Gulfport, FL
We are still homeless but thankfully, under contract!
Potentially just in time, too. The Federal National Mortgage Association (FNMA), or, Fannie Mae, is about to open their mortgage loan approvals to folks with poor credit scores, but good history of paying their rent over the past 12 months.
Some of you will have a strong opinion about whether this should happen, especially with a “Government Sponsored Entity,” or GSE. But, for me, it simply means that millions of people who previously couldn’t get approved for a loan, will be able to, on September 15th.
All else equal, (which it never is) that should put additional support under home prices all around the country, along with the shares of home builder stocks.
On the other hand, these are the sorts of practices that set off the Great Financial Crisis… and the largest housing decline on record.
Nobody wants to deny another person the “right” to own a home.
The problem is that owning a home isn’t actually a right. It (like a driver’s license) is a privilege. With it, comes the responsibility to pay taxes, even if you paid cash for the property. You don’t just get to keep your home without paying your taxes.
A gross oversimplification of history follows…
Looking back through history, the first way people could have a home was to build it. Many did exactly that hundreds of years ago, with their own bare hands. After building homes for themselves they left them to their children, along with the carpentry knowledge and skills to build new structures for their own children.
Then specialization of occupation began to take hold and not everyone had to produce their own food and build their own home… and many folks who couldn’t otherwise afford to buy a home lost the skills needed to build their own.
Obviously, those with the skills to build saw the opportunity to build structures for people other than their family, for profit.
The first home built by a “contractor” and sold to the homeowner was probably a pay-as-you go structure. There was certainly no bank involvement. The deal was between the builder and the owner, and nobody else. If one didn’t trust the other, they could walk away.
Next probably came a payment in full, upfront, arrangement where the contract took on all the risk of material prices and labor costs – in the hopes of making a profit.
Then the bankers got involved. They said, well, we have all these dollars that just sit in our bank all the time, and don’t get used. We should lend that money to reputable people in our community so that they can build their own homes and we can charge them interest. If they don’t pay, we can take the home as payment.
Now, that was a great idea. I mean, nobody loves their banker, and no banker is working for free – but I have to give credit where credit is due.
If there is really $10,000 sitting in the bank all day, and roughly that same amount sits there day, after week, after month, after year… then why wouldn’t we use it to be productive?
If the bankers had just stopped there… we would have never had the Great Financial Crisis.
But they did not. The central bankers got ahold of the idea and took a productive arrangement and turned it into the most destructive financial arrangement in history.
You see, so far, I haven’t mentioned anything about a credit score, or a PMI, or a mortgage-backed security (MBS), or a tranche, or any crazy financially engineered nonsense like that.
These old loans were simple. The bank lends money to a borrower, and then if the borrower doesn’t pay it back, the bank loses money. The bank had great incentive to make sure they loaned money to reputable folks. That means no loans for strangers, for sure.
It also means a lot of discrimination… so the simple loans weren’t perfect.
Today, loans don’t work anything like this.
Today, when a borrower takes a loan from the bank to buy a home, the amount of money that is owed to the bank as a stream of monthly payments for the thirty years is viewed as an “asset” of the bank, just like a chair, or a desk, a TV or the bank building.
That asset (the stream of payments due in the future) can be sold to someone else, just like any other asset.
Who buys these streams of income assets? The Federal Government, primarily. And then, GSE’s like Fannie Mae…
Once the bank has sold the loan to the government, or someone else, the bank has no interest in whether the borrower ever makes another payment.
This process of the bank making a loan, and then selling the loan to a third party happens almost instantaneously. It is called securitization. The stream of income is a “security,” just like a bond.
The big difference from the first bank mortgage loans compared to now, is that the bank’s incentives have completely flipped. The bank used to be incentivized to lend only to reputable borrowers. Now, the bank is incentivized to get borrowers to meet arbitrary standards set by third parties – whether the borrower can actually repay the loan or not.
Essentially, Fannie Mae just made it easier for the bank to get folks approved who will not be able to repay.
On the surface, it is great that under these new rules millions of new borrowers will be able to get approved for a loan and buy a home. It will be great for the economy when those folks start buying things to put in that new home, too.
I personally know several people who this rule will impact. These are people of high reputation (my opinion) and have a great history of honesty and employment. For those people, this is a miracle. And they should celebrate and be excited.
For a whole bunch of other people, it is a dangerous game. But what do they have to lose? Can you blame the borrower for taking the money the bank offers after (dishonestly, in many cases) explaining that the approval process all but ensures that the loan can be repaid? These folks were never going to get a home loan before… so, if this doesn’t work out, no big deal.
But as we know from the Great Financial Crisis, the last time the bankers got it wrong millions ended up homeless and jobless.
