Dave:
Hey, everyone. Welcome to On the Market. I’m your host, Dave Meyer, and today we have an incredible guest, Liz Ann Sonders, who is the chief investment strategist for Charles Schwab. That means that she and her team oversee the assets, almost $8 trillion in client assets that are invested into the stock market. So if you want to learn from someone who is truly in tune with everything that’s going on with the economy, this is going to be an incredible episode for you. I’ll just let you know that we don’t talk that much about the specifics of real estate or the housing market, but I assure you, if you invest in literally anything, you are going to want to hear what Liz Ann has to say.
She has some of the most sophisticated, but honestly really digestible and easy-to-understand opinions about what is going on, not just in the stock market, but in the bond market and how that correlates to the broader economy, and by way of the broader economy, also correlates to real estate. So I’m going to just stop talking because this show is going to be so great. I’m so excited to share it with all of you. We’re going to take a quick break, but then we’ll be right back with Liz Ann Sonders, who’s the chief investment strategist for Charles Schwab.
Liz Ann Sonders, thank you so much for joining us here On The Market.
Liz:
Hi, Dave. Thanks for having me. Looking forward to our conversation.
Dave:
Oh, it’s our pleasure. For audience who doesn’t know you already, can you just introduce yourself and what you do for Charles Schwab?
Liz:
Sure. So Liz Ann Sonders, I’m the chief investment strategist at Schwab. I’ve been in this role and at Schwab for 23 years. I was, 14 years prior to that, at another firm, so I’ve been in the business for 37 years. My role at Schwab, I guess, would be best termed as an interpreter of what’s going on in the combination of the economy and financial markets, in particular the US equity market, and trying to connect the dots between the economy and the market and share perspectives and advice and learnings and tips with our $8-plus trillion worth of client accounts.
Dave:
Wow. Oh my God.
Liz:
Almost all of which are essentially individual investors, so we’re big.
Dave:
That’s a lot of assets under management. Very hefty client portfolio you manage there. So the people who listen to this audience, I don’t want to generalize everyone, some of them are certainly experts in equities, but most of us are primarily real estate investors. So could you just start by giving us an update on what the state of the stock market is at this point in 2023?
Liz:
Sure, so this has been an incredibly unique cycle both for the stock market and the economy over the past three and a half years for obvious pandemic-related reasons. You had the pandemic, very brief pandemic recession and in turn bear market stocks, and then courtesy of massive stimulus, both monetary stimulus and fiscal stimulus, you launched out of that very brief recession as well as the very brief bear market and had a couple of very strong years. Last year was a much more difficult year obviously for the equity market with the market topping out at the very, very beginning of the year and the chief culprit behind the bear market was what has been the most aggressive rate hiking cycle in at least the past 40 years in terms of Fed policy. And that was the key reason why the market went into bear territory.
You had a relatively recent bottom in October. The market has had an extraordinarily strong move up off that October low. Burning questions around, “Is it just a rally within an ongoing bear market or did that represent the start of a new bull market?” To some degree, I’m not sure the semantics matter all that much. I think that the recent consolidation in the market has been driven by actually stronger than expected economic data, which meant yields have moved well back up again and concerns that maybe the Fed isn’t quite finished. And I grew up in this business working for the late great Marty Zweig who actually coined the phrase, “Don’t fight the Fed.”
So that was certainly the market was not fighting the Fed last year, is fighting the fed a little bit now. So I don’t think we’re out of the woods yet. There’s a lot of uncertainty, but this is the nature of the equity market. There’s bull markets and there’s bear markets.
Dave:
So what do you think has driven the run-up in the stock market this year, whether it’s part of a bear market or bull market, as you said, that’s semantics, but what is driving the inflow of capital or the investor sentiment that’s led to this run-up in prices?
Liz:
So I think there were several contributors when … If you go back to last October when we started this move up off those recent lows, some of it was actually the retreat in bond yields that we were starting to see where you had had, about a week after the equity market bottomed, you saw the 10-year treasury yield peak up around where it is right now at, about 4.2%, and you subsequently saw that yield drop almost a full percentage point. And that became a pretty powerful tailwind behind equities. There was also a sort of a budding impression or hope that the Fed, because of how aggressive they had been, that they were getting close to the point that they could pause rate hikes. That ultimately got pushed further into this year than what was originally expected, but that was a basis for the move higher.
And then there’s another old adage around market performance, which is the market likes to climb a wall of worry. So oftentimes uncertainty, weak or perceived or otherwise economic conditions aren’t necessarily negative for the market because of that contrarian sentiment perspective that the stock market often displays. And then what particularly happened to narrow the market’s performance was the banking crisis that started in early March with the failure of Silicon Valley Bank. That was the point where the market became very heavily concentrated up the capitalization spectrum, a very small handful of names. The Super 7, the Magnificent 8, whatever fun label you want to apply to it, was driving 100% of the performance.
And I think that unique part of this move up was driven by the banking crisis. We want to go into highly liquid names that have strong balance sheets and cashflow was this era’s defensive type names, those techie kind of names. That in and of itself though represented a risk for the market and I think that’s some of what has been at play more recently in this consolidation period because of concerns about that concentration. The analogy that I think is often apt, not that we ever like to think about battlefields, but when it’s just a few soldiers at the frontlines or a few generals at the frontlines and the soldiers have all fallen behind, that’s not a very strong front. When you’ve got the soldiers coming up to the frontline, even if the generals start to step back, that’s a stronger battlefront. So that’s an analogy that I think helps put that concentration risk in context.
Dave:
So just to make sure I’m understanding, the run-up especially since the bank crisis has really been concentrated in some of these mega cap companies and-
Liz:
Until a month or so ago.
Dave:
And now in the last month or so, to continue your analogy, are the soldiers catching up or are the generals falling back to where the soldiers were?
Liz:
For a while there, it was a little bit of both. So you had convergence happening where you saw some profit taking amongst that small handful of names while, at the same time, you were starting to see broader participation down the cap spectrum into other areas of the market that hadn’t participated. More recently, what they call market breadth, their percentage of stocks that are doing well, that has rolled over and you’ve seen deterioration pretty much across the board and that’s why I call it a corrective phase or a consolidation phase. Prior to that, you were seeing this convergence where the generals had taken a few steps back, but more soldiers and that, for a while, looked like a healthy development.
Now we’ve seen a bit of broader deterioration in breadth. There’s probably still a bit more to go on the downside there before I think the market can find more stable footing.
Dave:
Do you think this recent consolidation or just generally the sentiment in the market tells us anything useful about the broader economy?
Liz:
So investor sentiment and more economic sentiment measures like CEO confidence or consumer sentiment, they don’t always tell the same story. There can sometimes be some overlap. In fact, some of the consumer confidence or consumer sentiment measures have the questions embedded in the surveys. They have one or two about the stock market. So sometimes a strong stock market can help boost more economic measures of sentiment and vice versa. But what was interesting in the last couple of months is, at the end of May, beginning of June when we saw the most extreme concentration, there was also a lot of frothiness that had come into investor sentiment indicators. Extreme high level of bullishness on some of the survey-based measures of sentiment like AAII, American Association of Individual Investors. You were seeing huge inflows into equity ETFs, especially tech-oriented ones. At the same time, there was still a lot of consternation expressed in some of these more economic sentiment measures by CEOs, by consumers.
Now investor sentiment, at extremes, tends to represent a contrarian indicator, not with anything resembling perfect timing, but my favorite thing ever said about the stock market goes right to the heart of sentiment as a driver and it was probably the most famous phrase ever uttered by the late greats Sir John Templeton and it’s, “Bull markets are born on pessimism, they grow on skepticism, they mature on optimism and they die on euphoria.” And I think there’s not a more perfect description of a full equity market cycle. Maybe what’s compelling about that phrase is that there’s no word in there that ties into what we think on a day-to-day basis drives the stock market, what we focus on, earnings and valuation and PE ratios and economic data and Fed policy.
It’s all emotions and there’s probably nothing better that defines major bottoms in the market and major tops in the market, not every little wiggle, than extremes of sentiment. Launch points for bull markets tend to come when sentiment is incredibly despairing and vice versa. So that’s what I spend probably more time focused on than the other more technical economic valuation-oriented metrics. I think that really defines market cycles probably better than any other set of indicators.
Dave:
That’s really fascinating. Obviously, you look at the stock market, you see all this complex technical analysis and I’m sure that still has use, but it’s really interesting to know and it makes sense that behavior and psychology is really driving the entire market.
Liz:
It’s not only the market. Behavior and psychology drives inflation. Behavior and psychology drives the economy. The whole notion of animal spirits is embedded in everything that we do and observe and how we live. And it’s not just a market phenomenon, it’s an economic phenomenon. Animal spirits and fear and greed, it comes in play in everything that we do.
Dave:
Absolutely. And a great stock trading podcast, Animal Spirits as well. I totally agree with what you’re saying, but the data analyst to me now wants to know how I can measure sentiment and psychology. Is there a good way to do that?
Liz:
Yeah, there’s myriad ways to do it. I would say the first thing is to understand that there are two broad buckets of sentiment indicators and now I’m talking investor sentiment, not economic sentiment. There’s attitudinal measures and behavioral measures. So attitudinal measures would be something like the AAII survey. It’s a weekly survey of their tens of thousands of members. They’ve been doing this since the late 1980s. And based on the questions, they come up with three categories of investors, bullish, bearish, neutral. And then they apply percentages to how many are bullish, how many are bearish, how many are neutral. So that’s purely an attitudinal-based survey. They’re getting on the phone and saying, “Are you optimistic? Are you not?”
Interestingly, AAII also does a monthly analysis of the actual exposure to equities, to fixed income, to cash of their same members. And what’s really interesting is there are times where what investors are saying and what they’re doing are diametrically opposed and that was the case a little more than a year ago in June of 2022 when the market was really first struggling into what was a pretty significant low at that point. You saw, I think, a record or a near record percent of bears in that survey, but they hadn’t lowered equity exposure. So they were saying, “I don’t like the market,” but they actually hadn’t acted on that view.
Dave:
That’s interesting.
Liz:
So you also have to look at behavioral measures of sentiment. AAII, that allocation survey represents that, something like the put-call ratio in the options market. That’s a behavioral measure of sentiment. Fund flows, the amount of money going into equity ETFs or equity mutual funds, that’s a behavioral measure. There are other attitudinal measures too. One of them is investor’s intelligence, which looks at the advisors that write newsletters and just writers that are just out there writing investment newsletters. That’s an attitudinal measure because it’s not tied to what the advisor’s doing. It’s how they’re expressing their views in the public domain. So I look at all of them. So it’s the amalgamation that’s important and understanding that you’ve got to see whether the behavioral side matches the attitudinal side. Sometimes they can be disconnected.
Dave:
That’s fascinating. Just using your example from June of last year, do you think the disconnect comes from a lack of other options like people didn’t know where else to put their money or what do you attribute the contrast there to?
Liz:
Well, in June of last year, we knew we were in a very aggressive tightening cycle. The Fed had started to raise rates in March. They were also shrinking the balance sheet. So that was seen as a big near term negative. June of last year was also the month that there was a nine-handle on the consumer price index. So inflation was at its peak at that point. You were starting to see deterioration in a lot of the economic data, particularly expectations tied to inflation. So it was just a confluence of things happening at that particular time and the market was weak. So people were reacting in surveys to weak action. They just hadn’t really done much yet at that point.
Fast forward to the October low, the attitudinal side matched the behavioral side. You were back in washout mode, despair in the attitudinal measures, but you would had capitulation behaviorally. What I often like to say is the, I’ll use a real technical term here, Dave, the puke phase, where everybody is just, “I’m out.”
Dave:
[inaudible], yeah.
Liz:
It wasn’t quite as extreme as times like March of 2009, but you finally had that better balance between pessimism behaviorally and pessimism attitudinally.
Dave:
Oh, that’s so interesting. Thank you for explaining that. I want to shift a little bit to some recent market events, which is, we are recording this on the 17th of August just so everyone knows, and just in the last few days, bond yields have started to run up pretty aggressively. Obviously, that is implications for the equities markets, and for real estate investors, we care a lot about this due to their correlation to mortgage rates. So I’m just curious if you can help us understand why yields have been rising so quickly.
