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December
20
2023

Hot markets are circling the doom-loop toilet bowl
David Haggith

And that doesn't exactly lead to a tunnel of light.

Markets are in a doom loop and don’t know it because they don’t want to know it. Another voice chimes in today about Powell’s big blunder as Bill Bonner scoffs at investor mania and Fed miscommunication and market misinterpretation:

Pivot Error: The Fed's fantastic fumble … and serious mental illness...

Last week was a good week for Wall Street. Traders were sure that if the fix weren’t in already, it would be soon. It was just a matter of time, they believed, before the Fed finally ‘pivots’ and the happy days are here again….

But what the Fed governors expect to happen usually doesn’t happen.

In the 2020-2021 period, for example, everyone with a brain could see that flooding the economy with $6 trillion in new money…while also reducing output by ‘locking down’ much of the economy…would produce higher consumer prices. But the Fed didn’t see it, or didn’t want to say anything….

Then, when inflation suddenly picked up, the Fed totally mis-understood what was going on, insisting that it was ‘transitory.’ As late as April of 2021, when the Fed should have been aggressively raising the sea-wall before the tsunami hit, the Fed – with its hundreds of Ph.D economists – still had no idea of what was going on….

A year later, the CPI was over 9%. Oops…. How about now? The CPI is around 4% – it’s come down recently but is still at a high we had not seen for more than 30 years…. At this stage, it’s impossible to know whether consumer prices are rising or falling…in the short run….

Yes, that’s the point, dear reader. Things don’t work the way you think they should work. In practice, if it weren’t for chicanery, stupidity and hypocrisy, at least half of all newspaper headlines would disappear and most of what we know as ‘public policy’ would vanish.

In fact, inflation has been giving indications of an overall turn upward each month since summer, but we have yet to see if those monthly increases in various measures of inflation meaningfully turn year-over-year inflation up. It is clear, though, which way the pressures are now pushing each month, and even YoY inflation has leveled its decent to where it could start to turn upward as early as next month, which would vaporize every hope Powell implied, however unintentionally.

As for the chicanery, stupidity, and hypocrisy, if it weren’t for that, I often think we’d have no government at all.

Investors are off to the races

Investors have shrugged off all the clear warnings from Fedheads who spoke after Powell to try to clean up the mess Powell left behind—gently, of course, lest they stun the markets into realizing that the Fed barely, as Bonner points out, has clue what it is doing—that its braintrust economists miss the obvious things that the rest of us can clearly see … and do so repeatedly and one might even say “extravagantly.”

So, Wall Street keeps extending its rally higher—out over nothing—and I have no reason to think it will stop since nothing swirling delirium is causing investors to turn off every word the Fed now says. They heard that hint of “pivot” they wanted to hear, though Powell didn’t even use that word or talk about policy discussions on reducing rates, but they heard the Fed’s whispers about what was swimming in the minds of its officials, as they used pictures of little dots to represent sugar-plum dreams of days ahead when they might be able to lower interest rates sometime next year, and sugar plums are just the candy the market needed to push its pivot narrative into pure euphoria.

Bond investors are not any less invested in sugar plums as their enthusiasm pushes bond yields down to chug continually along under 4% on the 10YR Treasury. You needn’t think those bond investors are the wise money any longer:

“Similar to today, the US yield curve became more inverted in late 2007 as bond yields fell about -100bp,” Hyman wrote in a note to clients. “The Great Recession started 3 months later.”

Not everyone high up in the bond market who gets regularly quoted by the mainstream press, however, believes the Fed:

“Fed communication confuses people,” the president of Queens’ College, Cambridge, and a Bloomberg Opinion columnist [Mohamed El-Erian] told Bloomberg Television. “I think we have a real problem.”

A very big real problem, in fact; yet, the financial press touted the good news about housing starts picking up nicely in November today, and investors predictably grabbed ahold of that as further proof that Powell’s practically promised soft landing is coming in right on schedule; however, search the headlines a little deeper (as I have done below), and you can find crashing planeloads of evidence for extremely deep real-estate troubles all around us now.

Real estate rubble

Take, for example, commercial office space around our nation’s capital where now nearly three-quarters of it is in imminent risk of default or already in default. That’s up from 38% a year ago. That represents a massive drain of office buildings sinking into the swamps around the Potomac. 

Lest you say, oh well, that is only Washington, and they deserve it because the place is run by all those chicanery hypocrites mentioned above, note that the number is within 1% of being equal to that in San Francisco. Of course, many would say the same argument applies there, and they wouldn’t get any quarrel from me. California is, after all, the place with the most cars and the greatest number of electrical blackouts and brownouts that is now forcing its citizens to convert entirely to electric vehicles in the shortest amount of time. They seem to believe electricity grows on trees as they are also not too enthusiastic about a lot of new electrical projects … unless they are built in some other state like the one where they get all their water as they entice more illegal aliens into their sanctuary cities in order to consume a lot more water that they are already short on, a lot more electricity that they are already short on, and drive a lot more cars, of which they already have way to many; but I digress.