“They weren’t being stupid. They just didn’t care.”
I don’t want to ruin anyone’s day… but I feel like this is one of those times to watch the last few minutes of The Big Short. You can click here to watch.
If you don’t have time to watch, here is some of the text you would see if you did:
“When the dust settled from the collapse, 5 trillion dollars in pension money, real estate value, 401k, savings, and bonds had disappeared.
8 million people lost their jobs, 6 million lost their homes. And that was just in the USA.”
Performance
The S&P 500 (SPY) was down slightly for most of the month of July, falling by almost 1% as of the 19th before staging a nice recovery and finishing up 2.1%.
The Appreciation Strategy was up for the month but underperformed the SPY in July. The Income Strategy beat its benchmark (50% of SPY, when up) again.
Income is way ahead of its benchmark for the year 2021, and Appreciation still has some catching up to do between now and the end of the year.
Appreciation is still ahead of SPY (net of all costs) since January 2020. So, while this year has (so far) been very challenging for trend-following strategies, technology stocks, and growth stocks… and therefore the entire Appreciation Strategy; a longer-term analysis helps put a challenging “first half plus July,” into perspective.
For those who have forgotten, the goal of the Appreciation Strategy is to match the SPY on the upside and lose less on the downside. While we can’t do it every day, week, month or quarter – in the long run we have exceeded our objectives and it shows in the account values we manage.
Outlook
If you think stocks are expensive… don’t look at bonds.
It is probably worth noting that we own zero *traditional bonds in either of our strategies, as has been the case for over a year. Good thing too, because bonds are down over 5% since stocks hit their COVID-19 bottom in March of 2020.
Bonds are in a bigger bubble than stocks – by a long shot. Until after the FED has raised short-term rates, that bubble is likely to keep inflating, even if at a slowing rate, before bursting. Then, when prices are low and rates are high, we will be looking to load up on bonds.
Until then, grab a bag of popcorn because we are on the sidelines of the bond market.
For now, I am anticipating a move into what our friends over at HEDGEYE refer to as Quad 3 which is indicated by rising inflation and slowing GDP growth.
We have run the numbers and we know which stocks and sectors tend to do well in this environment, and which tend to perform relatively poorly. Here is a high-level overview:
We do not move in order from 1-4 through the matrix. We tend to “bounce” around. But we are currently in Quad 2, and I do believe we will move into Quad 3, next/soon.
Longtime clients know that we have another “Macro” framework that we use in determining our outlook which is based on momentum and valuation, which we borrow from at Stansberry Research. It looks like this:
We are presently (and still) in “Uptrend/Expensive” land.
Based on these frameworks, we know that we want to stay long stocks, and we know which types of stocks tend to do best in the current environment, and whichever “Quad” we find ourselves in, next. The key is paying attention to the signals so that we know when we have left one and entered another – and then acting accordingly.
In closing
Nobody said investing was easy… some of the smartest people who ever lived have lost fortunes in basically the same exact way, time and time again. Which is why even though it seems like it just happened, and we should know better, the US housing market and its propensity for financial engineering, could blow up the entire global economy again… just like it did a little over a decade ago.
I read this article in The Atlantic, this month. It is old, but worth sharing. It was news to me!
“If Isaac Newton could lose all reason in the pursuit of riches, so can anyone else.
Early in august 1720, Sir Isaac Newton was faced with a choice. In a year when London’s stock market was roaring upward in an utterly unprecedented boom, should he sell the last of his safe investments to buy shares in the South Sea Company? Since January of that year, shares in the firm—one of the largest private companies in history—had gone up eightfold, and had made paper fortunes for thousands.
Already a wealthy man, Newton was usually a cautious investor…”
Click here to continue reading…
As always, thank you for reading!
Shane Fleury, CFA
Chief Investment Officer
Elevate Capital Advisor
*We do own some floating rate bonds in the Income Strategy, which tend do well when rates rise, the opposite of traditional bonds.
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This commentary expresses the views of the author as of the date indicated and such views are subject to change without notice. Elevate Capital Advisors, LLC (“Elevate”) has no duty or obligation to update the information contained herein. This information is being made available for educational purposes only. Certain information contained herein concerning economic trends and performance is based on or derived from information provided by independent third-party sources. Elevate believes that the sources from which such information has been obtained are reliable; however, it cannot guarantee the accuracy of such information and has not independently verified the accuracy or completeness of such information or the assumptions on which such information is based. This memorandum, including the information contained herein, may not be copied, reproduced, republished, or posted in whole or in part, in any form without the prior written consent of Elevate. Further, wherever there exists the potential for profit there is also the risk of loss.