Life comes at you fast and you better be ready to handle any curveball that gets thrown your way.
The curveball I’m talking about is the increase in COVID-19 cases we are seeing in many states, including my state of California. The significant uptick in many areas following the relaxation of stay-at-home orders forced some governors to scale back the reopening of the economy.
Previously, I wrote that the first hurdle we as society would need to conquer in order to get the economy back on track was to flatten the curve of new infections. Slowing the spread of COVID-19 is the first of many steps required to revitalize the economy.
In April and May we were on the verge of success, then some of us –– in fact, way too many of us –– got sloppy. The relaxation of stay at home orders was accompanied by relaxation of common sense. In Texas, Arizona, Florida and California, we weren’t careful, and now virus infection rates are rising.
Prior to this setback, the U.S. economy wasn’t exactly in full swing, but we were making some progress. Most notably, the U.S. housing market made a full V-shaped recovery. This is based on four straight weeks of the highest levels of double-digit growth in purchase applications in 2020. Now with higher infection rates back in play in many areas, we need to entertain the possibility that our victorious V-shaped recovery in housing may turn into a “W-shaped” recovery.
What we need to avoid the W-shape
In order to avoid a reversion of our progress and hold on to the recovery in housing, we need to see the following four things: flat to positive purchase applications, flowing credit, stable bond yields and control of the infection rates, again.
1. Flat to positive purchase applications
We need to have flat to positive, year of year growth in purchase applications for the rest of the year. Typically, total volumes of purchase application fall after May which is why we need to focus on the year over year comparison rather than look at month to month comparisons. The recent 18% and 21% year-over-year gains are robust, so sustaining this level of growth is not likely.
Considering our current situation, I will be happy with any growth in purchase applications compared to last year. In the early months of the COVID-19 crisis, purchase applications were negative year over year by 11%, 24% and 35% before stabilizing and heading higher.
2. Credit Flow
Credit needs to be flowing for a functioning housing market.
Frankly, we got lucky that Freddie Mac and Fannie Mae were not out of government conservatorship when the virus hit. Because the GSEs still have the government backstop, the major pipeline of credit for home purchases continues to flow, despite economic chaos elsewhere.
The government forbearance plans, too, provide a safety net for American homeowners who lost employment due to the crisis. If the GSEs were publically traded companies with no government backstop, credit standards would have become much tighter and there would be no mortgage deferment programs offered, at least not quickly.
Under our current crisis conditions, the GSEs would be at high risk for failure and the government would likely be forced to take them back in conservatorship. We were able to handle the March mortgage market meltdown with only a few casualties in the non-qualified mortgage market, the jumbo market and for low FICO score FHA loans.
3. Target 10-year yield rates
The one area we don’t need to worry about is mortgage rates. Mortgage rates are going to be low or at least below 4.5%, the level that begins to affect demand, for some time. For the 10-year yield, however, I would like to see higher yields because this would indicate that the economy is improving.
A 10-year yield above 0.62% bodes wells for the future. However, if yields go lower than 0.62%, then the bond market is expecting more economic drama. I put the recessionary yield range between -0.21% and 0.62%, whereas yields above 0.62% indicate that the bond market has confidence in the future.
4. Decrease in COVID-19 cases
Back in February, I predicted that we would flatten the curve of new infections by May 18, which we did. I am now predicting that we will get this rebound of infection rates under control before September 1. This will require a lot more testing and common sense.
If we all work together we can be in a better place by September 1 -– and this is critical because we need to be ready for the second wave that could hit in the winter months.
A resurgence of infections nationwide with no concerted efforts to lower the rate of growth of cases could significantly impact our recovery. If the virus infection rates do get worse and stay at home orders are reenacted, credit could tighten and purchase applications could fall, year over year. We may not be able to sustain our V-shaped recovery in housing.
If that happens then our best-case scenario would be to work towards a W-shaped recovery.
Early signs of a W-shape
If fear of the virus prevents buyers from looking and sellers from putting homes on the market, our V-shaped recovery in housing could be in jeopardy. Our good demographics and low-interest rates mean we should have baked-in demand for housing. But this demand can be quashed by buyer and seller fear.
If real estate professionals follow safe practices, there is no reason why homes can’t be shown for sale and transactions executed safely. Our industry has a responsibility to make this known.
Also of concern, in the last two weeks we have seen an increase in the Financial Stress Index to 0.21%, indicating a loss of confidence by the markets in the U.S. economy.
This might result in more tightening of credit which was actually getting slightly better recently. We need to see the St. Louis Financial Stress index go back to zero or negative to know that we are in recovery mode. We don’t want to see this index get above 1.21%, because if it breaks past 1.21% then typically it has the potential to rise quickly.
Mortgage rates to the rescue
On the bright side, we also have the potential for the stock market and economy to recover relatively quickly. This is because even though the economy is suffering, we do not have a consumer credit bubble. Plus, inflation is low, we have a fiscal capacity to provide disaster relief and we have good demographics.
America was enjoying the longest economic and job expansion ever recorded in history because it had millions and millions of people of prime working age wanting to consume goods and services. This virus is the one thing that has the ability to obliterate that advantage.
Even with the virus and the job losses and the shutdown, we have over 133 million people working. Perhaps because of this, the U.S. housing market is the single most outperforming economic sector in the world today.
The virus can cause a lot of damage to the economy in the short term (like it did in March and April, resulting in the sharp decline in purchase application data), but it cannot defeat us.
Because the primary drivers of housing are demographics and mortgage rates (and we have those two things in spades), all we need to show the full potential of years 2020-2024 is to be in good health, work and walk the earth freely.