Liz:
Well, some of the economic data has been better than expected. So as a tie in to what’s going on in the economy, you can point there, but you also have to remember, and it’s amazing to me how many investors still don’t grasp the relationship between bond yields and bond prices. They move inverse to one another. So when bond yields are going up, it means prices are going down. So sometimes the yield movement can be driven by what’s going on in the economy, but sometimes supply demand, fundamentals, the aggressiveness of the buyers or the sellers can move the price, which in turn moves the yield.
And I think on the price side of things, what has conspired to bring prices down is increased supply of treasuries in the aftermath of getting through the debt ceiling potential debacle, but we also had the recent Fitch downgrade of US debt. So I think the supply demand issues put downward pressure on prices, all else equal put separate pressure on yields and then you have that, for the most part, better than expected economic data and you’ve seen a breakout on the upside. There’s a lot of money in the equity market that trades off of technicals, speculative money that’s more short term in nature and it might be algo driven or quant based and triggered off certain technical levels.
Well, there’s also money that does that in the fixed income side of things. So sometimes they move down in price and move up in yield, can feed on itself and the speculators will play that momentum at some point. So you could see some momentum-driven trading that has potentially exacerbated the move beyond what the fundamentals might suggest.
Dave:
And do you have any idea or thoughts on whether yields will stay this high?
Liz:
So my colleague, Kathy Jones, is my counterpart on the fixed income side, so she’s our chief fixed income strategist. I say it without really meaning it as a joke, but 15 years ago or so when Schwab brought Kathy on was a joyous day in my life because that’s when I was able to stop pretending like I was an expert on the fixed income side of things. So very important caveat. I don’t spend my waking hours deep diving on the fixed income side, but I can certainly, she’s part of our larger group, compare it some of the thinking there. And for the past year plus, yields have been somewhat range bound, low 3s to low 4s and you’ve been bouncing up and down, but we seem to be breaking out on the upside.
There probably is going to be some pressure at some point where yields don’t go too far higher unless we really see surprising, not resilience in inflation, but a turnback higher in the inflation data or if the expectations around Fed policy start to really shift as a result of that. All that said, what I don’t think, let’s assume 4.3 is a near term high in yields and let’s assume the market is right in pricing in rate cuts starting next year. Now I disagree with the market’s perception of that, but we can talk about that separately. What I don’t think is going to happen is, when yields start to come down, when the Fed is done, when they eventually have to start cutting rates again, we are not going back to what we call the ZIRP world, the zero interest rate, which at the time that the US for many years was a 0% interest rate, a lot of the rest of the world was actually in negative territory.
I think that ship has sailed and the next easing cycle, barring some extreme shock to the financial or economic system globally, I think that experiment in zero interest rate policy and negative interest rate policy is one that for the most part was seen as having more in the fail column than in the success column. I think it bred capital misallocation, lack of price discovery, zombie companies. And so I don’t think we head back to 0% interest rates. I also think we’re also entering into a more volatile inflation secular environment. The great moderation, that term was coined by Larry Summers and it stuck and it defined the period from the late ’90s up until the pandemic where you basically had declining inflation the whole time. And that was because the world had abundant and cheap access to goods, to energy to labor. We were in the massive globalization surge, China coming into the world, economic order. All of those ships have sailed.
And I think we’re going back to what was the 30-year period or so prior to the great moderation. There’s no coined term for it, the one I’ve been using. Maybe it will take off like great moderation is the temperamental era, which wasn’t a, “Inflation is high and stays high in perpetuity,” there was just a lot more volatility inflation, and in turn, more volatility in terms of what the Fed had to do to combat the problem. And I don’t think this is the 1970s, but I think we’re in a more volatile inflation backdrop.
Dave:
So in addition to maybe the zero interest rate policy being somewhat of a failed or controversial, at best, experiment, you think the Fed needs to keep some ammunition, if you will, by even if there is a pullback in the labor market, keeping rates a little bit high so that they have some wiggle room if there is some volatility in inflation.
Liz:
So not only wiggle room to come lower, but I think the lesson that the current Fed and Powell specifically, I think, takes from looking at the experience of the 1970s was not so much the playbook of the drivers being similar, they’re quite different, is that the problem in the 1970s was declaring victory a couple of times prematurely, easing policy only to see inflation get let out of the bag again, scramble to tighten policy again, hang the Mission Accomplished banner, rates go down again, inflation’s let out of the bag again. And that’s ultimately what led to Paul Volcker having to come in and pull a Paul Volcker by just jamming up interest rates, almost purposely bringing on the back-to-back recessions of the early ’80s in the interest of really finally breaking the back of inflation.
And I think that’s really … That’s why I think there’s a disconnect between what we’re facing here in the current environment in terms of growth and inflation and the market’s expectation right now that the Fed could cut at least five times next year. And I think the market hasn’t quite come to grips with the message the Fed is trying to impart, which is, once we pause, once we get to the terminal rate the stopping point, the inclination is to stay there for a while, not to quickly turn and start easing policy again because they want to make sure that inflation has not only come down, but it is likely to stay contained.
Dave:
Yeah, and they have cover to do that, right? Because the labor market continues to show pretty good strength. GDP is not amazing, but it’s still up. So it feels like, unless-
Liz:
They not only have cover.
Dave:
There’s no impetus for them to do it.
Liz:
Right. That’s the better way to think of it. That’s where I think the disconnect is. It’s almost a, “Be careful what you wish for,” because an environment that suggests the Fed has to, as soon as the beginning of next year, go into fairly aggressive rate cutting mode, that’s not a great economic backdrop. And this idea that simply if inflation continues to come down that that represents a green light for the Fed to cut doesn’t make a lot of sense. It does support a pause, but the pivot to rate cuts, I think that the Fed’s bias, especially with a 3.4% unemployment rate, is once they get to the terminal rate is to stay there for a while.
Dave:
Yeah, that makes total sense to me. Unless there is a reason, an economic driver for them to cut rates, they’re not just going to do it just to supercharge the economy, at least it doesn’t seem like.
Liz:
Well, the only, I think, rational thought behind why the Fed could start cutting next year without there being a clear recession in sight, without significant deterioration in the labor market is, if disinflation persists at the point the Fed is no longer raising rates and they’re holding steady, the fact that inflation continues to come down means real rates are going up. And so some are thinking that they don’t want to establish the conditions for restrictive policy getting more restrictive even though they’re not doing anything, but with inflation continuing to come down, it means real rates are going up. So there is some rational thought there.
Dave:
That makes sense.
Liz:
It’s just a question of whether real rates going up and being restrictive, whether the Fed views that as starting to represent potential damage for the economy. All else equal, I think the Fed’s inclination is to sit tight for a while.
Dave:
And does that mean you’re not forecasting a break in the labor market or a recession anytime in the near future?
Liz:
So for more than a year now, we’ve been calling this a rolling recession, rolling sectoral recessions. And that is somewhat unique, certainly unique relative to the past two recessions, which were bottom falls out all at once across the economy, different drivers each time. Obviously, the pandemic caused a bottom falls out all at once because the world shut down our economies. So that was unique, but that was an all at once, everything all at once. To some degree, that was the same thing in ’07 to ’09, particularly the worst part of the financial crisis with the combination of the Bear Stearns failure and the Lehman failure and the housing bubble bursting.
And because of the trillions of dollars in the alphabet soup of derivatives attached to the mortgage market in a massively over leveraged global financial system, the housing market busted and it took down the entire global financial system with it. So that’s sort of everything-all-at-once-type recessions. This one, not that any of us want to relive the last three and a half years associated with the pandemic, but it’s important to go back to that point, the point where the stimulus was kicking in, courtesy of the Fed, courtesy of the fiscal side of Treasury and Congress. And that money, the demand associated with it, all that stimulus at that time, was forced to be funneled into narrow segments of the economy, particularly the goods side of the economy, housing, housing-related, consumer electronics, Peloton machines, Zoom equipment, etcetera because we had no access to services.
That was the launch for the economy to come out of the recession, but it was heavily goods-oriented. That was also the breeding ground of the inflation problem we’re still dealing with and it was exacerbated at the time by the supply disruptions. So that was the initial stage of this. But since then, those categories, manufacturing, housing, housing-related, a lot of consumer-oriented goods, electronics, etcetera, leisure, those have gone into recessions. It’s just been offset by the later strength and services. Same thing has happened within the inflation data. You had a massive surge in inflation initially on the good side, then you went into disinflation and in some categories were an outright deflation, but we’ve had the later pick-up on the services side. Services is a larger employer, which helps to explain the resilience in the labor market.
So we’ve seen the weakness roll through. It hasn’t yet hit to a significant degree, services or the labor market. To me, best-case scenario is not so much soft landing because that ship already sailed for the segments of the economy that have had their hard landing, is that, if and when services and the labor markets start to get hit, that you’ve got offsetting recovery in some of the areas that have already gone through their recessions. So I just think you have to look at this cycle in a more nuanced way. That said, if somebody said, “All right, feet to the fire, Liz Ann, you’ve got to say yes or no in terms of, will the NBER at some point say, ‘Okay, recession?’” I would say yes.
Dave:
Okay. Well, I liked your much more nuanced answer anyway. I think we’ve talked on the show a few times that the label recession has almost lost its meaning in a way because it doesn’t actually describe the conditions that we’re seeing and doesn’t actually give you any actionable insight that you could base your decisions off of.
Liz:
Well, it’s so lagging too. The NBER, the day they make the announcement, it’s a recession. And the NBER, the National Bureau of Economic Research, they’ve been the official arbiters of recession since 1978. It’s not two-quarters in a row of negative GDP. That’s never been the definition. I don’t know why people think that’s the definition, but it’s not. They look at a lot of different variables, but simultaneous on the day the NBER says, “Okay, it’s a recession,” they announced the start, which is by month, not by day. They go back to the peak in the aggregate of the data that they’re tracking, which is why, if you were to look at a whole roster of data points, looking back at what we know were the start points of each recessions, the data actually at that time looked pretty good.
What you did know at that time was the descent would be significant enough that it reached a low level sufficient enough to say, “Okay, it’s recession,” the dating it then goes back to the aggregate peak. The average lag in terms of the NBER saying, “Okay, it’s a recession,” and when they backdated as having started is seven months and sometimes it’s even longer. The NBER came out in December of ’08 and said, “Okay, we’re in a recession. By the way, it started a year ago.”
Dave:
“Right, yeah, thanks for letting us know.”
Liz:
And when the NBER announced recession associated with the pandemic, when they announced that, “There was a recession and here’s when it started,” it was actually already over at that point, but it was another 15 months before they said, “Okay, it’s over,” and it ended 15 months ago. So this idea of, “Well, why don’t I just wait as an investor? Why don’t I just wait until the coast is clear? We know we’ve had a recession. We know it’s over. It’s been declared as over. Stock market’s a leading indicator,” man, you have missed a lot of the move on the upside.
Dave:
Yeah, like you said, it is by definition a retroactive label. You can’t use it to make decisions, which is an excellent transition to the last topic I wanted to get into, which is, for our audience, people who are probably mostly investing in real estate, but I would hope are still considering investing into bonds and stocks as well, what strategy would you recommend in these confusing and uncertain times?
Liz:
There is no one cookie cutter answer that’s right for all investors and that’s really important because I think, particularly in the world of financial media, there is either a desire for the cookie cutter answer or there’s just not a willingness to provide the time for the real answer to questions around, “How do I invest? What should I do with my money?” The financial media, in particular, it’s all about, “Should I get in? Should I get out?” And I always say, “Neither get in nor get out is an investing strategy. That’s just gambling on two moments in time.” So the first thing is to actually have a plan and that plan has to be tied to your own personal circumstances. The obvious ones like time horizon, but also risk tolerance. And sometimes people make the mistake of equating the two, meaning, “I’ve got a long time horizon. Therefore, I’m risk-tolerant. I should take a lot of risk.”
What then comes into play is the other really important thing you need to do is try to assess before you make the mistake and learn the hard way, whether your financial risk tolerance, “What’s on paper? How much money do I need to live on? How much do I want to try to save? Do I need to live on the income associated with my investments or I just want the appreciation to grow the sum, the retirement nest egg?” That’s your financial risk tolerance. But if you get the first 15% drop in your portfolio because you go into a bear market and you panic and sell everything, your emotional risk tolerance is entirely different from your financial risk tolerance. So trying to gauge that.
