Is the Bond Market Forecasting a Recession Sooner than Later

On more than one occasion when discussing the Denver housing market I have heard “This time is different”. While we have experienced an unprecedented bull market concerning housing and equities since coming out of the Great Recession; it is never different. Unless I missed the memo, business cycles have not ended.

So why this blog today? Well a couple of reasons:

The Bond Market May Be Advising A Recession is Not Far Off:  While I am a real estate broker I do keep an eye on the bond markets as they influence mortgage interest rates. It is well-known interest rates on mortgages have been ticking upwards from historic lows and still, historically are quite attractive at sub 5%. To be honest mortgage interest rates are not what is worrying me, it is what is called The Yield Curve.

While I can probably explain The Yield Curve the following from The New York Times is an excellent simple description:

“The yield curve is basically the difference between interest rates on short-term United States government bonds, say, two-year Treasury notes, and long-term government bonds, like 10-year Treasury notes.

Typically, when an economy seems in good health, the rate on the longer-term bonds will be higher than short-term ones. The extra interest is to compensate, in part, for the risk that strong economic growth could set off a broad rise in prices, known as inflation. Lately, though, long-term bond yields have been stubbornly slow to rise — which suggests traders are concerned about long-term growth — even as the economy shows plenty of vitality.

At the same time, the Federal Reserve has been raising short-term rates, so the yield curve has been “flattening.” In other words, the gap between short-term interest rates and long-term rates is shrinking.”

What is worrisome, on the 21stof June (a few days ago) the gap between two-year and 10-year United States Treasury notes was roughly 0.34 percentage points. It was last at these levels in 2007 when the United States economy was heading into what was arguably the worst recession in almost 80 years. Of note the Yield Curve fell below zero in late 2007 and the Great Recession started soon after.

Ok, so there is a risk of a recession. A layperson may argue the Yield Curve is not accurate HOWEVER it has predicted recessions over the last 60 years as noted by research conducted by the San Francisco Federal Reserve which can be found via the following link https://www.frbsf.org/economic-research/files/el2018-07.pdf

However to be fair interest rates on long-term bonds have been somewhat manipulated downward due to worldwide central bank interventions i.e. long-term bond buying to shore up economies and keep interest rates low. Thus one could suggest and I partially buy into the idea that the flattening yield curve may be somewhat artificial and not truly representative of the economy’s future course.

Case-Shiller Housing Index: One of my favorite monthly reads and this month’s numbers are nothing new as the same cities continue to hold the top spots: Seattle, Las Vegas, and San Francisco continue to report the highest year-over-year gains among the 20 cities. In April, Seattle led the way with a 13.1% year-over-year price increase, followed by Las Vegas with a 12.7% increase and San Francisco with a 10.9% increase.

Yet what intrigues me (and I hope the readers of my blog) is the historical perspective coupled with factoring in inflation as noted from the most recent report in italics as follows:

Looking back to the peak of the boom in 2006, 10 of the 20 cities tracked by the indices are higher than their peaks; the other ten are below their high points. The National Index is also above its previous all-time high, the 20-city index slightly up versus its peak, and the 10-city is a bit below. However, if one adjusts the price movements for inflation since 2006, a very different picture emerges. Only three cities – Dallas, Denver and Seattle – are ahead in real, or inflation-adjusted, terms. The National Index is 14% below its boom-time peak and Las Vegas, the city with the longest road to a new high, is 47% below its peak when inflation is factored in.

Thus if you were a buyer in Denver even during the peak in 2006 and managed to hold onto your home through the Great Recession to today, you are actually ahead concerning real and inflation adjusted dollars.

However I have provided evidence of real estate purchased within the last few years when adjusted for inflation actually losing value.  Thus I decided to look at the annualized return on housing within Denver in a style similar to how mutual funds are profiled i.e. 3, 5 and 10 year annualized returns:

For Denver:

  • 3 Years: 8.17%
  • 5 Years: 9.06%
  • 10 Years: 5.20%

Based on the above-annualized return the last 3-5 years have been a great time to buy and sell. However 10 years ago when the recession started as you can see from the above the annualized return was 5.2%. Yes this beats inflation which we all desire, however when compared to the S&P 500:

S&P 500:

  • 3 Years: 7.30%
  • 5 Years: 7.07%
  • 10 Years: 6.76%

Over the longer term equities continue to beat the housing market.  My message is simple; I believe we may be in an inflated housing market in Denver. As I have provided evidence in past blogs the luxury market seems to be showing signs of resistance to upward prices as evidenced with price reductions coming on line sooner and days on market longer even in what should be peak selling season.

Even the middle and lower end of the market seems to be reacting to the interest rate environment with price increases not as dramatic as higher interest rates reduce affordability.

Between the whipsawing of economic news concerning tariffs/trade, the potential for an inverted yield curve, a slow down in the Denver housing market possibly due to interest rates or buyer fatigue due to lack of inventory based on anecdotal observations or just a bull market that is getting long in the tooth; maybe it is time to take profits and if in cash, maybe time to sit on the sidelines and chill.

 

 

 

 

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