In the face of such political foresight, who could have expected this:

Washington’s woes are more protracted because the federal government is slow to respond to changing work patterns, and office demand could soften dramatically if government austerity measures kick in…. Washington, DC, could be the new ground zero for office distress.

An article on LinkedIn News says these problems are expected to worsen, and that is really hardly news at all, as most of us probably are already expecting the plight of office space to worsen in light of what we’ve been reading here.

Vacancies will likely rise as more leases expire and firms choose to downsize, The Wall Street Journal reports. Building landlords are now increasingly defaulting on their mortgages, and experts say many may need to sell their properties at steep discounts to stay afloat. 

While none of that is any surprise at all, it shows how warped investors views of the world around them are. Why would anyone believe we’re coming in for a soft landing with a major real-estate meltdown like that slowly crushing down on banks, especially anyone who lived through the Great Recession? The answer is “we never learn.” We just don’t. That’s the theme of my little book that I tout from time to time. We just never learn and, so, keep repeating the same cycles.

Then, of course, we are still working through the boarded-up vacancies in commercial retail space. Now that lower bond yields are helping mortgage rates a tiny bit, I’m sure many landlords locked into loans that have to be rolled over on CRE are rushing to grab merely moderately high loans while they can be had before rates rise again; but it is likely to be a short opportunity for reprieve in my opinion.

Lower rates would make the “looming refinancing crisis much more manageable," Piskorski said. But if borrowing costs drop by only a little, and office property values remain low, the sector may be headed for greater pain."

The stress in commercial real estate values is beginning to lead us into the "Urban Doom Loop…” That passes through to tax assessments and tax revenues.

The numbers are in: In 2023, San Francisco’s office market had a total occupancy loss of -6.7M sq.ft., which is the 2nd highest total since 2020 (-9.9M sq.ft.)… The amount of vacant space has reached highest level ever recorded in the city’s history.

Investors seem to be saying, as they price stocks to new record highs, “Let’s just all pretend none of that is happening and that it doesn’t overshadow our world.”

But it is happening, and it does overshadow the world, and it will fall because there is not a darn thing in view that could save it. Employees still are reluctant to come back to work at all; and, when they do, many of them sure don’t want to work in an office.

Employees are winners in the work-from-home and hybrid-work era. Employees report they value the ability to work from home two or three days a week as much as an 8% pay increase. Additional benefits are less commuting, lower stress, and more personal, leisure, and family time.

Employees have found higher values in their minds than being wedded to work and a utilitarian work space all the time. On the upside, this reduces costs for companies, but the downside is more failing banks ahead (and we rarely get to know they are about to fail until they DO fail. We learn they are falling in an over-the-weekend, emergency, real-estate deal hammered together by the Fed and FDIC.

‘Return to the office is dead’: Stanford economist says the US is 'stuck' with remote work as more offices sit empty

…the reality is that Americans like working from home (WFH) and the flexibility it provides….

The data shows that in November of 2023, the percentage of U.S. employees who are working remotely or have a hybrid working arrangement is sitting at just under 42% and has been sitting at roughly that level since 2021.

Many bustling hubs are now starting to look like ghost towns as office occupancy in the 10 largest U.S. metro areas has been hovering at around 50% this year,according to Kastle data.

“We are three and a half years in, and we’re totally stuck.”

Stuck and staying stuck, so get used to it as the new norm because workers clearly are not budging. Expect once-vibrant downtowns to slowly take on some of that empty ghost-tower look that is now haunting overbuilt parts of smoggy China. That can have a dim effect on other downtown real-estate. With such a big drop in employees around town, other businesses like lunch shops will continue to struggle, and some will go out of business. It’s decline. I’ve talked about it coming for some time.

Not only have office vacancies reduced foot traffic in the “office adjacent” economy — impacting local businesses like restaurants, retailers, convenience stores and hair salons — but it has also dulled investor confidence in the sector.

It’s contagious. It’s decline. Some cites, maybe even most, will eventually figure out their new demographics and find ways to repurpose the space, but that doesn’t mean it won’t have to price down and go through loan defaults and take out a few banks before it prices down enough to match its new purpose, whatever that may be.

Housing as a new purpose? Who wants to live there?

“While 2023 is shaping up to be a banner year for office building conversions to other uses like residential, they account for less than 2% of total U.S. office inventory.”

And with all of that for stock investors to avoid thinking about, I didn’t even have time today to go into the massive swirl of events around the Red Sea today that will be inflating prices tomorrow. Maybe, if tomorrow is a low-news day, I’ll come back to that then. 

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Seeing the Great Recession Before it Hit

My path to writing this blog began as a personal journey. Prior to the start of this so-called “Great Recession,” my ex-wife had a family home that was an inheritance from her mother. I worked as a property manger at the time, and near the end of 2007, I could tell from rumblings in the industry that the U.S. housing market was on the verge of catastrophic collapse. I urged her to press her brothers to sell the family home before prices dropped. The house went on the market and sold right away — and just three months before Bear-Stearns and others crashed, taking the U.S. housing market down for the tumble. Her family sold at the peak of the market.

 

 

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