Markets suffered another bruising performance this week coming on a variety of disappointing earnings announcements and forward-looking guidance from notable names in the banking and growth sectors. While company specific announcements have left their marks, the market is primarily struggling with an overall awakening to a rising interest rate environment. The U.S. 10-year treasury surged to a high of 1.90% on Wednesday, prompting a continued sell-off in richly priced growth stocks. The tech heavy Nasdaq Composite fell into correction territory, down more than -14.00% from its 52-week high. Earnings announcements in the banking sector continued to prompt a sell-off in financial stocks with the sector falling -10.00% this week alone. Rising compensation costs continued to be a sticking point as Goldman Sachs joined JPMorgan citing rising wages as a hit to the bottom line. On Friday, Netflix announced that it was experiencing slowing subscriber growth. This sent its shares down -21.79%. With earnings and interest rates once again dominating the headlines, less attention was paid to the week’s economic news on housing or China Q4 2021 GDP. By the closing bell, the S&P 500 fell -5.68% on the week.
A Mixed Housing Market
High prices and a lack of inventory led homebuyers to take a break from buying homes in December, sending existing home sales down -4.60% to a seasonally adjusted annualized rate of 6.18 million units. The sticker shock for homebuyers continued with the median price of a home rising 15.80% year-over-year (yoy) to $358,000. Prices have continued to move higher for existing homes as inventory remains tight. At the end of December, there were a mere 910,000 homes up for sale, a record low. That represents a 1.8-month supply. Historically, six to seven months is considered a healthy balance between supply and demand. Home sales continue to be driven by the upper end of the market. Sales of homes priced between $750,000 and $1 million rose 32% yoy. Meanwhile, sales of homes priced between $100,000 and $250,000 dropped -23% from the year ago period. Would-be homebuyers are forecasted to see some price relief in the spring with more sellers placing their houses on the market.
The tight existing home market conditions continued to push homebuyers into new construction. An unseasonably warm December helped lift homebuilding 1.40% to a seasonally adjusted annual rate of 1.702 million — a nine-month high. For the full year, housing starts were up 15.60% to 1.595 million. December’s increase was driven by a 13.70% surge in multi-family housing as homebuilders sought to fill the strong demand for rental housing. The rise helped more than offset the -2.30% decline in single-family housing starts. The pipeline for new construction looks strong with permits for future homebuilding jumping 9.10% to a rate of 1.873 million units. Although demand for housing is likely to remain healthy in 2022, labor and materials costs remain a formidable headwind. Prices for softwood lumber, used for framing, soared 24.40% in December as the Biden administration quietly doubled duties on imported Canadian softwood lumber. The mounting costs and limited supply has added weeks to the typical construction timeline. Despite the delays, the acute shortage of existing home sales should continue to drive traffic to new homebuilders.
Covid and Real Estate Woes Cool China GDP
Economic growth in China continued to slow in Q4 2021 as the country maintained its zero-Covid strategy and as regulators have intervened to cool an overheated property market. Q4 2021 GDP decelerated to a 4.00% annualized rate, down from Q3 2021’S 4.90% rate. During the quarter, consumers curtailed their expenditures as China locked down a greater number of regions in order to contain Covid outbreaks. Economic momentum also slowed as defaults at some heavily indebted firms have weighed on the housing market, prompting Chinese regulators to step in to prevent contagion. Q1 2022 is setting up to be another challenging quarter for Chinese growth. With several new cities being hit with outbreaks in advance of Chinese New Year celebrations commencing on January 31 and with the Olympics on the horizon, greater lockdowns have been ordered and economic momentum is waning. China is preparing to add monetary and fiscal stimulus in response. Just this week it announced it would cut interest rates to help support the economy. Fiscal stimulus, in the form of tax cuts, could also soon be on the way. It is rumored that the government may revisit its zero-Covid strategy once the Omicron wave has crested and once international eyes are not so tightly focus on the country following the Olympics’ conclusion.
It was clearly another tough week for markets, but investors should recognize that the S&P 500 is still higher than its level in October, and it is 1200 points higher than where it was a year prior to that. It has been a remarkably strong and calm period that has encouraged investors to take on greater leverage and risk, which we’re now seeing unwind. The fact that rates went to zero to support the economy during the pandemic always meant this corrective moment would come, and long-term investors should not be discouraged by the de-risking of traders around them. We’d add that we don’t think that this sell-off is over. The Nasdaq and select sectors may have hit correction territory, but the broader indices have yet to do so. We’re in a transition period, and while we’d expect volatility to be front-loaded relative to the Fed’s actual rate increases, we’ve not seen the type of decline needed to convince us we’re back at fair value after having been overvalued for so long. The Fed holds its FOMC meeting next week but we’re unlikely to see a material change in their messaging. The good news in all of this is that, based on the Fed’s dot plot, the projected Fed Funds rate does not reach pre-pandemic levels until after 2024. Rates will still be very low, and a Fed Funds rate at 2.00-2.25% is unlikely to stall growth. As such, we are still constructive on the economy and equities by extension (exception to speculative growth noted). Unfortunately, investors often find themselves swept into the currents created by traders surrounding them, but it is also times like these when the most attractive opportunities present themselves.