Then those other facets of … What I always say when somebody will say to me, “What are you telling investors to do?” and I always answer that, even if I had a little birdie land on my shoulder and tell me with 97% certainty what the stock market was going to do over the next, whatever year or two, what the bond market’s going to do, what commodities are going to do and I had that information, very high conviction, but I was sitting across from two investors. Investor A, 75 years old, retired, built a nest egg, can’t afford to lose any of it and needs to live on the income generated from that. Investor B is 25 years old, they go skydiving on the weekends. They inherited $10 million that they don’t need. They’re not going to open their statements every month and freak out at the first. So one high conviction view, almost perfect knowledge of what the markets are going to do, what I would tell those two investors is entirely different.
So it all is a function of your personal situation, your risk tolerance, your need for income, the emotions that come into play and so you got to have a plan.
Dave:
I absolutely love that. I’m smiling, because in real estate, we talk about that a lot as well because people want to know, what, buy for cashflow, buy for appreciation, buy in different types of markets and there is no one-size-fits-all advice for any type of investment. If you’re approaching your retirement, “Are you 22 years old? Do you have a high income? Do you have a low income?” it’s completely different. And like you said, with media, people want a quick answer, but if you want to be a successful investor, you have to root your strategy in your own personal desires, and to your point, your own psychology and behavior.
Liz:
That’s right. And maybe it’s a little more boring to talk about things like diversification across and within asset classes and have a plan and be diversified and periodic rebalancing. Maybe it’s not as exciting as, “The market is really expensive here. I think a crash is coming and I think it might happen by next Tuesday and then you want to be an aggressive buyer.” That’s just gambling on moments in time and investing should be a disciplined process over time.
Dave:
Yeah, one gets a lot of YouTube views and the other one’s actually a good investing strategy. Sometimes those are at odds.
Liz:
Yeah, and don’t get investment advice from TikTok or YouTube. It can be a component of good information, but make sure it’s in the context of an actual plan and the education associated with that.
Dave:
Absolutely. It could inform your strategy, but you can’t take their strategy.
Liz:
Right.
Dave:
I think there’s a difference between those two approaches.
Liz:
100%.
Dave:
All right. Well, Liz Ann, thank you so much for being here. This was a fascinating conversation. We really appreciate your time.
Liz:
My pleasure.
Dave:
If anyone wants to follow your work, where should they do that?
Liz:
Well, interestingly, our research, everything that I write, videos that I do, my counterparts in international and fixed income, all of our research is actually on public site schwab.com. You don’t have to be a client, you don’t have to have a login. So all of our research is on schwab.com, but I’m also on, I guess, we don’t call it Twitter anymore, so I’m on X and I post everything that I write, all the videos that I do, TV appearances, promote podcasts and day-to-day, minute-to-minute charts and information and reaction to economic reports coming out. So that’s probably the most efficient way to get everything, but I’ve had a rash of imposters, so just make sure …
Dave:
Oh, that’s the worst.
Liz:
… you’re following the actual @LizAnnSonders.
Dave:
We will put a link to your profile in the show. I’ve been following you on Twitter. That’s how I first found out about you. Excellent. Well, X, I’ve been following you on X, whatever you say now. But yeah, great information just about the economy, super digestible as well, so highly recommend it.
Liz:
Thank you.
Dave:
Liz Ann, thanks again. We appreciate it.
Liz:
My pleasure. Thanks for having me.
Dave:
All right, another big thank you to Liz Anne Sonders for joining us. Honestly, that is truly one of my favorite interviews that I have ever done. I think Liz Ann does an incredible job just explaining what is going on in the economy and what’s going on in the stock market. And I know not everyone who listens to the show is super invested into the stock market, but I think there’s some really interesting and important takeaways here. One thing I was really fascinated about was just about how much investor sentiment really drives behavior and drives the economy.
And it’s not always all of these technical, financial, monetary policy things that I definitely am always obsessing over like Fed policy or what’s going on with certain indicators. And it just makes you realize that obviously the economy is just an amalgamation of human behavior and so you should just be paying attention to, as much as you can, sentiment. I think that is broadly applicable to the real estate market. Just think about something like, for example, the lock-in effect. That is something that is, sure, it’s financial, it is rational in some ways, but it is, in a lot of ways, psychological and behavioral and that is really driving a lot of what’s going on in the market right now. Or people’s feeling of competition in the housing market, that might be driving demand right now. Not everything is entirely rational and a lot of it is based on market sentiment. So I absolutely love that thing.
And then the second thing I just wanted to call out was her explanation of the “rolling recession”. I think it was the best explanation of the economy that I’ve heard to date. I slacked because Kailyn, our producer and I, we have a little chat going to make sure the show flows well and I said to her, “I think I finally understand economics,” during that part of the show because it was just so … It really helped understand that there’s these waves of economic activity and not everything is the same. We saw this uptick in goods inflation and that calmed down, but then we saw this uptick in service inflation and that is starting to calm down, but that’s a strong employer and why we haven’t seen as much of a decline in the labor market as you might see.
So I thought this was so interesting, and absolutely, if you couldn’t tell, loved her comments at the end about how strategy, whether you’re a real estate investor or a stock market investor, really just has to come from you and your own personal circumstances. I was nerding out about that and very excited about that because I’m actually writing a whole book about that topic for real estate investors. It’s due in two weeks, so it’s all I’m thinking about right now and it comes out in January, so you’re probably going to want to check that out, hopefully.
Thank you all so much for listening. If you love this show as much as I did, please give us a five-star review either on Apple or on Spotify or share this with a friend. Maybe you have someone who’s interested investing in the stock market or just wants to learn more about the economy. I think this is a great episode to share with really anyone. Thanks again for listening. We’ll see you for the next episode of On The Market.
On The Market is created by me, Dave Meyer and Kailyn Bennett, produced by Kailyn Bennett, editing by Joel Esparza and Onyx Media, researched by Puja Gendal, copywriting by Nate Weintraub, and a very special thanks to the entire BiggerPockets team. The content on the show, On The Market, are opinions only. All listeners should independently verify data points, opinions and investment strategies.
Help us reach new listeners on iTunes by leaving us a rating and review! It takes just 30 seconds and instructions can be found here. Thanks! We really appreciate it!
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Sculptor accuses founder of acting on resentment amid scrutiny of Rithm’s deal
In a letter to a group of founders and shareholders, New York-based asset management firm Sculptor Capital Management said their request to inspect the company’s books and records pertaining to its acquisition by Rithm Capital was “improper” and motivated by founder Daniel Och’s “long-standing resentment” of being exited from the company.
Sculptor also said in the letter sent on Tuesday that Och and the other shareholders have requested millions of dollars in cash for legal expenses incurred during the process of being acquired by Rithm Capital. Och and shareholders also requested a prepayment related to a tax agreement tied to the company’s IPO in 2007.
Och, shareholders and Rithm Capital did not reply to requests for comment.
The letter from Sculptor is the latest chapter of a dispute between the asset management firm, Och and other shareholders since Rithm — the real estate investment trust that operates NewRez, Caliber and several other businesses —announced a deal to acquire Sculptor for $639 million in July. If regulators approve, it will bring Sculptor’s $34 billion in assets under management to Rithm.
“While ostensibly requesting information about the sales process described in the Company’s preliminary proxy statement, your Demand for books and records is set against historical context that makes clear that purpose is pretextual, and that the true purpose is the continuation of what the company views as Mr. Och’s well-publicized, years’ long smear campaign against the Company’s management,” the letter states.
Och, who founded Sculptor in 1994, stepped down as CEO in 2018. In 2016, an Africa-based subsidiary entered into an agreement with the Department of Justice (DOJ) to pay a criminal penalty of more than $213 million in connection with a bribery scheme involving officials in the Democratic Republic of Congo and Libya.
Och, who is still an active shareholder, and other former executives sued the firm in 2022 over CEO Jimmy Levin’s $145.8 million compensation.
Och, who was previously a mentor to Levin, now finds himself on the opposite side of a dispute with Levin in which the Rithm deal is a key issue.
On August 16, a group of shareholders, including Och, Harold Kelly, Richard Lyon, James O’Conner and Zoltan Varga, sent a letter to Sculptor’s special committee of the board of directors saying the deal with Rithm “substantially undervalues the company.”
They noted that on December 17, 2021, when “the Board of Directors approved the exorbitant compensation package” for Levin, the stock was trading at $20.02.
“Just over 18 months later, the Board now has approved a deal that would pay the public shareholders $11.15 per share, just a fraction of what the stock was once worth.”
In the letter, Och and the other shareholders said they were working with Rithm to see whether deal terms could be improved. Absent “material changes,” the group will “vigorously oppose this transaction,” they wrote.
On August 21, Sculptor replied in a proxy statement that it received multiple takeover bids higher than the Rithm offer, some valuing the company at more than $700 million. Sculptor did not accept these bids due to burdensome conditions, lack of secured financing, or, according to the company, because Och and other founding partners rejected its terms.
Och and other shareholders, in subsequent correspondence, demanded that Sculptor release books and records on August 22.
“The suggestion that there were other credible bids that provided greater value and certainty of closing, with or without current management, is distorted — no such bid exists,” Sculptor said in response to the request. “Nor does Rithm’s bid crystallize supposed losses from the adoption of Mr. Levin’s compensation package. Mr. Levin has also agreed to substantial reductions in his compensation to support a Rithm transaction.”
Sculptor said in its letter that Och and the other shareholders asked Rithm to agree to advance tens of millions of dollars as a prepayment at the favorable discount rate of the company’s Tax Receivable Agreement.
Och and shareholders also demanded Rithm pay an additional $5.5 million in cash for the group’s legal expenses supposedly incurred in connection with the company’s sales process.
“The transaction under discussion between the Och Group and Rithm would have included the option for a rollover in order to allow you to avoid recognizing significant taxable gain received in the transaction. Notably missing from those discussions were meaningful concessions by any of you for the benefit of public stockholders,” Sculptor states in its letter.
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Pending home sales rose 0.9% in July
Mirroring the trend for new home sales(up 4.4%), pending home sales rose 0.9% in July, according to data released Wednesday by the National Association of Realtors (NAR).
Year over year, pending home sales were down 14%, a smaller decrease than the 15.6% annual drop recorded in June. However, unlike the market for new homes, which has recovered convincingly above last year’s lows (+31.5%), pending home sales continue to lag behind year-ago levels (-14.0%). The NAR’s Pending Home Sales Index climbed to a reading of 77.6 in July. An index of 100 is equal to the level of contract activity in 2001.
“The small gain in contract signings shows the potential for further increases in light of the fact that many people have lost out on multiple home buying offers,” said NAR Chief Economist Lawrence Yun. “Jobs are being added and, thereby, enlarging the pool of prospective home buyers. However, rising mortgage rates and limited inventory have temporarily hindered the possibility of buying for many.”
A regional look
Regionally, on a month-over-month basis, pending home sales in the South (95.3) and the West (61.3) climbed and showed the smallest declines from one year ago, according to Realtor.com Chief Economist Danielle Hale.
Meanwhile, the Northeast (63.2) and the Midwest (77.5) fell, even though these two regions recently boasted more robust real estate activity and stronger pricing. Compared to a year ago, pending sales activity was down by more than 20% in the Northeast region, the biggest decline in that region over the past year, noted Lisa Sturtevant, Bright MLS chief economist.
“Greater availability of homes for sale in the South and price breaks in the West were likely contributors,” said Hale.
Overall, pending home sales fell in all four U.S. regions compared to one year ago.
Is the housing market finally gaining momentum?
The median existing home price crawled north of $400,000 in July while mortgage rates inched above 7%.
“These significant affordability challenges, as well as a continued dearth of inventory, lower the likelihood that pending sales will continue to grow,” said Kate Wood, home and mortgage expert at NerdWallet.
While it is common for pending sales to decline between June and July, this year’s situation is tougher, said Sturtevant.
“Buyers are being forced to lengthen their home search since there are so few properties available for sale,” she said. In fact, two out of three Mid-Atlantic buyers who purchased in July had to make an offer on more than one home before they were successful, found a Bright MLS’s recent survey.
Sales activity is expected to remain slow for the rest of the year, as inventory remains low and mortgage rates remain high, noted Sturtevant.
