The Days Ahead:

  • Earnings season ramps up; first look at Q3 GDP.

This Week:

  • Housing is a large part of the inflation basket.
  • But it lags the rest of the economy.
  • We compare other measures of rent and housing.
  • They’re all headed down.
  • We try to make sense of market reactions to the Hamas attack on Israel.
  • And compare it to past events.
  • Toyota or Tesla…recently, you would have made more money in Toyota shares.

How Hard Is It To Measure Rents?

Turns out, it’s quite hard. First we start with the standard Bureau of Labor Statistics (BLS) CPI report and find that rents, which are about 32% of the CPI index and 40% of the core index, rose 0.6% last month and 7.1% over the year. We know that the rent index of the CPI is made up of two components: rent paid on a residence to a landlord and imputed or estimated rent if you own your own place. Since Covid-19 both have gone up by around 20%. (BTW, we’ve used the words “rents” to cover what the BLS also calls shelter and housing costs).

How do they come up with the number? The BLS tries to follow all residences in a given area, for both upper, middle, and lower-income renters. It’s a fiendishly difficult undertaking. They apply a number of factors. They exclude rent-controlled units. They limit the number of detached houses. They use the 8.1 million census blocks around the U.S. and then use five units from each block. They then weigh the five depending on whether the unit is in an expensive or low-income area. The logic there is that a price swing for the latter impacts spending more than for the former. They exclude outlier units, like mansions, luxury apartments and purpose-built houses. Finally, the blocks are divided into six panels and they survey each panel twice a year. That’s worth noting because it means that 83% of the prices are more than a month old and 17% are five months old. They’re not timely.

The imputed rent part follows the above with one exception. Instead of the BLS asking renters how much they pay, they ask homeowners:

“If someone were to rent your home today, how much do you think it would rent for monthly, unfurnished and without utilities?”

That creates its own problems because owners may overvalue their home, or base it off, say, an outdated mortgage.

All those adjustments mean the BLS captures a broad group of leases and rents, but those rents don’t change very often because they’re re-set only annually or when the tenant changes. This tends to mean that the BLS index of rents lags the rest of inflation.

OER and CPI Less OER Chart
Source: FactSet, 10/17/2023

You can kind of see it. In 1985, regular ex-rent inflation (blue line) dropped and rents (Owners’ Equivalent Rent or OER in green) increased, only starting to fall about a year later. It’s the same in 1991, 2001, 2009, and now. The annual inflation less-rent rate is now below the Fed’s target of 2% but rent inflation is again running about a year behind at 7%

The way we get round this is to look at the Zillow rent index. This measures new leases on known units (so no new buildings) and mainly from on-line sources, which means they tend to be higher end units. It also weighs units depending on whether they have high turnover, say units around a college or military base, or low turnover, say in suburbs and cities. They also do various smoothing and seasonal adjustments because people are more likely to move in August and September, than, say, February and March.

In the Zillow world, rents are up 3% over the year and 30% since Covid-19 days. Again, that compares to 7% and 20% for the BLS rents. Rents in September rose 0.2%, compared to 0.6% in the BLS world and they actually dropped in many former growth hotspots for Covid-19 like Austin, Memphis, Orlando, Salt Lake City and Las Vegas. The highest growth was in more affordable markets like Providence, Chicago and Cincinnati.

So, now we know from Zillow that these are relatively high-end units on only new rents and on already built units. So, if we take the Zillow rents and advance it by a year, we should get some idea about what will happen in the BLS data.

Zillow and OER Chart
Source: FactSet, 10/17/2023

The green line is the Zillow annual growth in rent and the blue is our old friend, the rent index from the BLS. The Zillow data is pushed ahead by one year. This is better. Zillow data fell in 2017 and about a year later the BLS rents came down. And they fell in 2020 and about a year later, the BLS rents came down. It’s happening again in 2023 with one difference: the BLS rents are not falling as much as the Zillow rents would suggest. This is probably noise not signal but we’ll keep watching.

Ok, now we’ll look at another measure which is the BLS’ New Tenant Repeat Rent Index or NTRR. This also measures new leases but measures only leases paid by new tenants. Why would you do that? Well, it eliminates renters who may receive favorable benefits (they don’t have Led Zeppelin appreciate night on Tuesdays) and it cuts out units which may have old amenities or decoration. How has this measure done? The NTRR is up by 29% since Covid-19, 4% over the last year and -0.2% in the last month.

We can also look at the prices of new homes and existing homes. We’d note that new home prices show the most price flexibility because a developer wants to sell new houses and move on. Often, they’ll throw in appliances and extras which can distort prices. So, the prices are probably the most volatile of all housing price data. We can also use CoreLogic who track rents of single detached and semi-attached family homes only, excluding multi-units. All the data hunting leaves us with this:

Table showing housing and rent price increases
Source: BLS, Zillow, Census Bureau, CoreLogic

So, what to make of this all?

One, rents and housing prices have peaked.

Two, the BLS data is probably the broadest and most comprehensive, but…

Three, it lags actual price activity by as much as a year.

Finally, we know rent growth is heading lower and will do so for about another year. We may not see a house price correction but the rate of growth will drop. That will continue to bring the core measures of inflation down. The Fed will like that.

A Vale of Tears

We hope we are never inured to the horrors of terrorism and war. Yet, capital markets seem to be unperturbed. Are they wrong?

First reactions. The first reaction to the attack on Monday was very typical of a shock event. The Japanese yen and the Swiss franc rallied. They’re conventional safe currencies, seen as apolitical, and backed by strong central banks, and strong economies with low inflation. The Swiss franc has always been so. The yen is a more recent trend. Crude oil also rallied on the knee-jerk, and incorrect, reaction that supplies would be hurt. All three gave up their gains within days.

