Tudor March 2024 Commentary

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Fifteen Months of Recovery

2022 market challenges are becoming a distant memory, as the long term trend of market recovery that began in 2023 continued into the first three months of 2024. The first quarter of the year saw enough good news to buoy the spirits of investors, helping markets finally surpass their 2021 highs.₍₁₎

There isn't much to complain about economically - record low unemployment as baby boomers funnel out of the workforce leaving unfilled positions behind, investors feeling flush with investment and real estate gains, and then political stalemate reflected in the lowest number of Congressional bills passed this past year since the Great Depression.₍₁₎ Markets love political stalemate.

The current environment suggests a sort of economic utopia. But there are three matters that should garner attention:

First, stock valuations are stretched. After a fifteen month run, the inventory of reasonably-priced securities has evaporated. Perhaps an ideal time to trim overpriced securities. Better to exercise patience and temporarily earn mid single digit money market returns than purchase overpriced securities.

Second, as we discuss below, there is a reckoning of sorts that must be worked out in residential real estate. We discuss three conflicting factors at work that will have to be reconciled before real estate transactions pick up again.

Third, as though investors didn't learn important lessons in 2022, speculation has ramped up in frothy elements of the investment universe. Anything labeled artificial intelligence, crypto currencies and large tech are examples of this return to speculation. These things end poorly - stay tuned.

In the meantime, we celebrate the strength of the American consumer in the current environment...a sort of anti-recession period. This strength is reflected in strong consumer spending and stock prices fully reflect this.

 Market Transitioning in 2024?

Certain market sectors have had big runs to the exclusion of some very fine market sectors - for example, large tech has led the market for a number of years now. We suspect that a transition will occur as the year progresses. We will communicate this when it occurs.

The Intersection of Home Prices

Interest Rates and

Household Income

The January 19, 2024 edition of the Wall Street Journal noted that home purchase/sale transactions hit a 30 year low last year in 2023. This suggests home buyers and sellers are at a stalemate, stuck in their respective homes. But why?

Financial writer/commentator Morgan Housel does a wonderful job of elaborating on this current real estate oddity. This is an unusual period, never experienced similarly in history, that suggests something has to give to bring real estate back into equilibrium.₍₄₎

There are three primary factors at work in this unusual period in history:

Interest rates: Would-be buyers that bought or refinanced in pre-COVID years are sitting on 3% mortgages. Current 30 year mortgage interest rates at 7.50%₍₁₎ are more than double the pre-COVID rates, so current homeowners double their carrying costs if they move. In every past period, large interest rate increases caused home prices to plummet. This hasn't occurred in the current cycle.

Prices: The National Association of Realtors in February noted that home prices in the last three years have surged 42%. Starter homes in major cities are currently priced at $1 million or more. As a result, new buyers are largely locked out of the real estate market since they did not ride the real estate price train during the last three years upsurge. At the $1 million price point, 10% down is $100,000 that has to come from somewhere. Not only have prices risen, but as noted above, carrying costs of ownership have more than doubled. Full financing of $1 million is $75,000/year in interest.

Salary levels: Most homeowners in the U.S. could not afford their own homes if they were starting fresh. Salary levels are simply not high enough (haven't grown 42% in the last three years) to support current home prices and the higher current carrying costs of home ownership.

What has to Happen in Real Estate to Bring Buyers/Sellers into Alignment?

Reconciliation of all these real estate challenges will have to come to a head. Either inflated prices home sellers are expecting (sourced by Zillow and similar sites) must come down significantly to realistic levels, interest rates have to plummet, or salaries have to skyrocket.

It is clear that the current standoff in real estate will come to a head in coming years. Sellers may have to make the first move.

Who is Paying the Taxes?

Taxes are a hot button item with politicians. Arguments for more taxes (on other groups of people, of course) and for fewer taxes make headlines and rally constituents.

Looking at information straight from the government's Congressional Budget Office makes it clear that total taxes paid in the U.S. move in very even lockstep with income levels - lower wage households pay lower amounts (or even negative taxes due to the earned income credit) and higher wage households pay a much large percentage of total U.S. income taxes.

According to the March 29 2024 Wall Street Journal, the bottom half of taxpayers (which equate to those making less than $46,500/yr and who filed 77 million tax returns) paid 2% of all federal income taxes. The top half of earners - paid 98% of federal income taxes.

The proportion of federal income tax paid by the top 1% of earners has grown from 33% of total income tax in 2001 to 46% in 2021. A household income of $682,000 is required to be in that top 1%.

In 2021, to make it into the top 10% of taxpayers required $170,000 of household income. Those filers submitted 14 million tax returns.

The only group to pay a significantly greater proportion of total U.S. federal income income taxes are the top one percenters. The portion paid by the lowest 50% has declined a bit since 2001 and the other 49% are paying into the total at about the same rate as 20 years ago.

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