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Brokerage showdown: Flat-fee vs. traditional real estate brokerage models
In the competitive world of real estate recruitment, brokerages fight for the attention and loyalty of talented agents who can drive their success. As the lifeblood of the industry, agents play an important role in attracting clients, closing deals and determining the ultimate profitability of a brokerage. For real estate firms, recruiting a high number of agents as well as recruiting the best-fit agents for your firm is the key to long-term success.
Today, new brokerage models and disruptors are the norm. A firm’s ability to adjust to new competitors and evolve its way of doing business will determine if it comes out ahead in the agent attraction showdown.
At the heart of our comparative analysis, we’ll examine two popular brokerage models: the flat-fee model and the traditional model. Each one boasts its own approach to compensating and supporting agents, promising distinct advantages and challenges. By examining the data, we aim to gain a deeper understanding of each and determine which ultimately comes out ahead.
The flat-fee model: Simplifying compensation, embracing independence
In the flat-fee model, the traditional commission-based structure takes a backseat. Instead, agents are charged a fixed fee or a flat monthly rate, which allows them to retain a more substantial portion of their commissions from transactions. This straightforward approach grants agents the freedom to keep more of their hard-earned income, resulting in potentially higher take-home pay.
The traditional model: Commission-driven powerhouses
In the traditional model, agents are compensated through the classic commission-based structure. They earn a percentage of the commission from each completed transaction, but a portion of it is shared with the brokerage. This model has been the bedrock of the real estate industry for decades, with established firms carrying well-known brand identities.
The analysis
To assess the agent attraction expertise of the flat-fee and traditional brokerage models, we looked to the data. We meticulously examined a collection of 20 of the largest real estate firms; 10 flat-fee firms collectively closing $100B in annual sales volume versus ten traditional firms which were also collectively closing $100B in annual volume [2022 RealTrends 500 brokerage data]. We excluded from our analysis any alternative models, disrupters, luxury brands and any other firms that may skew our findings.
Agent count & average sides per agent comparison
Using 2022 data from RealTrends, we first looked at the number of agents associated with each model as well as the total number of sides transacted. The data reveals that flat-fee firms collectively had a 136% higher agent headcount than their counterparts, the traditional models.
As a whole, the flat-fee firms also transacted more sides than traditional firms; approximately 19% more sides closed. We would expect that flat-fee firms would transact a higher number of deals since they have a significantly higher agent count. However, agents within the flat-fee model on average closed four deals per agent while agents within the traditional model closed eight deals per agent.
Average volume per agent & average home price per transaction comparison
Another critical data point to review is found in the average closed volume per agent. A higher closed volume can indicate an agent’s future earning potential as well as longevity in the business. In addition to examining the total volume, it’s also helpful to review the average size of the deals closed by agents within each model, which will provide insight into experience level and expertise.
The data shows that agents within flat-fee firms close less in average volume per agent, approximately 52% less. We can also see that they also closed smaller deals, on average.
Attracting new-to-the-business agents
Based on the statistical analysis, it becomes apparent that flat-fee firms often focus on a large agent count with high transaction volume. A notable trend emerges where agents drawn to flat-fee models are frequently those who are relatively new to the industry or are brand new licensees. Additionally, individuals attracted to the part-time flexibility that a real estate career offers are inclined towards flat-fee firms.
Consequently, a greater number of agents are required within flat-fee firms to achieve equivalent volume targets. Remarkably, this demand for increased agent numbers has not posed a deterrent for flat-fee firms, as evidenced by their substantial growth in recent years.
Historical shifts
While the initial data analysis reinforces existing assumptions, a more interesting and unexpected dimension emerges when historical shifts in volume and sides across both brokerage models are examined. Following the post-COVID real estate boom, both flat-fee and traditional firms experienced a surge in sides transacted as well as increasing property values, contributing to an upswing in overall sales volume.
However, the scenario shifted in 2022 with the market downturn. Traditional brokerages experienced a sharper decline in sides, attributed in part to agents leaving due to high costs, whereas flat-fee firms exhibited greater resilience. The notion that flat-fee models attract individuals who do not rely primarily on real estate as their main business is worth noting. Most intriguing is the fact that although sides decreased more significantly, the impact on overall sales volume was less severe for traditional firms compared to flat-fee firms.
A plausible theory suggests that agents within traditional firms specialize in higher value properties than flat-fee firms, leading to increased value growth. Their higher production per agent, coupled with greater experience and support, equips them to navigate market fluctuations more adeptly.
Takeaways:
As we conclude our analysis, it’s evident that the many seasons of change in real estate demand a strategic negotiation between innovation and tradition. Agents, the driving force of the industry, now have the luxury of choice. To win in agent attraction, flat-fee models can further bolster their appeal by offering targeted support and mentorship, enhancing their brand recognition, and cultivating a sense of community among their diverse agent base.
Conversely, traditional models can leverage their established brand identities to attract experienced agents while embracing flexibility in their offerings to cater to the changing preferences of a new generation of real estate professionals. By embracing the strengths of both models and charting a course that resonates with modern agents, brokerages can ensure they remain at the forefront of the industry’s evolution.
Diana Zaya is the founder and president of Maverick RE Consulting.
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In July, job openings declined to pre-pandemic level
U.S. job openings fell in July, declining to an early 2021 level. A few weeks ahead of the next Federal Open Market Committee meeting, this latest data release offers fresh evidence that the labor market is cooling.
The number of job openings edged down to 8.8 million in July from 9.17 million in June, the Bureau of Labor Statistics’ Job Openings and Labor Turnover Survey, or JOLTS, showed on Tuesday. It marked the sixth decline in the last seven months. In July, the number and rate of hires were little changed at 5.8 million and 3.7%, respectively. Also, vacancies fell for sixth time in the last seven months.
“The Fed is getting exactly what it wants; it wanted to attack the labor market, and finally, they’re getting closer to their goal,” said HousingWire’s Lead Analyst Logan Mohtashami.
The quits ratio, which measures voluntary job leavers as a share of total employment, decreased to 3.5 million with a rate little changed at 2.3% — this is its lowest since the start of 2021. In other words, Americans are less confident in their ability to find another job in the current market.
Job openings decreased in professional and business services, health care, social assistance and government. By contrast, job openings increased in information, transportation, warehousing and utilities.
The latest report confirms that the labor market is rebalancing, with improved supply and moderated demand. Consequently, wage growth has tempered. The Fed expects this trend to continue, said Jerome Powell last Friday at an economic policy symposium in Jackson Hole, Wyoming. However, the Fed Chairman remained cautious and if the labor market stopped easing, the Fed would have to provide a monetary policy response. Meanwhile, unemployment remains historically low.
“I believe they will feel a lot more comfortable with job openings around 7 million, but the quits ratio is back to pre-pandemic levels, so their attack on the labor supply is working,” added Mohtashami.
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Image Analytics from CoreLogic helps users analyze property images quickly and accurately
Reviewing appraisal imagery, an essential step in the valuation review process, is time-consuming and laborious.
CoreLogic developed Image Analytics to drive innovation in the appraisal review process and help lenders and mortgage industry professionals analyze property images quickly and accurately. This technology eliminates the need for manual, multi-touchpoint review, which saves time and reduces errors.
Image Analytics is a fully automated solution that evaluates the content of the appraisal photos, highlighting errors and allowing lenders to reduce time, effort and costly manual mistakes within their operations.
Image Analytics’ accuracy rate of 99.7% allows lenders’ staff to focus on exceptions in the appraisal reports rather than manually reviewing every photo in the report. The Image Analytics solution also detects mismatched report quality ratings and missing or mislabeled photos at a rate of 99.9%.
Appraisals traditionally are manually reviewed by 2-3 people per report, each spending 10-15 minutes on imagery review. With Image Analytics, the process takes a fraction of the time previously needed. The image review time is reduced by up to 45 minutes per report. As a result, fewer people are required for each report review, reducing personnel expenses and freeing time to spend elsewhere.
“Our trustworthiness and reputation as an expert in the industry have earned us credibility among our customers,” said Bob Jennings, executive of mortgage valuation solutions at CoreLogic. “The accuracy and efficiency of Image Analytics will strengthen this relationship as a technological expert solution provider.”
Image Analytics meets the need of the industry to lower costs per loan, improve operational profitability and help satisfy regulatory requirements, ensuring lenders can be confident they are reviewing trustworthy collateral investment valuations.
Image Analytics is a solution that supports the industry’s increasingly complex requirements and helps lenders make confident collateral investment decisions related to appraisal imagery. Image Analytics is revolutionizing the valuation review process!
To learn more about Image Analytics, contact CoreLogic here.
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Why all your exes probably live in Texas
Texas continues to outpace other states in attracting new residents, according to migration data from John Burns, with Houston, San Antonio and Fort Worth showing strong housing demand. The other top cities for in-migration include Jacksonville, Florida, Charlotte, North Carolina, and Nashville, Tennessee.
However, the Austin housing market, which boomed during the pandemic, is now seeing barely positive migration numbers, along with Phoenix, Arizona, and Las Vegas, Nevada.
According to Altos Research, the Austin metro housing market shows signs of a substantial normalization in home prices compared with the overall trends of the pandemic years and pre-pandemic years. The median sale price for a home in the Austin metro area reached a peak of $675,000 in April 2022. By April 2023, that figure had dropped by 14.07% to a median sale price of $580,000. As of August 2023, the median sale price in the Austin metro area had moderated further to $569,900.
The John Burns report shows housing demand is weak in Sacramento and Riverside-San Bernardino, California.
Meanwhile, in metros such as Denver, Seattle and Philadelphia, the concern doesn’t revolve so much about the people coming in but too many going out, as out-migration is becoming a real issue.
At the very bottom of the list, the East Bay area, Orange County, San Diego, San Jose, Miami, Washington, D.C., Boston, Chicago and San Francisco show very negative domestic out-migration. However, this exodus might be offset by international migration.
To conduct this study, John Burns monitored domestic migration trends in near real time, using postal address change forms that are current within a few months. This data excludes international migration.
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New Agent Lawsuits Could Have Profound Effects
New real estate commission lawsuits could change home buying and selling as we know it. Long gone may be the days of buyers walking away paying zero commission and sellers having to bear the entire burden of a real estate transaction. Two new class action lawsuits against the National Association of REALTORS (NAR) could change how agents are paid and deals are done, but should investors even care?
We brought in James Rodriguez, Senior Real Estate Reporter at Business Insider, to explain exactly what could happen to commissions, what this means for the future of buying and selling real estate, and whether or not the next agent extinction is on our hands. With over $40 billion in damages from these combined lawsuits, real estate agents may wake up to an entirely new housing market where their services are rarely needed.
But who’s forging this fight against real estate agents, and why are they pushing for a “decoupling” of commissions? And, if you’re a full-time agent, should you be concerned about where your next paycheck could come from, or is this merely a hollow case with no REAL threat to hard-working agents and realtors? Stick around; we’ll get into who should (and shouldn’t) be worried.
Dave:
Hey, everyone. Welcome to On The Market, I’m Dave Meyer. Joined today by Henry Washington to talk about Henry’s favorite topic in the entire world, antitrust law. How excited are you?
Henry:
Oh man, I woke up this morning thinking, “I can’t wait to dive into more antitrust law.” And here I am.
Dave:
I knew it. That’s why we called you for this one. But all jokes aside, we were actually talking about something that is super relevant to real estate investors, which is the way that real estate agents are paid through commissions.
I’m not sure if you all have heard about this, but there’s basically two major multi-billion dollar lawsuits out there, that are saying that the way that real estate agents are paid, which we’ll get to and talk about a lot throughout this episode is anticompetitive, and basically it needs to change.
And so we are bringing in an expert, James Rodriguez, who is a reporter for Insider to talk about these lawsuits and the potential implications for real estate sellers, obviously, for real estate agents, for buyers, for basically everyone in this industry because everyone is genuinely affected by the way that commissions are paid out currently.
So Henry, what should people be listening to, given your expertise on antitrust real estate law?
Henry:
Look, I’m excited for this show because there is still so much confusion around how commissions are paid, who commissions are paid to, why people pay certain people commissions. It took me a while in this industry to even understand how all that truly works. And so being able to talk to somebody who has a general understanding of it and then talking about, how it might change or could change or should change is super interesting to me because obviously this affects my everyday business.
