Head of Equity Strategy
Summary: The US housing market is slowing down with real estate brokers laying off people and mortgage applications hitting some of the lowest levels since 1990. For homebuilders the situation is even worse as the much higher financing costs are not being offset by lower prices on construction materials. We take a look at the US housing market and Lennar's Q2 earnings published in the US pre-market session. In today's equity update, we also take a look at Tesla and the growing geopolitical risk over Elon Musk's decision to deliver Starlink to Ukraine.
Can the US housing market avoid a material slowdown?
This year’s change in the US 30-year mortgage rate from around 3.3% to recently 6% has a caused a dramatic fall in mortgage applications with the 12-week average now in the 5% percentile since 1990 suggesting housing activity is slowing fast. Several real estate brokers have recently laid off employees in an anticipation of declining activity.
Lennar, the second largest US homebuilder, has just reported FY22 Q2 (ending 31 May) earnings with revenue at $8.4bn vs est. $8.1bn as the homebuilder is still enjoying the tailwind from previous orders. More impressively the gross margin improved 340 basis points to 29.5% suggesting good cost management amid cost pressures. New orders increased only 4% reflecting the dynamics explained above while the backlog rose 16% y/y and the backlog dollar value increased 33% to $14.7bn reflecting the inflation in construction materials and thus prices of new homes. Lennar’s new orders guidance for the current quarter is 16-18,000 vs est. 17,750, so demand is coming in weaker than estimated.
For homebuilders the situation is situation is even worse with Lennar’s share price down 44% reflecting revenue and profitability slowdown. Higher financing rates for homes while building material costs remain high coupled with a tight labour market are an awful cocktail making it less attractive to build a new home relative to buying an existing home. The 6-month average of US leading indicators has gone into negative in the latest print with the downward move accelerating suggesting the US economy will materially slow down over the coming six months. Whether it turns into a recession, or to what degree, is still uncertain but the probability is definitely rising.
Ironically it is the rising recession risk that is now cooling commodity prices and fading the momentum in interest rates reducing the pressure on equities. Historically drawdowns are not a continuous decline to the trough, but instead a stop-and-go sequence, and it is likely that unless adverse developments enter the equation that we could be in for a slightly more positive equity market in the weeks to come. The next leg down in equities to new lows could come from the fact that there is a natural limit to how high the nominal interest rate can go before the Fed will have to halt the tightening and thus allowing inflation to run hotter for longer which will likely cause headwinds for equities longer term.
Tesla is now facing two major risks
The NHTSA recently elevated its probe into Tesla’s Autopilot increasing the risk of a potential suspension. With rising commodity prices Tesla has been raising prices lately to protect its gross margin, but the majority of the cash flow generation is coming from its software sales of Autopilot. In fact, Tesla has said it themselves that they expect the majority of future free cash flow coming from the Autopilot software. A suspension is a key risk as we have highlighted before.
Another risk emerging for Tesla is well described in today’s FT article Elon Musk’s Starlink aid to Ukraine triggers scrutiny in China over US military links in which Elon Musk’s decision to send Starlink receivers to Ukraine is seen as a threat to China’s national security. The Chinese EV market and the Shanghai Gigafactory have been very important factors behind Tesla great success in the past couple of years. The question is whether increasing geopolitical risks and the tensions between China and the US could suddenly become a major issue for Tesla.
Tesla’s share price is still priced for perfection execution and we acknowledge the impressive results of the company, but when something is priced for perfection the sensitivity to changes in expectations is so much greater. A new fragmented world order can render some of today's infrastructure obselete, but it also calls for massive new investments across the globe, which requires a new set of strategic and tactical investment strategies.
Steen Jakobsen,
Chief Investment Officer
As globalisation turns to fragmentation, China seems set on playing a role in the global economy, while simultaneously working towards proofing its own economic situation from external shocks and crises.
Redmond Wong,
Market Strategist
The recent bank runs and ensuing challenges are reminicent of something we've seen before. Will it end like the S&L crises of 1986 and 1995?
Chris Dembik,
Head of Macroeconomic Research
Equity markets need to recalibrate to another - fragmented - global world. What's your view on equities in this market - are they going up or down?
Peter Garnry,
Head of Equity Strategy
With every development comes new opportunites, some of which could be in India. Have you considered the country as a part of your diversification strategy?
Charu Chanana,
Market Strategist
A collar is an option strategy that allows some protection while maintaining some upside potential. What investment would you like to use a collar strategy for?
Hans Oudshoorn,
Trainer Academy
There are arguments to be made for many commodities to have upside. Which are you paying the most attention to this quarter?
Ole S. Hansen,
Head of Commodity Strategy
In a very challenging macro environment, which currencies do you think will come out on top?
John J. Hardy,
Head of FX Strategy
