do everything in its powers to quell any type of political risk to ensure our financial systems continue uninterrupted. That’s a fact. We’re a developed nation, a leading world power, we won’t allow for anything crazy to happen. At least this is the sentiment the government is trying to relay. Whether it’ll work or not is up for the future to decide. I will point out that it’s been interesting to me to see how much the media (on both sides) are showing how many troops are coming to DC for the inauguration to quell any sort of violence. The biggest question I have is, do we truly believe that all those rioters will just stop after the inauguration? That somehow everything will be okay and everyone will suddenly live in peace and harmony. And don’t get me wrong, I want unity. But any rational person knows that these ideologies don’t just stop all of a sudden. They will persist until we can get to the root of the problem. What is the root problem? Well, there’s many answers to this question, it’s not my job to pin it down but to instead figure out what this means for all of us financially.
Wall Street did not really react to what we saw on January 6th, but then again, Wall Street has been in its own world for the majority of the pandemic. We’ve been witnessing record high valuations that are not justified by any means. This is seen everywhere from stocks to cryptocurrencies to real estate. I will go into depth about each of these. But before I do, I want to reiterate that our economic fundamentals are still lagging. People who are living comfortably and are happy with their lives, don’t tend to riot. They don’t tend to act out like this. So it is my belief that though Wall Street is not responding to this now, it will eventually have to. It may not be through political risk, it may just be a reckoning with our economic fundamentals. Most economists agree that a correction will occur, though the magnitude and timing remain uncertain.
2020 in Review
Stocks
I think people need a reminder that just because a company’s stock price goes up, that doesn’t mean the company somehow makes money off of it. They make $0 when that happens. Okay, so why is everyone buying into the “growth hype?” I think there are two predominant reasons. First, is that interest rates are at an all time low, this means that the safest assets you can invest in are paying you anywhere from 0.01% to 1.5% at the most. So where else are you left to invest? The stock market. Unfortunately, this leads to my second reason that many other amateur investors want to follow the pack and do the same. This eventually leads to this growth hype. Do we really think Tesla, for example, is going to start mass producing cars like no tomorrow to fall in line with their current inflated valuation? Or will their valuation drop to fall in line with their capabilities? This is just an example but applies to so many of these “growth” companies. The S&P 500 saw a 1 year return of 16.26% in 2020 alone.
Graph 2
S&P 500 Growth from 2011 to present
https://www.spglobal.com/spdji/en/indices/equity/sp-500-growth/#overview
Looking at Graph 2, above, it’s obvious that by just looking at the year 2020, we see a strong dip which occurred around March/April 2020 but the rest of the year saw a very steep increase. This steep increase is worrisome. As I showed previously, it’s not due to great economic fundamentals but due to people not having any other options to invest their money. A bubble is occurring!
For anyone interested, this is best described as irrational exuberance, also the name of a book written by economist and Nobel Prize winner Robert Shiller. He first wrote it back at the height of the dotcom bubble, then came out with a second edition right before the housing crash, in which he predicted the crash would happen. His third edition came out in 2015 where he gave a warning of holding long term bonds and pointed out that global housing prices were being inflated. But what is irrational exuberance?
Irrational exuberance is unfounded market optimism that lacks a real foundation of fundamental valuation, but instead rests on psychological factors.
It would make sense if that is indeed what we are seeing. It may not rest solely on psychological factors and as I stated before, there really isn’t many options as to where to place your money right now when everything except the bubbly assets are giving weak returns. But I’m sure we know many people that are so hell-bent on certain stocks and even cryptocurrencies.
Cryptocurrencies
There’s been A LOT of hype when it comes to cryptocurrencies. These days you can even walk into a grocery store and see a kiosk where you can buy bitcoin. I know many of you have heard of cryptocurrencies but are probably not 100% sure what it is.
A cryptocurrency is a digital asset designed to work as a medium of exchange wherein individual coin ownership records are stored in a ledger existing in a form of computerized database using strong cryptography to secure transaction records, to control the creation of additional coins, and to verify the transfer of coin ownership.
So, it’s a currency that is based completely online. Why has there been such a rush to this kind of currency? Well, it’s completely decentralized, meaning there is no central entity that controls the supply. It’s interesting to note that there is a finite supply of these currencies as opposed to the dollar supply that can be expanded or contracted by the Federal Reserve as deemed necessary. Many believe that a decentralized currency is the way of the future. A big skepticism is that this type of currency has no asset backing, meaning there is no intrinsic value to the currency.