And if it’s confusing to me, somebody who is in this business all day, every day, it’s got to be scary and confusing to people just entering the market, trying to buy a home or people selling their home. These are peoples, typically, it’s their only net worth. It’s their only true wealth that they’ve accumulated.
And so it’s got to be scary to just go into this market and not fully understand how you might or might not be impacted and could it cost you thousands of dollars or should you pay thousands of dollars? And so I’m super excited to dive into this topic and hopefully shed some light on both how agents are compensated and whether or not it should change or not.
Dave:
Yeah, absolutely. That’s a great way of putting it. I think for people like us who have been doing this a long time, it’s still confusing, don’t fully understand the implication. So super excited to speak with James today.
Also want to say, I was joking about Henry’s expertise in law. You probably know a couple things, but please don’t expect that anything Henry or I say, is any way informed by actual law. Please consult an attorney before you take any of our advice in this episode or any episode.
But for real, this is a great episode and if you do like it, we ask that you please share it with someone that you know, I mean, I think this is going to impact anyone who or could, I should say, it could impact anyone who is involved in this industry, whether it’s you know someone who’s selling a home, buying a home, or is a real estate agent. And if you like the show, please don’t forget to give us a review on either Apple or Spotify.
But that, let’s bring on James Rodriguez, who is a senior real estate reporter at Insider. James, thank you so much for joining us for On The Market. Let’s start by having you tell us a little bit about your position as a reporter at Insider, what you cover and how you got into covering the national housing market.
James:
Sure. And thanks for having me. So I am a senior reporter on Insider’s Discourse teams. So basically we focus on tackling big questions or ideas through analysis and feature pieces. And so for me, that means asking big questions about the housing market, whether that’s what are the challenges for first time home buyers right now or these lawsuits that we’ll be talking about, which could, as I mentioned in the story, could radically reshape how we buy and sell homes.
And I got my start in Denver, actually. I was originally a data reporter there. So basically any story that involved a lot of numbers I’d be on in some capacity, and there was just so much real estate development and real estate news going on there at the time. This was back in 2018, and so I kind of just naturally fell into a backup real estate reporter role, just working on extra stories that the full-time reporter didn’t have time to get to.
And then when that job opened up at the beginning of 2020, I took on the role of real estate reporter full-time, and kind of had a front row seat to the way that COVID just altered the landscape for real estate in Denver and then nationwide as well. And so then ended up moving to Insider and now focus on more of a nationwide housing market.
Dave:
We picked a very good time to get into the housing market. It’s very interesting time to be in media covering the space, at least for us at BiggerPockets, and on the show it has been.
It sounds like you have very qualified background, James, and you wrote an incredible article. I loved reading it, called The multi-billion dollar lawsuit that could radically reshape how we buy and sell homes forever. And that’s what Henry and I are so eager and interested to talk to you about today, is these lawsuits that could potentially change the way that real estate commissions are structured.
So let’s just start at the top. We do have a lot of real estate agents who listen to the show, so they probably know this, but for everyone else who maybe hasn’t worked with an agent before, can you just tell us a little bit about how agents are currently compensated and then we’ll go into some of the prospective changes?
James:
Sure. So on a very basic level, most real estate agents are independent contractors, so they rely on commissions to earn a living, and they’re affiliated with brokerages that provide mentorship and training. But the main feature that they provide is just the ability to hang their license to operate in the market. And so in exchange for that, typically the agents will provide them with a cut of their commissions.
And typically the commissions for a real estate deal will range between 5% and 6% in the US, and in most transactions that’s split between the listing agent who’s representing the seller, and the buyer’s agent. Usually it’s an even split, but there can be a lot of variation there. And that’s pretty much at a basic level how real estate agents make their money today.
Henry:
Yeah. What’s interesting is this article, well obviously the lawsuit is interesting in general, but I think there’s a misnomer in general in the real estate agent space about how agents get paid.
I think most people think that each agent is paid by the prospective person that they’re representing. I think everybody understands, “I’m going to pay 6%, the seller’s going to pay 6% and that three goes to the buyer and three goes to the seller.” But that’s not really how it works, is it? It’s that all 6% goes to one of the agents, who is then somehow responsible for paying the others.
Can you shed a little more light on what that truly looks like?
James:
Yeah. Absolutely. Because it’s really interesting serpentine path that I described in this story, which is basically, when the seller lists their home for sale, they’re working with the listing agent typically, and they say, “Look, I’ll pay you the listing agent 3%.” But they’re also agreeing to pay the buyer’s agent say 3% as well.
And so at closing, the buyer pays the seller usually with the help of a mortgage, and then the seller will pay their agent, that say 6% commission, and then the listing agent will actually split that commission with the buyer’s agent.
So even though the buyer is the one who’s kind of fronting all the money, the commissions then come out of the seller’s pocket. And actually up until a couple of years ago, buyer’s agents could actually tell their clients that their services were free, because of this model, because the seller pays out the listing agent who then splits that commission with the buyer’s agent.
Henry:
Yes, exactly. And so I knew this because we’re doing deals all the time. And I don’t know that a lot of people actually read through their contracts with their agents to understand that that’s what’s actually happening.
And so I think, you said it a little bit in the intro, but a lot of the times this can vary from market to market on what those actual percentages are, and those percentages could have an impact on how quickly or not quickly your home gets sold, because I know here even regionally here in Arkansas, so we’re split between two counties, right? We’ve got Washington County and Benton County. And in Benton County, each little niche market has its own general rules for how these agents deal with commissions.
And so in Benton and Washington County, it’s expected that a buyer and seller’s agent are both going to get 3%. I’m sorry, in Benton County. But in Washington County it’s typical to see that one agent is going to get, I think it’s 3.7%, and the other agent gets 2.3%, and that’s like…
Dave:
I’ve never heard of that.
Henry:
Could be considered normal for here, but that could have an impact on the amount of eyeballs that see your property. So I was wondering if you’re seeing that in other areas of the country or can explain how that might actually impact your home sale?
James:
Yeah. And I think a lot of that just boils down to just how local real estate is in general. I think we see so many different ways of operating around the country, and a lot of that can depend too on guidance from local realtor associations. They’re going to have different norms and different ways of organizing their members all under the National Association of Realtors umbrella of course, but everything can be so local.
And then of course, it also depends on the arrangements that the agents themselves have between themselves and their agents or the clients. So the buyer agent and their client may have an agreement that says, “No matter what the seller is offering, I would like to get two and a half percent.” And so even if the seller is offering 2%, then it might be upon the buyer to pay that extra half percent, or there are all kinds of agreements that a buyer or seller can make with their individual agent to agree on commission before any transaction’s done.
Dave:
Okay. So we have a basic framework of this. I guess it’s not basic. Somewhat confusing framework for how real estate agents get paid currently, but the news here is that there are two currently very large class action lawsuits pending.
One is called Sitzer, is that Sitzer? Versus NAR and the other is Moehrl versus NAR. Basically trying to challenge the way that real estate agents are compensated. What is, basically what are they challenging?
James:
Yeah. And one interesting little wrinkle about the Sitzer case too. It’s actually been renamed Burnett et al versus NAR et al, and then there’s Moehrl, which is the larger of the two cases, but I can kind of break down each of those.
So in the Burnett case, which was filed in Missouri, it’s the smaller of the two cases. It’s scheduled to go to trial in October of this year. Both these cases have been bubbling since 2019, but really starting to gain traction now, especially when both of them were given class action status. So each of these cases is representing a broad swath, of home sellers who are the plaintiffs who are basically arguing that they were forced to pay unfairly high commissions, and they’re suing the National Association of Realtors, as well as all of these large brokerages.
You think of RE/MAX, Keller Williams, Anywhere Real Estate, which includes Coldwell Banker and Century 21, and they’re saying that NAR and these large brokerages basically conspired to force sellers to pay these unjustly high commissions. And the way that they’re doing this is through the rules of the multiple listing service or the MLS. And basically, because of this requirement in the MLS that says, “When you list your home, you must promise to offer the buyer’s agent some sort of commission.”
Now, the NAR doesn’t specify what that commission needs to be, but as we see in practice, it typically ends up being between two and a half or 3%. And that rule, it’s the cooperative compensation rule, which is really at the heart of this lawsuit. That rule is really the reason why we have this strange way of paying out agents, where the buyer pays a seller who pays a listing agent, who then pays the buyer’s agent. That’s because of this rule, which is when you list a home, you’re promising that compensation.
And so these lawsuits basically contend that, because of this rule, these sellers don’t want their homes to go overlooked in the MLS. And so they feel that in order to entice buyer’s agents to show their clients the property, they need to promise a commission that’s in line with kind of the going rate. So they’re essentially forced to pay for this buyer’s agent service.
So I mentioned the Burnett case, which is scheduled to go to court, go to a trial in October this year with a backup date in February 2024. The damages in that case could total nearly $4 billion. And then you have the Moehrl case, which is the larger of the two cases. Damages in that case could actually total more than $40 billion. And that case includes a much wider group of home sellers. And there hasn’t been a trial date set. People that I talked to expect it to be sometime in 2024.
So really these cases are starting to gain a lot of traction. Both of them. A judge reviewed them and granted them both class action status, and so they’re moving forward and they could have these really profound effects for the ways in which we buy and sell homes. And I’m sure we’ll get into that, but that’s kind of the basic state of play right now.
Henry:
Okay. So for clarification’s sake, because it sounds like there’s a few things here. They’re sellers and if they’re saying, “I don’t want to pay for a buyer’s agent.” Or, “Is the rub that if my agent is taking a less than what’s considered fair commission, and this gets posted on the MLS where all of the prospective agents can see this, that I won’t get eyeballs on my property and it might take longer to sell.” What specifically are they concerned about and what’s driving this lawsuit?
James:
Yeah. The real issue here with the plaintiffs that the sellers are seeking to accomplish is a decoupling of the commissions. Basically, they’re arguing that if each side just pays their own agent separately, it doesn’t go through this process where the seller then pays the listing agent and so on, that there will be more transparency, more incentives for both sides to actually negotiate rather than accepting, “This is the way that things have always been done.” “This is the way that they’ll continue to be done.”
So this decoupling they say, would incentivize buyers to negotiate more for themselves and negotiate lower commissions with their buyer agent. And then for the listing agent, they wouldn’t have to then pay out the buyer’s agent at all, and they could focus on negotiating with their listing agent and getting what they feel is a fair commission there as well.
Dave:
And James, sorry if I’m not understanding this, but all this, what you’re saying makes sense. I’m tracking what you’re saying, but what about it is illegal? I get that there’s sort of this frustration here by sellers, but what is the law that they’re saying is being broken?
James:
They’re basically arguing that this is an anticompetitive practice, that this is discouraging competition because of, there’s also what they’re concerned about is this issue that you alluded to Henry of steering, which is basically they’re arguing that, because they are forced to offer compensation to the buyer’s agent.
They don’t want to offer less than the going rate because if they do, then buyer’s agents might be more inclined to just steer their client away from that property altogether that they’ll just say, “Look, I can get a better commission somewhere else. I’m just not going to even bother showing my client that property.”
So the issue is basically they feel like because they’re forced to pay the buyer’s agent, they’re being forced to kind of meet that going rate. And again, the NAR argues that commissions are always negotiable. They’re saying that basically if you wanted to offer the buyer’s agent $1 or 1 cent, technically, that would comply with the rules of the MLS.
Which again, these MLS there’s about 600 independent local databases where agents list properties, they’re governed by rules, they’re controlled by local realtor associations and governed by rules mandated by the National Association of Realtors, the NAR. So that’s why the plaintiffs are taking issue with the NAR because they’re handing down these rules that they feel are basically forcing them to have to pay this kind of going rate of two and a half or 3% to buyer stations.
Dave:
Henry, can I just ask you, have you ever paid anything other than 5.7 to 6% in your life?
James:
Absolutely not.
Dave:
It’s just what it is. I’m not saying that’s right or wrong, but I’ve never seen someone really successfully negotiate a different split in my life, at least.
Do you know, James, if that’s common, is that part of the lawsuit that are people refuting the idea that it’s negotiable with evidence?
James:
Well, that’s the thing here is we’ve seen, you can look at average commission rates in the US which have admittedly gone down slightly, it’s around 5% now, is that the average commission rate for real estate deals in the US. But it’s been pretty stubbornly high despite all of these innovations in the market.
