This past week has been a rough ride with the S&P losing over 7%. Is this a minor correction or something more? President Trump says blame the “loco” fed not the China trade war. Is he correct? What are the drivers of the recent decline and what does this mean for real estate? Is now the time to panic? Is this the “end” or a blip?
Don’t worry, now it is not the time to panic just yet. There are two primary drivers of the recent market decline. Interest rates and uncertainty in the market. Both are indicative of the recent market turmoil.
Interest rates:
The president is clearly putting the blame on the federal reserve that interest rates are rising too quickly. He has called out on multiple occasions that the federal reserve must be “crazy” to raise rates. It is important to note why the federal reserve is currently raising rates.
Why is the fed raising rates?
The federal reserve’s job is to help not only fight inflation but “smooth” out economic cycles. Currently inflation has been non-existent as wages have basically stagnated. The federal reserve is instead focusing on smoothing out the economic cycle. It appears that the federal reserve continues to raise rates to ensure that they have room to drop rates when the next economic cycle hits which most economist are saying is around 2020.
The president is forcing the fed’s hand
The federal reserve is viewed as an independent financial body that is outside the reach of politics. With the heavy criticism the federal reserve has received from the president, they are resolved to ensure their independence and not be swayed by politics. As a result, the federal reserve might be raising rates more than is needed to show the American people that it is an independent organization.
The federal reserve has been consistent in their messaging
Although the federal reserve has been consistent in their messaging that rates would continue to rise gradually, the market wasn’t buying into the federal reserves “plan”. The market was anticipating a slower pace than the federal reserve was conveying since inflation continues to be non existent. This mismatch led to a sudden jump in longer term treasuries which caught the market off guard and drove interest rates up substantially.
Market Uncertainty:
Along with rates, there is considerable uncertainty in the market around trade, wage growth, inflation, etc… The market had factored in a resolution to many of these questions this year, but yet none of them have been fully answered. There is still considerable uncertainty in the market.
Trade:
The market has become worried the trade war with China could drastically increase consumer prices due to the tariffs. These prices would be passed on to consumers. Either consumers absorb the increases which will spur inflation or consumers might not be able to absorb the price increase and demand falls. Both scenarios are not good for businesses and will drive profits down.
Wage Growth:
We’ve been hearing for the last 3 years that wage growth will pick up. Unemployment is near record lows and yet wage growth has been stagnant. The Federal reserve is predicting a pickup in wage growth which is helping drive their resolve for continued rate increases. What happens if wage inflation fails to materialize? Why hasn’t it materialized thus far? These are still open questions that will influence the market depending on the answers
Inflation:
The federal reserve is resolute on fighting “future inflation”. The market is beginning to question whether the future inflation will materialize or if the federal reserve is raising rates too quickly and will put the brakes on the economy before inflation occurs.
Impact on real estate:
The current selloff is a combination of market uncertainty and rising rates. Both of which have a profound impact on real estate. Rising rates reduces buying power on a purchase and raises the cost of capital. It also pushes up capitalization rates (I’ll send out another e-mail next week explaining this piece in more detail) that decrease the price of commercial real estate. Along with actual “costs” associated with real estate, the bigger question is what impact this has on consumer confidence. Both businesses and individuals want certainty before making a large long-term purchase. With the gyrations in the stock market, I would expect consumer confidence to decrease. If the market gyrations continue, this will filter through real estate sales over the next couple months.
Is the sky falling?
Although I don’t think the sky is falling or that this recent correction is the beginning of the next cycle, it is a stark reminder that we are towards the tail of a cycle. Volatility typically picks up at the end of an economic cycle. I’ve said many times in the past that the federal reserve is behind the curve, they should have been raising rates years ago to get towards a “neutral policy”. At this stage the fed is out of options and must raise rates to ensure they have room to wiggle during the next cycle. It makes me wonder if the recent 7% drop a precursor for the “main event” or is this just a small blip. What do you think?
Resources/Additional Reading
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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending. Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in the Colorado Real Estate Journal, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.
Fairview is a hard money lender specializing in private money loans / non-bank real estate loans in Georgia, Colorado, Illinois, and Florida. They are recognized in the industry as the leader in hard money lending with no upfront fees or any other games. Learn more about Hard Money Lending through our free Hard Money Guide. To get started on a loan all they need is their simple one page application (no upfront fees or other games).