But I will say that the coolest thing about cryptocurrencies is how it’s stored. You can access your money from anywhere as long as you can remember a 13-digit code. For example, if you had to leave your country behind as a refugee, with nothing on your back but just remembering the 13-digit code, you’ll have access to your money when you arrive at your destination.
Let’s take a look at how well Bitcoin, arguably the most popular type of cryptocurrency, did in 2020.
Graph 3
Bitcoin Returns verses Gold and S&P 500, 2020
https://www.coindesk.com/bitcoin-prices-in-2020-heres-what-happened
Now, looking at Graph 3, above, we see something pretty shocking. I just went on and on about how inflated the S&P 500 returns were but if we look at it in comparison to Gold and Bitcoin, it was nothing. Graph 3 was created on December 12, 2020, though now outdated still captures the hype Bitcoin has experienced. On December 12, Bitcoin saw a YTD return of 160.40% whereas Gold saw 21.60% and the S&P saw 13.73%. This is a shocking figure to most economists. I think it’s fair to claim this phenomenon we are witnessing in cryptocurrencies is irrational exuberance.
Real Estate
If you’ve been reading my blog for some time now, you know that I believe that there is a bubble occurring in the housing market as we speak. Since I’ve spent a lot of time already talking about it, I won’t go into too much depth about it, but instead look at what transpired in it over 2020.
Graph 4
Average Sale Price of Houses Sold in the US (Q3 2015- Q3 2020)
https://fred.stlouisfed.org/series/ASPUS
Looking at Graph 4, above, we see the average sale price of houses sold in the US. Though there was a dip in the second quarter of 2020, it has since recovered and then some. As of Q3, the average sale price of a house is $387,000. It’s surprising to me that with all the eviction moratoriums in place, there is still a rise in home prices. Yes, a lot of the demand is caused by the move from urban areas to suburban areas. But the thing we keep missing is the fact that the purchasing power of a dollar from an urban area is a lot higher than a dollar from a suburban area. An example of this happening is in Reno, NV. We have been experiencing an influx of people from the Silicon Valley, as well as other places in California, Colorado, and New York. A lot of these people come into our real estate market and see just how cheap it is to buy a house here compared to where they originated from. They end up causing bidding wars and end up inflating prices further.
Another factor that is causing this is the record low inventory, we are currently experiencing as well. In the National Association of Realtor’s latest release they mentioned
Total housing inventory at the end of November totaled 1.28 million units, down 9.9% from October and down 22% from one year ago (1.64 million). Unsold inventory sits at an all-time low 2.3-month supply at the current sales pace, down from 2.5 months in October and down from the 3.7-month figure recorded in November 2019.
This is important to note, since we are hitting an all time record inventory low. Again, I understand there is an influx of people fleeing urban areas, but at some point it won’t be sustainable for those living in suburban areas to try to keep up with housing costs. What do I mean by this? Well, let’s take a look at the average income in the US.
Since, we are using Q3 2020 numbers for the homes, which is the most current available, let’s take a look at Q3 2020 weekly earnings according the the Bureau of Labor Statistics, or the BLS. As of Q3 2020, the average worker earned $994 a week and assuming the average worker works 50 weeks a year that is approximately $49,700. Now, according to most lending rules, lenders follow a 28/36 rule. This means that they will not lend to you if the monthly payment for the mortgage exceeds 28% of your gross monthly income. And they won’t lend to you if your total debt expenditures, including your mortgage payment exceeds 36%.
Knowing this, it’s pretty simple to calculate the 28% rule and see what a person making $49,700/year can afford. In this exercise, we use a 3.92% interest rate for a 30 year mortgage. We know that a person making $49,700/year, makes roughly $4,142/month. If we multiply 28% by $4,142, we get $1,159.76 as the highest monthly mortgage payment a lender would approve. So, if we assume a standard 20% down payment on a home, we see that the highest price of a home this person can obtain is $275,000, with a $55,000 down payment. This person would not be approved for a home at $387,000, the national average. This is very important to keep in mind as we move forward into the new year.