You think of the ability to look for homes online, you think of new technologies and as well as an influx of agents over the past decade. You’ve had all of these real estate agents kind of chasing deals in the wake of the great recession, as we’ve seen home prices rise. And normally you’d expect that to result in more price competition to see in a competitive market, you’d expect to see maybe some type of, you expect to see commissions fall maybe, as a result of that more competition in the marketplace.
And you do have, I will say, some discount broker models out there that will work with you for say, a 1.5% commission rate or some sort of flat fee model. They do offer less service in some cases. I can’t speak broadly for every single one of them, but that model hasn’t gained traction in the way that I think when it was initially introduced, people thought it would. So that’s why we have seen commissions remain where they’ve typically been at despite all these changes.
Henry:
So it seems like a lot of the hangup is with the model of having to sell on the MLS, is it possible for homeowners to sell their home without using the MLS or are people forced to use this system?
James:
So the MLS is pretty much the best way to get the most eyeballs on your home to theoretically get the best price for your home. So when you look at last year, the NAR reported that roughly 87% of sellers used the MLS. So it’s still the most widely used method of selling a home, and that data from the MLS then filters to sites like Zillow and Redfin. And so that’s how you have online listings.
And if you’re a seller, you probably want access to the MLS. And the way that you get that access is through at dues paying member of the local realtor association, which operates that MLS. So about 97% of MLS are operated by a local realtor association. So one of the best arguments for working with a realtor actually is you get access to this MLS, and you get as many people looking at your home as possible.
There are ways to, you see for sale by owner, which is someone just kind of going out on their own and maybe advertising through other methods, Craigslist or even just hanging out flyers or just putting a for sale sign in their front yard. There are companies as well that offer flat fee MLS listings, which is basically you pay them a few hundred dollars.
They’ll get your property on the MLS and kind of call it a day from there, or you could again work with a discount brokerage that offers maybe fewer services, but we’ll get you on the MLS and get you some of those services that you need to get your home out there.
Dave:
So in the case that the plaintiffs win and there is some decoupling as you called it, what would this mean for how agents are paid and what do you think it means more broadly for the home buying industry?
James:
Yeah. It’s really interesting, because basically the way that it works right now, is the buyer is essentially able to off-load the payment for their agent, who they work with to the seller, of course, they’re usually financing their home purchase, and so they’re kind of able to bundle that into their mortgage, they pay for the house, and then their agent eventually gets paid out.
If they’re paying for their agent directly, the plaintiffs say, and an expert from the Consumer Federation of America who I talked to, basically you might see more buyers choosing to just kind of pay their agent on an hourly basis and just this is, “I’m paying you for this work, this service of help me find a house and maybe some negotiating in there.” But you won’t get a piece of the eventual price, which it brings up an interesting question of, if you’re a buyer working with an agent and you theoretically want to get a home for the best price, one person I talked to basically said, “Why are you paying? Why are you paying them a commission? Why are they getting commission that’s incentivizing them to basically get a higher price?” Which would mean a bigger commission for them. Why are they getting a commission in the first place?
So you might see more of that kind of paying a buyer agent hourly, but also on a more dramatic scale, you might just see fewer people using buyer’s agents altogether. If they’re forced to pay for a buyer’s agent out of their own pocket, you might see people not wanting do that. That could be a lot of money. If that’s a two and a half or 3% of a house, that’s tens of thousands of dollars in some cases.
And so you might see in other countries where the Netherlands or Australia or the UK where only five or 20%, between five and 20% of home buyers actually work with an agent compared to, you see much more buyers here in the US using agents. And as a result, you see total commissions in those countries far less than, than what we’re seeing in the US.
Two to 4% instead of this five to 6% that we’re used to. And if commissions were to fall to three or 4%, the Consumer Federation of America estimates that consumers could save 20 to $30 billion every year through smaller-
Dave:
Wow. Oh my god.
James:
… smaller commissions.
So you would have basically, fewer buyers may be using agents, using agents in a different way. We have this oversupply of agents right now, because so many people kind of dove into the industry, in the decade after the recession, but particularly during COVID when we saw prices skyrocketing and people were looking for that flexibility, looking for ways to get into the industry and capitalize on rising home prices. And so you’d see those agents kind of scrambling to get deals and kind of more of an emphasis on maybe working on the listing side as well.
So basically the plaintiffs argue, when you have each side paying their own agent, there’ll be more incentivized to negotiate. And so they’re predicting that commissions would fall. Now, the NAR has pushed back strongly against this as have the other brokerages, but the NAR is really the lead defendant here, and they take, they’re the shield for the industry in this case.
And so they argue that this is the most efficient way of doing things and that it would actually be a calamity for first time buyers and low-income buyers. If they have to pay their agent themselves, they say they need that expertise, but they wouldn’t be able to afford it. So that would be a really big problem.
And basically they also say as well that the seller gets a lot of benefit from the buyer’s agent, bringing forth a buyer who’s willing to pay hundreds of thousands of dollars for their home. And so they should be willing to pay for that service of procuring a buyer for them. And so that’s kind of the dramatic, earth shaking scenario in which you have far fewer agents, far fewer buyers who are using agents, using them in a different way.
You can also make a case for the status quo, which would basically be, even if the sellers aren’t required to pay out the buyer’s agent, they might just continue to do so anyway because it’s the easiest way. Again, if you’re a buyer, you’re not allowed to fold your buyer agent commission into the mortgage.
It’s kind of done implicitly through this process in which the buyer’s agent get paid, but you can’t just tack on this extra amount and say, “This is going to go straight to my agent once I get this loan.” So the industry might be highly incentivized to find some way to allow financing for these buyer’s agents.
Henry:
There we go.
James:
Find some way so that even if the buyer can’t pay their agent out of pocket, find some way for them to still be able to afford to do that through some sort of loan.
Henry:
Yeah. That’s where my brain went, James. You talk, I can understand thinking that yes, this might be problematic for new home buyers because not understanding the process of how this is supposed to work, and then getting themselves into a situation where they either, they’ve gone into a transaction and didn’t get the amount of money that they could have gotten had they been educated.
Also, the cost of paying your agent, if you’re a buyer. I get that, but buying a home in general is expensive and people are figuring out ways to do it, just like you said, because they’re forced to figure out ways to do it. That either means they’re saving up enough or there’s programs or incentives out there that are helping them be able to afford that. And I don’t see why that couldn’t be the case for also helping you pay for your agent. We just don’t have to go figure that problem out right now because the system doesn’t force people to.
So I am kind of on the fence about all of this because I’m in this business and are educated on the practices, and I think there are those people who are from the outside looking in, see agents as people who just unlock doors and show you properties. And a lot of the work that they do is that. But I think everybody’s like, “I could do that for myself.” Until it comes down to things like negotiation.
Most people are uncomfortable with negotiations and a lot of these transactions, a lot of the money that we’re talking about that goes back and forth happens in this negotiation. And so I think that if you decouple it and now you have to go pay for your own representation and then you get into this negotiation that you don’t know how to do, you could end up hurting yourself.
And so I think there’s a lot of weight with saying, “I want to pay a professional, especially when it comes down to the negotiation aspect of real estate.” And when you think about negotiating in terms of professional services that are outside of real estate, we do pay people based on percentage of the deal, if they negotiate for us better. That’s a common practice amongst other industries to say, “I’ll pay a professional to negotiate with me and if they get me more money, I’m happy to pay them a percentage of whatever it is they go get me.” And then there’s some areas of real estate where, “We don’t pay people based on a percentage.”
I don’t pay my plumber based on the percentage of the value my home is. I pay them hourly based on the service that they provide. And so I can kind of see both sides, but I think negotiation is in our form and I don’t know that agents even do it really well. I think that having a good negotiator doesn’t necessarily mean your negotiator needs to be an excellent real estate agent to get you the best outcome.
James:
Yeah. I think that’s a really interesting point about the need for some professional help and guidance along the way, I even, I talked to Steve Brobeck who’s a senior fellow for the Consumer Federation of America. Very outspoken critic of the current system of agent commissions and has argued that basically, why are agents being paid essentially the same commission, whether they’ve been in the business for 30 years or at the peak of their game or they’re just fresh out of getting their license and going through a few weeks of coursework and passing that test.
Even he told me that he works with the real estate agent would never go through this process without a real estate agent, because a lot of times you really need someone who can just kind of guide the process along to, aside from even the negotiations, just there’s so many different steps along the way and paperwork and different processes to go through to actually reach that finish line. And then on top of that, you do have the issue of the strategy of what kind of offer do you put in and what kinds of contingencies should you push for and all these different things that really do require some expertise here.
And so you do see a case, and I think the plaintiffs aren’t saying, they’re not arguing for the debt of realtors altogether. They’re basically saying that there should be more negotiating on commissions. And that’s really their key point here is that there just isn’t enough negotiating right now. There isn’t enough competition on commissions relative to what you’d expect to see in a competitive marketplace.
Dave:
James, how concerned should real estate agents be about this? Is this going to be a threat to their livelihood?
James:
It is interesting, because when I started reporting on this back in the spring, it hadn’t really been on my radar too much, prior to that with the Moehrl case getting class certification in the spring, that’s the bigger of the two lawsuits.
Again, more than $40 billion at stake there. That started to raise more eyebrows, I think. But even then, when I was talking to agents, I would ask them just at the end of a conversation, “Are you worried about these lawsuits? Is this causing any concern?” And for the most part they would say, “No, it’s really not even on my radar that much.”
I think we’ve started to see that change actually over the summer as I talk to people. Those conversations at least, that conversation of action, “Wait, should I be worried about this? Is this something that I should be thinking about?”
Dave:
Now that you mentioned it, I’m worried.
James:
I think you are starting to see more of those conversations. Now, on the other hand, it’s practically guaranteed that whichever side loses at trial, they’re going to appeal. The NAR has a very powerful lobby. If they were to lose, obviously they got to push back the other side as well.
There’s a lot of money and just kind of the way of doing things is at stake right now, and so you’re likely to see this continue to play out in the years to come. And that I think makes it hard to prepare for agents, the question of should they be concerned right now? I think the kind of logical thing right now is to, there’s not much they can do at this point other than be really upfront and clear about their compensation and getting things kind of nailed down through representation agreements so that every site feels like they’re very clear on the commission that they’re going to be paying or receiving and what they’ll be getting in exchange for that.
So it sounds kind of nebulous, but providing value for clients, I mean, that’s something that brokerages are really going to be, I think pressing upon their agents in the months and years to come is really making sure that clients feel like they’re getting their worth out of the commission that they’re paying. And so making it clear to them kind of what they’re getting in exchange.
And again, you might see people kind of shifting more toward trying to get listings, which is under less of a threat than the buyer agent commissions just because of if you have fewer buyer agents out there or fewer buyers willing to work with a buyer agent, you’re still going to have people who are needing to sell their home, they’re still going to be listing their home, and you can still work with them on that side as well.
So that’s kind of how people might start to think about preparing, but again, this is going to be a long road. There’s going to be a lot of twists and turns along the way, and it’s going to take a while to fully play out.
Henry:
Yeah, I mean, I agree with you. When you think about, should agents be concerned right now, in my opinion, this kind of just goes along with what we’re seeing in the real estate industry as a whole, as things are tightening, as interest rates are rising, we’re starting to really see that the people who are succeeding both with investing or with navigating this process are the people who are educated and the people, I think if you’re an agent, you don’t need to be concerned.
If you’re focused on being the best agent and running the best business you possibly can, because if you’re going to set yourself apart, I think the top percent of real estate agents are going to continue to be the top. They’re going to continue to get the business because they understand their value, they understand how they help people, they understand how to be good marketers to find their customers.
I think the people you’re going to see this hurting are the people who are just average agents, who are just in it because they want to pick up a few commissions here and there, and aren’t really running a tight ship or a great business. I think those people might potentially get hurt as things change, if things change. But the market is kind of weeding those people out anyway, because it’s harder as an agent right now to sell homes because there’s not a ton of them and there’s a ton of agents and buyers. There’s not as many buyers as we would typically see because of people getting priced out.
So I mean, the market’s already trimming the fat, so I think those who are left behind are going to be top producers and continue to be top producers.