Gold, another go-to safety trade, initially didn’t do much but has since gained around 6%. But we’d put that down to some extreme short positions that were flushed out. Why were they short? Because high real interest rates undermine the inflation protection value of gold and high nominal rates increase the opportunity costs of holding gold. Gold comes with negative carrying costs (you have to pay storage) and of course pays no interest. A 1-month U.S. Treasury yielding 5.4% compares very well to the zero income from gold.

There’s a lot of oil. Saudi Arabia, OPEC and Russia may call the shots on oil prices short-term but the U.S. outproduces both by 30%. In July 2023 the U.S. produced a record 402 million barrels of oil which was about 10% above last year. And it did it with 501 rigs in operation or 20% fewer rigs than a year ago and 70% fewer than the 2014 peak.

Chart showing oil production by country
Source: FactSet, 10/18/2023

In other words, don’t underestimate the importance of crude oil production. If the U.S. needs to produce more oil, it can and will.

We’d also note that European natural gas stocks are at record highs, so if oil production was cut, either by force or by retaliation, the world can sit it out for a long time. This is not 1973.

People don’t know. Ugh. Reading some of the commentariat has been dispiriting, compounded by the unfiltered dialogue on social media. We saw this week a famous but one hedge fund manager put out a note that the odds of “uncontained world war” stand at 50%. It’s difficult to read his stuff with a straight face especially as he gets basic history wrong. Still, he does come up a with this gem:

“these changes take place in a timeless and universal cycle that I call the “Big Cycle””


There’s a lot of scaremongering and people grab the nearest analogy they can to try and make some sense. That’s fine but this is a time for professional historians and subject matter experts, not tourists trying to sell a book. This week saw calmer heads prevail.

We know about past market reactions. Many of the risks we’ve seen start with a market overreaction, followed by an underreaction, and then events take over. The average crisis is soon priced in by markets. Here’s a quick table on past events.

Table showing stocks and political risks
Source: LPL, Wikipedia, FactSet, Cerity Partners

On average the total drawdowns are around 5% and that’s from the first day to the worst day. And on average it takes around 20 days to reach the bottom and 42 days to fully recover the loss. Pearl Harbor is an obvious outlier.

We’d also bring out our long-term chart where we’ve listed just about every bad thing that’s happened in the last 123 years.

DJII 122 Years Chart
Source: FactSet, 10/18/2023

It can be hard to read but the quick look is that every circle is a major conflict and every rectangle is a decline and correction. The markets seem to move on.

We’ve read plenty of scenarios: Hezbollah gets involved, Iran sends in Revolutionary Guards, Iran develops nuclear weapons, the tunnels under Gaza become a kill-zone, densely populated Gaza is bombed flat, civilians flee south, proxy wars break out. For now, the markets have kept calm. That seems rational given what we know and the U.S. attempts to broker some agreement that falls short of all-out war.

We will of course keep close watch on developments but for now the economic and market reaction is that the worst won’t happen.

Tesla, Toyota…

Tesla has its fans and the stock has performed well. It was up 140% year to date in July but reported some not great numbers this week and fell 10%. It’s now up 79%. Not shabby except that it’s much the same price as it was in 2020. Its production was 430,000 units, down 11% over the quarter and it earned $0.53 cents per share. About 30% of its net income is from the sale of energy credits. What? They’re basically government cash given to car companies to incent EV production….Tesla receives more than it needs and sells the rest to other car companies. Basically, its selling government subsidies for cash. It pays no dividends. Tesla shares trade at around 140 times earnings.

Toyota does not have a CEO that anyone outside a core fan group could name but here he is, Akio Toyoda. It sells around 11 million cars a year, and its last reported sales were up 8%. Toyota shares trade at around 9.7 times earnings and it pays a 2.3% yield.

Toyota shares have started to attract attention. In the last two years, its share price (top line) is up 30% and Tesla’s is down 23%.

Source: FactSet, 10/19/2023

Tesla faces increasing competition from Chinese, Japanese and European auto makers. BYD, a Chinese EV auto manufacturer builds almost twice the number of EVs than Tesla including some pretty nice looking models that you won’t see in the U.S.

Photo of BYD car
Source: BYD Company Ltd.

It sells for around $35,000 compared to a Tesla S at $75,000.

Anyway, it’s nice to see Toyota stock perform and it’s a reminder that even though the U.S. stock market trades at around 17 times earnings, there are plenty of companies selling at cheaper prices in the rest of the S&P 500 that are not the Mag 7, and there are plenty of companies trading at cheaper prices outside of the U.S.

The Bottom Line

The eye-catching event of the week was the bond market and especially the Treasury market. The 10-year Treasury yield climbed from 4.6% to an intra-day high of 4.95%, its highest since 2007. The 30-year Treasury broke decisively through 5%.

We’d put this down to some good economy numbers. Retail sales were stronger than expected and jobless claims fell to 198,000, the lowest level since January. There’s a lot of noise in the weekly claims series, but that number was way lower than expected.

It seems to us that there’s a wholesale repricing of U.S. rates with even the 2-year treasury note touching 5.25%. The market is taking its lead from two weeks of Fed speak that suggest rates are high enough but aren’t heading lower. And they’re not heading lower because the economy and employment are doing so well.

Stocks are moving more on company news than macro events. The S&P 500 drifted down over the week but that could reverse with some favorable earnings news.

Art: Stephanie Holman (b. 1967)

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