Yes, many believe demand will continue to stay strong, but if the average worker cannot afford an average priced home, this is not a good sign of things to come. Now, you may ask, well why can’t those people continue to rent? They absolutely can and they very well may, but when home prices increase, many landlords will want to increase the rent in order to keep up with market value. And as we discussed earlier, since there aren’t that many other places to park money and obtain a sizable return, these landlords may eventually want to sell and in order to be attractive to potential buyers will increase rents to show great returns.
economic Forecast
Many have questions about what we should expect from 2021. What assets should we expect to see growth in? What assets should we expect to see losses in? And the most popular question I receive, where should I put my money? I’m not a financial advisor. My goal with this blog is to educate you about what is happening on the macroeconomic level. I try my best to present data and help you find the story the data is telling. With that being said, many finance companies have already came out with their forecasts of what 2021 will look like. I’ve heard many commercial real estate colleagues say that by the second half of the year everything will return back to normal. I do not share this same sentiment, as I see that there is a major need to get back to a healthy equilibrium, getting at or close to true asset prices instead of highly inflated ones.
Here is a highlight of what some Wall Street firms believe 2021 will look like:
Allianz Investment Management
It looks increasingly promising for vaccines and herd immunity to suppress the virus. With the U.S. election resulting in a divided government we anticipate only modest policy changes with the new administration. The Fed is likely to remain accommodative on monetary policy keeping short-term interest rates low throughout 2021. These factors should combine to provide a favorable backdrop for the continued economic recovery and prove supportive for the reflation of growth and risk assets in 2021.
Amundi
The damage to the global economy will last well beyond 2021. Output and personal income losses, the rise of inequality and the disruption in some sectors will be the legacies of the pandemic. Expecting that a vaccine will cause these to dissipate within a few months is too optimistic.
Bank of America
We look for a rocky start to 2021 as many countries battle Covid outbreaks. However, a combination of fiscal stimulus and wide vaccine distribution should boost growth by mid-year.
JP Morgan Asset Management
Following a winter slowdown, widespread vaccination should allow U.S. growth to surge later in 2021, precipitating a relatively fast rebound from a deep recession. However, the recoveries for GDP, jobs and inflation are on different timetables.
UBS
2021 will be about going cyclical, small, and global as the sectors and markets most heavily affected by lockdowns start to revive.
Vanguard
Our baseline forecast assumes that an effective combination of vaccine and therapeutic treatments should ultimately emerge to gradually allow an easing of government restrictions on social interaction and a lessening of consumers’ economic hesitancy. But the recovery’s path is likely to prove uneven and varied across industries and countries.
Looking at all these statements, it seems like a lot of mixed signals. There’s a lot of hope that 2021 will turn out to be a much better year than 2020, but one thing many of these firms touch on is the macroeconomic factors as well as exogenous factors, like substantially reducing the Covid-19 spread. Many epidemiologists agree that it’s still too early to assume everything will go back to normal with the arrival of vaccines. If you’ve kept up on the Covid-19 vaccine news, you’d know that the US is having a very hard time rolling out the vaccines efficiently and effectively. I will remain hopeful of things to come for 2021, but it’s sad to see what is occurring already.
On a final note regarding future economic predictions, I came across this graph, below, of GMO’s (an asset management firm) forecast for the next 7 year based on several asset classes.
Graph 5
7-Year Asset Class Real Return Forecasts
https://www.gmo.com/americas/research-library/gmo-7-year-asset-class-forecast-4q-2020/
As show in Graph 5, GMO remains pretty pessimistic in returns for US and International stocks and bonds. The only positive is in emerging market valuations, but even then it’s pretty hard for foreigners to invest in emerging markets and is also known to be extremely risky. I thought it was an interesting graph and wanted to share with you all.
European View
I’m happy to see that this blog has many new readers in Europe. Due to the rise in popularity, I will be going more in depth in our European View segment. Thank you all for your support, I look forward to growing our audience further both domestically and internationally! This time, we’re turning our attention to some real estate related stories in Denmark and England.
Denmark
I was surprised to see a headline stating that Denmark is now offering 20 year mortgages at a 0% fixed interest rate. That is still an unthinkable phenomenon in the US, but how and why did Denmark get here? Well, first before I get ahead of myself, I will clarify that though Denmark is part of the European Union, it is in fact not part of the Eurozone. Denmark uses their own currency called the Krone.
So how did Denmark end up in such an interesting predicament? Well, it started back in 2012 when Danish policymakers decided to set their main interest rate to below zero. Why would they do this? Well the Danes ended up pegging their Krone to the Euro and in order to protect the value of the Krone they had to drop interest rates to below zero.