James:
Mm-hmm. That’s definitely something that I’ve been writing about over the past few months, is we really saw this glut of agents, during the pandemic a lot of people, again seeking that flexibility, seeking those fatter commission checks, and since mortgage rates have risen over the past year and a half and deals have become harder to find.
I mean, it’s still competition for the homes that are on the market has been fierce, but with fewer homes being listed, that competition among agents has really heated up, and that’s something that just keeps coming up again and again in the conversations that I have.
Dave:
Well, James, thank you so much. This has been incredibly insightful and you did a great job explaining this situation to us and we really appreciate it. If people want to follow your reporting, where should they do that?
James:
Sure, so insider.com, under my byline James Rodriguez focusing on big stories about the housing market. On Twitter as well, Jamie, jamie_rod, R-O-D. You can keep up with my stories there as well.
Dave:
All right. Thank you so much, James. We appreciate it.
James:
Thanks so much for having me.
Dave:
Henry, I know you have a lot of thoughts about this one, so just let it rip. Just start going.
Henry:
You know what? I think it’s cool from the perspective of it’s shedding light on a system that’s been in place for a long time, that may or may not be fair. I’m not here to tell you or say that I think it’s a fair system or not a fair system. I can argue literally both sides of whether or not I think it’s fair.
I do think decoupling to some level makes sense because why should I have to pay for someone who doesn’t represent my best interests? Just on its surface, sounds like a fair question to ask, but man, I think that this system has been in place for a long time and there’s a lot of, I mean, this is like a legacy business. There’s lots of agents and lots of people with a lot of money that are going to have a lot to say about them not wanting this to change, and I think it does need to change somewhat.
Now, does it need to just be completely thrown to the wind and we need to bring in this new system? I’m not sure, but man, I know there’s a lot of ruffled feathers amongst agents when they hear about this lawsuit. And I think at the end of the day, no matter what side you’re on, we need to remember that this is about people in protecting people with them buying and selling, what in most cases will be their most valuable asset.
And so no matter what side you’re on, if we can look at this from the perspective of truly wanting to make sure that the people selling these assets are the ones that are protected, then I think maybe we can find some middle ground.
But I’m all for ruffling some feathers and getting people to look at old systems and deciding if we need to potentially think differently about how we do things because there’s some commissions that I’ve paid and went, “I just paid a whole lot of money for nothing.”
Dave:
Yup.
Henry:
And there’s some commissions that I’ve paid and went, “I’m so glad I had that agent on my side and I would’ve paid him more if I needed to in that situation.”
Dave:
Totally. Yeah. And I agree we’re ruffling some feathers. Just for the record, I think NAR is one of the biggest lobbying organizations in the entire country. It’s like they spend hundreds of millions of dollars to protect these commissions, so you can expect them to put up a very big fight.
Henry:
Yes.
Dave:
I agree. Listen, I respect the work that real estate agents do. I obviously use them and think that they’re serve a very valuable part of the real estate industry. I do think it’s kind of interesting though, just like you said, rethinking how these professionals are compensated.
Something I keep thinking about is it’s been 3% and 3%, but over the last couple of years, a seller’s agent deserved no percent, and a buyer’s agent deserves 6% because it was so hard to buy for the last few years. And meanwhile, the sellers are dictating it and they’re doing nothing. You could have just put it up on the MLS.
So I do think there are some more flexibility about the way the system works might be beneficial to everyone. I’m not saying agents don’t deserve to be paid. They do, but I just think whether it’s a little more flexibility or maybe some-
Henry:
Transparency. I think is more-
Dave:
… unbundling. Yeah, transparency. But sometimes it’s like, “Yeah, are you paying for negotiation? Are you paying for them just to really move the transaction along?” Maybe there’s some way that you can unbundle this so that you can pay for what you need and not pay for things that you don’t need. I don’t know, personally, I doubt anything’s going to change, but I think it’s going to be really interesting to see how these lawsuits play out.
Henry:
When I think about the most beneficial real estate agent relationships I’ve had, it’s been where my agent has come in thoroughly explained the process of what happens and then how they play a role in making sure my best interests are protected in that. Because I do think a lot of people who are uneducated about real estate transactions, think that an agent just unlocks doors and shows them properties, and that’s not true.
Dave:
No.
Henry:
There’s a lot of work that an agent does that they make sound way more difficult than it actually is. But there are some very key important steps in the real estate process that you are absolutely going to want a professional to help you navigate. And I think adding that transparency in payment will also add transparency where agents are going to have to explain to you the process, where they’re going to add value, why they’re going to add value, and then people can decide if that’s something that they want or not.
Dave:
Yeah. Yeah. I think that’s a great way of putting it, and I agree. I’ve gotten so much value out of my agent relationships and really don’t want to make it seem like what they do is trivial. I do just think it is a weird, I think we can all agree it is weird the way they are compensated, and there’s probably a way.
Henry:
I mean, it took us a while to explain it in the beginning of-
Dave:
Yeah. Exactly.
Henry:
… how this actually works. A lot of people still don’t know that you don’t pay your agent, you pay one side and they pay the other. Just that in itself shows you we need more transparency.
Dave:
Yeah. I know this isn’t really of necessarily part of this lawsuit, but my sincere hope is that somehow out of all this, the MLS just gets standardized and there’s just one MLS in the country instead of 350.
Henry:
Yes. That would be amazing.
Dave:
Can we sue NAR for that? That’s not a real threat, anyone BiggerPockets, that’s a joke. It’s a joke. We’re not suing anyone, but man, that would be cool.
All right, well, before I get myself in trouble, let’s get out of here. Henry, if people want to connect with you, where should they do that?
Henry:
You can reach me, I’m best to find on Instagram. I’m @thehenrywashington on Instagram and I have no relation or to Dave Meyer or anything he just said, so don’t come at me NAR.
Dave:
Absolve you of any connection to what I just said. It was a joke. We love you. And I’m Dave Meyer. You can find me at Instagram, @thedatadeli. Thank you all so much for watching On The Market. We’ll see you for the next episode.
On The Market is created by me, Dave Meyer and Kailyn Bennett. Produced by Kailyn Bennett, editing by Joel Esparza and Onyx Media, research by Puja Jindal, copywriting by Nate Weintraub. And a very special thanks to the entire BiggerPockets team.
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Mortgage lender AmeriFirst Financial files for bankruptcy
Retail lender AmeriFirst Financial Inc. filed for Chapter 11 bankruptcy protection in Delaware, just two months after it got back into the forward mortgage origination business.
The Mesa, Arizona-based company listed estimated assets and liabilities as much as $100 million each, according to a filing in the U.S. Bankruptcy Court for Delaware.
RCP Credit Opportunities Fund is listed as the largest unsecured creditor in the AmeriFirst Chapter 11 case — with a claim of $17.9 million, court pleadings show.
Other creditors in the AmeriFirst bankruptcy with unsecured claims exceeding $500,000 include – RCP Customized Credit Fund ($5.97 million) and Wells Fargo Bank ($1.1 million).
The nature of the claims is listed as bond debt for RCP Credit Opportunities Fund and RCP Customized Credit Fund; and trade debt for Wells Fargo in the court pleadings.
The bankruptcy filing so far does not include a list of secured creditors, only a creditors matrix (which does not include financial figures).
AmeriFirst told Housingwire that the bankruptcy action has no impact on closed mortgages and the loans in the pipeline will be closed and funded. No further detail was provided.
The Arizona-based lender relaunched its forward mortgage origination business in June after ceasing it in December 2022 against the backdrop of rising interest rates.
Through its origination business, AmeriFirst kept its business purpose lending (BPL), providing four products, including debt-service coverage ratio (DSCR) loans, bridge financing, investor construction loans and residential transition loans (RTLs). Its BPL business originated about $30 million in volume every month, Eric Bowlby, CEO at AmeriFirst Financial told HousingWire in June.
The lender also maintained its servicing portfolio, servicing about $1 billion of Fannie Mae, Freddie Mac and Ginne Mae loans.
Getting back into the forward mortgage origination business, Bowlby had shared plans of keeping physical branches in 20 states while getting rid of regional and branch margins to give competitive rates to homebuyers.
The goal was to eliminate about 100 to 125 basis points built into the rates and offer lower rates as mortgage brokers.
“When your branch margin is taking everything to begin with, how does corporate make any money? Because now what they have to do is they have to go in and charge points to get their loans done,” Bowlby said in a previous interview with HW.
However, mortgage rates that were on a rising trend — ticking upward toward the mid-7% range — made it a difficult environment for AmeriFirst to stay afloat.
Bowlby had aimed to close $100 million in origination volume a month but AmeriFirst’s origination volume came in way lower than expectations.
The Arizona lender logged a production volume of $3.6 million in June when it resumed forward mortgage originations, according to mortgage platform Modex. The following month, the lender posted $11.5 million.
In 2022, AmeriFirst closed $2.5 billion in loan origination, data from Modex showed.
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Housing sector is showing signs of picking back up: Powell
In a hawkish tone, Jerome Powell said that Federal Reserve (Fed) officials are prepared to raise the federal funds rate further and hold it at high levels until they are confident that inflation is moving sustainably down to the 2% target. And that’s unclear at this point.
There are some sources of pressure on U.S. prices — among them is the housing market, Powell said Friday morning during an economic policy symposium in Jackson Hole, Wyoming.
“So far this year, GDP [gross domestic product] growth has come in above expectations and above its longer-run trend, and recent readings on consumer spending have been especially robust,” Powell said.
“In addition, after decelerating sharply over the past 18 months, the housing sector is showing signs of picking back up. Additional evidence of persistently above-trend growth could put further progress on inflation at risk and could warrant further tightening of monetary policy.”
Powell said that the effects of monetary policy became apparent soon after liftoff in the housing sector. Mortgage rates doubled in 2022, causing housing starts and sales to fall and house price growth to plummet.
In fact, mortgage rates kept an upward trend in 2023, following the Fed’s moves to combat persistent inflation. On Friday, the 30-year fixed mortgage rate was 7.37% at Mortgage News Daily, the highest in over two decades. Economists see rates potentially reaching the 8% level.
Regarding the housing services inflation, Powell said it lagged the monetary tightening. According to him, the main concern here is rents, which have only begun to slow down. “We will continue to watch the market rent data closely for a signal of the upside and downside risks to housing services inflation,” he said.
Other components of inflation show different trends.
Core goods inflation has fallen sharply due to tighter monetary policy and the slow unwinding of supply and demand dislocations. Less sensitive to the Fed moves, nonhousing services, which account for over half of the core PCE and include items such as health care and transportation, have moved sideways since liftoff, Powell said.
The labor market continues to rebalance, with improved supply and moderated demand. This rebalancing has eased wage pressures. The Fed expects the trend to continue, but evidence that the tightness in the labor market is no longer easing could also call for a monetary policy response, Powell said.
Committed to the 2% target
The core PCE inflation index, closely watched by the Fed officials, peaked at 5.4% on a 12-month basis in February 2022 and declined gradually to 4.3% in July 2023.
The lower monthly readings in June and July of 2023 were welcome but only “the beginning of what it will take to build confidence that inflation is moving down sustainably toward our goal,” Powell said.
“We can’t yet know the extent to which these lower readings will continue or where underlying inflation will settle over coming quarters. Twelve-month core inflation is still elevated, and there is substantial further ground to cover to get back to price stability.”
The Fed, however, remains committed to the 2% inflation target, Powell said. It’s challenging to know when such a stance has been achieved in real-time, he remarked.
Despite Powell seeing the current rate as restrictive to the economy, he can’t identify with certainty the neutral rate of interest – the rate at which monetary policy is neither stimulating nor restricting economic growth – which brings uncertainty about how high rates should be. In addition, it’s not clear the duration of the lags with which rate hikes affect economic activity and inflation.
“As is often the case, we are navigating by the stars under cloudy skies,” Powell said. “We will proceed carefully as we decide whether to tighten further or, instead, to hold the policy rate constant and await further data.”
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Why 2023’s “Rolling Recession” is Almost Impossible to Predict
Holding on to hope that mortgage rates could hit four or even three percent again? Unfortunately, that doesn’t look likely, at least to Liz Ann Sonders, Chief Investment Strategist at Charles Schwab. While Liz spends most of her waking hours thinking about the stock market, she always has her finger on the overall economic pulse. Whether it be bond yields, mortgage rates, economic cycles, or banking crises, Liz Ann needs to know market moves in order to manage Charles Schwab’s $8 TRILLION in assets.