So, what does it mean when we see negative interest rates emerge? In the most basic of examples it means that those with money in the bank will essentially pay the bank to hold their money, as opposed to receiving some interest on a savings account. It also means that people who end up taking out a loan receive interest payments for taking out that said loan. Why do this? Well, to stimulate the economy. It makes sense to do this in the short term, but to have this persist over the long term is just not conventional.
Still though, many of you may be asking, how will the banks profit off of 0% interest rates? Well it’s actually quite simple. See, since the Danish central bank is lending money to banks at a negative interest, they’re basically paying them to borrow. Now, with banks offering mortgages at 0% fixed interest rate, they’d actually find themselves in net positive territory, since the banks were paid to borrow the money in the first place.
Another note to point out is how the mortgage system in Denmark works.
Denmark has a so-called pass-through system in which mortgages are directly tied to the covered bonds used to fund the loans. Lenders act as brokers between borrowers and investors, generating income from fees, not interest rates.
So, these bankers don’t make money off interest rates but instead the fees. Many believe we will see more European countries doing the same. This means that many Europeans have a pretty pessimistic outlook of the future to offer 2 decades worth of 0% interest rates. Yes, it may be great to buy a home and not pay any interest on the mortgage, but what does this tell you about the overall European economy? We’ll have to wait and see what happens over the course of a few years with these negative interest rate policies.
England
Continuing on our same European real estate note, I thought it would be good to check in on England and see how their real estate market is being affected by the Covid-19 pandemic. In a recent survey, conducted by the Royal Institutions of Chartered Surveyors, it showed that many remain pessimistic about the outlook of real estate in the London area. As with the US, England is also experiencing mass exodus from urban areas to more suburban and rural areas. This is happening since more and more people are able to work from home and don’t need to pay skyrocketing housing prices in larger cities. Looking at the results of the survey conducted we see Graph 6, below.
Graph 6
UK Rental Expectations vs. London Rental Expectations (2016-present)
https://www.bloomberg.com/news/articles/2021-01-14/london-landlords-pessimistic-on-rent-as-u-k-housing-loses-steam?srnd=premium-europe&sref=jbVt2saA
This graph is telling us that London rental prices are expected to be depressed for quite sometime whereas the UK as a whole will continue to see rental prices increase. Will this last? That’s the biggest question on everyone’s minds.
England has also introduced a temporary property transaction tax cut. This doesn’t seem like much but this cut can be as much as 15,000 pounds for buyers. But, this is also causing inflated prices in these suburban and rural areas. Many in England believe that the new remote work lifestyle will be here to stay. I’d agree with that sentiment as it helps firms cut down on their operating expenses and also gives individuals more flexibility.
Graph 7
UK Housing Price Index Year-over-Year from (Dec. 2019 to Dec. 2020)
https://www.bloomberg.com/news/articles/2021-01-08/u-k-house-prices-climb-to-record-as-tax-cut-stokes-market?sref=jbVt2saA
As we can see in Graph 7, above, home prices in England have been increasing this past year. It’s hitting new highs. In December, the average home price in England was 253,374 pounds or roughly $340,000. Though Halifax went on to note that they believe prices will decrease by March as the temporary property transaction tax cut will expire along with other Covid related restrictions coming into play.
I will note that England is facing quite a bit of hardship as a whole and this current short term hype may be part of the irrational exuberance I explained earlier. In the midst of Brexit taking effect and a global pandemic which has caused them into their now 3rd lockdown, it’s hard to see a bright future ahead for England. I hope for the best for them, though I suspect that Halifax is right in their prediction. Only time will tell.
Concluding Remarks
It already feels like it’s going to be another exhausting year and we’ve only experienced the first few weeks of it. I won’t lose all hope and you shouldn’t either. It’s my belief that with every crisis or problem, opportunities always emerge, but it’s up to us to identify the crisis or problem. Ignoring it only kicks the can down the road further. But the innovators are usually among the first to identify the problem and come up with a solution. The purpose of this blog is to help us identify the problems with in our economy, we can brainstorm together to find the solution. That’s why I always welcome feedback from our readers.
We’ll soon be posting YouTube videos for the podcast. I hope it can be a space where people can ask me questions. Please continue to stay safe and healthy everyone! I look forward to writing to you all again in 2 weeks.