For most heavy real estate investors, the stock market is confusing at best and a game of chance at worst, but NOT knowing what’s happening in one of the largest investment markets in the world could be to your detriment. Since the stock market moves quicker and reacts to economic data at almost instant speed, real estate investors can get ahead by popping out of the property market we’re so preoccupied with.
In today’s episode, Liz Ann not only touches on the state of the stock market but why so many investors are acting out of pure emotion (and not logic), the effect rising bond yields will have on mortgage rates, why savvy investors refuse to “fight the fed,” and the “rolling recession” that could explain 2023’s constant economic hills and valleys.
Dave:
Hey, everyone. Welcome to On the Market. I’m your host, Dave Meyer, and today we have an incredible guest, Liz Ann Sonders, who is the chief investment strategist for Charles Schwab. That means that she and her team oversee the assets, almost $8 trillion in client assets that are invested into the stock market. So if you want to learn from someone who is truly in tune with everything that’s going on with the economy, this is going to be an incredible episode for you. I’ll just let you know that we don’t talk that much about the specifics of real estate or the housing market, but I assure you, if you invest in literally anything, you are going to want to hear what Liz Ann has to say.
She has some of the most sophisticated, but honestly really digestible and easy-to-understand opinions about what is going on, not just in the stock market, but in the bond market and how that correlates to the broader economy, and by way of the broader economy, also correlates to real estate. So I’m going to just stop talking because this show is going to be so great. I’m so excited to share it with all of you. We’re going to take a quick break, but then we’ll be right back with Liz Ann Sonders, who’s the chief investment strategist for Charles Schwab.
Liz Ann Sonders, thank you so much for joining us here On The Market.
Liz:
Hi, Dave. Thanks for having me. Looking forward to our conversation.
Dave:
Oh, it’s our pleasure. For audience who doesn’t know you already, can you just introduce yourself and what you do for Charles Schwab?
Liz:
Sure. So Liz Ann Sonders, I’m the chief investment strategist at Schwab. I’ve been in this role and at Schwab for 23 years. I was, 14 years prior to that, at another firm, so I’ve been in the business for 37 years. My role at Schwab, I guess, would be best termed as an interpreter of what’s going on in the combination of the economy and financial markets, in particular the US equity market, and trying to connect the dots between the economy and the market and share perspectives and advice and learnings and tips with our $8-plus trillion worth of client accounts.
Dave:
Wow. Oh my God.
Liz:
Almost all of which are essentially individual investors, so we’re big.
Dave:
That’s a lot of assets under management. Very hefty client portfolio you manage there. So the people who listen to this audience, I don’t want to generalize everyone, some of them are certainly experts in equities, but most of us are primarily real estate investors. So could you just start by giving us an update on what the state of the stock market is at this point in 2023?
Liz:
Sure, so this has been an incredibly unique cycle both for the stock market and the economy over the past three and a half years for obvious pandemic-related reasons. You had the pandemic, very brief pandemic recession and in turn bear market stocks, and then courtesy of massive stimulus, both monetary stimulus and fiscal stimulus, you launched out of that very brief recession as well as the very brief bear market and had a couple of very strong years. Last year was a much more difficult year obviously for the equity market with the market topping out at the very, very beginning of the year and the chief culprit behind the bear market was what has been the most aggressive rate hiking cycle in at least the past 40 years in terms of Fed policy. And that was the key reason why the market went into bear territory.
You had a relatively recent bottom in October. The market has had an extraordinarily strong move up off that October low. Burning questions around, “Is it just a rally within an ongoing bear market or did that represent the start of a new bull market?” To some degree, I’m not sure the semantics matter all that much. I think that the recent consolidation in the market has been driven by actually stronger than expected economic data, which meant yields have moved well back up again and concerns that maybe the Fed isn’t quite finished. And I grew up in this business working for the late great Marty Zweig who actually coined the phrase, “Don’t fight the Fed.”
So that was certainly the market was not fighting the Fed last year, is fighting the fed a little bit now. So I don’t think we’re out of the woods yet. There’s a lot of uncertainty, but this is the nature of the equity market. There’s bull markets and there’s bear markets.
Dave:
So what do you think has driven the run-up in the stock market this year, whether it’s part of a bear market or bull market, as you said, that’s semantics, but what is driving the inflow of capital or the investor sentiment that’s led to this run-up in prices?
Liz:
So I think there were several contributors when … If you go back to last October when we started this move up off those recent lows, some of it was actually the retreat in bond yields that we were starting to see where you had had, about a week after the equity market bottomed, you saw the 10-year treasury yield peak up around where it is right now at, about 4.2%, and you subsequently saw that yield drop almost a full percentage point. And that became a pretty powerful tailwind behind equities. There was also a sort of a budding impression or hope that the Fed, because of how aggressive they had been, that they were getting close to the point that they could pause rate hikes. That ultimately got pushed further into this year than what was originally expected, but that was a basis for the move higher.
And then there’s another old adage around market performance, which is the market likes to climb a wall of worry. So oftentimes uncertainty, weak or perceived or otherwise economic conditions aren’t necessarily negative for the market because of that contrarian sentiment perspective that the stock market often displays. And then what particularly happened to narrow the market’s performance was the banking crisis that started in early March with the failure of Silicon Valley Bank. That was the point where the market became very heavily concentrated up the capitalization spectrum, a very small handful of names. The Super 7, the Magnificent 8, whatever fun label you want to apply to it, was driving 100% of the performance.
And I think that unique part of this move up was driven by the banking crisis. We want to go into highly liquid names that have strong balance sheets and cashflow was this era’s defensive type names, those techie kind of names. That in and of itself though represented a risk for the market and I think that’s some of what has been at play more recently in this consolidation period because of concerns about that concentration. The analogy that I think is often apt, not that we ever like to think about battlefields, but when it’s just a few soldiers at the frontlines or a few generals at the frontlines and the soldiers have all fallen behind, that’s not a very strong front. When you’ve got the soldiers coming up to the frontline, even if the generals start to step back, that’s a stronger battlefront. So that’s an analogy that I think helps put that concentration risk in context.
Dave:
So just to make sure I’m understanding, the run-up especially since the bank crisis has really been concentrated in some of these mega cap companies and-
Liz:
Until a month or so ago.
Dave:
And now in the last month or so, to continue your analogy, are the soldiers catching up or are the generals falling back to where the soldiers were?
Liz:
For a while there, it was a little bit of both. So you had convergence happening where you saw some profit taking amongst that small handful of names while, at the same time, you were starting to see broader participation down the cap spectrum into other areas of the market that hadn’t participated. More recently, what they call market breadth, their percentage of stocks that are doing well, that has rolled over and you’ve seen deterioration pretty much across the board and that’s why I call it a corrective phase or a consolidation phase. Prior to that, you were seeing this convergence where the generals had taken a few steps back, but more soldiers and that, for a while, looked like a healthy development.
Now we’ve seen a bit of broader deterioration in breadth. There’s probably still a bit more to go on the downside there before I think the market can find more stable footing.
Dave:
Do you think this recent consolidation or just generally the sentiment in the market tells us anything useful about the broader economy?
Liz:
So investor sentiment and more economic sentiment measures like CEO confidence or consumer sentiment, they don’t always tell the same story. There can sometimes be some overlap. In fact, some of the consumer confidence or consumer sentiment measures have the questions embedded in the surveys. They have one or two about the stock market. So sometimes a strong stock market can help boost more economic measures of sentiment and vice versa. But what was interesting in the last couple of months is, at the end of May, beginning of June when we saw the most extreme concentration, there was also a lot of frothiness that had come into investor sentiment indicators. Extreme high level of bullishness on some of the survey-based measures of sentiment like AAII, American Association of Individual Investors. You were seeing huge inflows into equity ETFs, especially tech-oriented ones. At the same time, there was still a lot of consternation expressed in some of these more economic sentiment measures by CEOs, by consumers.
Now investor sentiment, at extremes, tends to represent a contrarian indicator, not with anything resembling perfect timing, but my favorite thing ever said about the stock market goes right to the heart of sentiment as a driver and it was probably the most famous phrase ever uttered by the late greats Sir John Templeton and it’s, “Bull markets are born on pessimism, they grow on skepticism, they mature on optimism and they die on euphoria.” And I think there’s not a more perfect description of a full equity market cycle. Maybe what’s compelling about that phrase is that there’s no word in there that ties into what we think on a day-to-day basis drives the stock market, what we focus on, earnings and valuation and PE ratios and economic data and Fed policy.
It’s all emotions and there’s probably nothing better that defines major bottoms in the market and major tops in the market, not every little wiggle, than extremes of sentiment. Launch points for bull markets tend to come when sentiment is incredibly despairing and vice versa. So that’s what I spend probably more time focused on than the other more technical economic valuation-oriented metrics. I think that really defines market cycles probably better than any other set of indicators.
Dave:
That’s really fascinating. Obviously, you look at the stock market, you see all this complex technical analysis and I’m sure that still has use, but it’s really interesting to know and it makes sense that behavior and psychology is really driving the entire market.
Liz:
It’s not only the market. Behavior and psychology drives inflation. Behavior and psychology drives the economy. The whole notion of animal spirits is embedded in everything that we do and observe and how we live. And it’s not just a market phenomenon, it’s an economic phenomenon. Animal spirits and fear and greed, it comes in play in everything that we do.
Dave:
Absolutely. And a great stock trading podcast, Animal Spirits as well. I totally agree with what you’re saying, but the data analyst to me now wants to know how I can measure sentiment and psychology. Is there a good way to do that?
Liz:
Yeah, there’s myriad ways to do it. I would say the first thing is to understand that there are two broad buckets of sentiment indicators and now I’m talking investor sentiment, not economic sentiment. There’s attitudinal measures and behavioral measures. So attitudinal measures would be something like the AAII survey. It’s a weekly survey of their tens of thousands of members. They’ve been doing this since the late 1980s. And based on the questions, they come up with three categories of investors, bullish, bearish, neutral. And then they apply percentages to how many are bullish, how many are bearish, how many are neutral. So that’s purely an attitudinal-based survey. They’re getting on the phone and saying, “Are you optimistic? Are you not?”
Interestingly, AAII also does a monthly analysis of the actual exposure to equities, to fixed income, to cash of their same members. And what’s really interesting is there are times where what investors are saying and what they’re doing are diametrically opposed and that was the case a little more than a year ago in June of 2022 when the market was really first struggling into what was a pretty significant low at that point. You saw, I think, a record or a near record percent of bears in that survey, but they hadn’t lowered equity exposure. So they were saying, “I don’t like the market,” but they actually hadn’t acted on that view.
Dave:
That’s interesting.
Liz:
So you also have to look at behavioral measures of sentiment. AAII, that allocation survey represents that, something like the put-call ratio in the options market. That’s a behavioral measure of sentiment. Fund flows, the amount of money going into equity ETFs or equity mutual funds, that’s a behavioral measure. There are other attitudinal measures too. One of them is investor’s intelligence, which looks at the advisors that write newsletters and just writers that are just out there writing investment newsletters. That’s an attitudinal measure because it’s not tied to what the advisor’s doing. It’s how they’re expressing their views in the public domain. So I look at all of them. So it’s the amalgamation that’s important and understanding that you’ve got to see whether the behavioral side matches the attitudinal side. Sometimes they can be disconnected.
Dave:
That’s fascinating. Just using your example from June of last year, do you think the disconnect comes from a lack of other options like people didn’t know where else to put their money or what do you attribute the contrast there to?
Liz:
Well, in June of last year, we knew we were in a very aggressive tightening cycle. The Fed had started to raise rates in March. They were also shrinking the balance sheet. So that was seen as a big near term negative. June of last year was also the month that there was a nine-handle on the consumer price index. So inflation was at its peak at that point. You were starting to see deterioration in a lot of the economic data, particularly expectations tied to inflation. So it was just a confluence of things happening at that particular time and the market was weak. So people were reacting in surveys to weak action. They just hadn’t really done much yet at that point.
Fast forward to the October low, the attitudinal side matched the behavioral side. You were back in washout mode, despair in the attitudinal measures, but you would had capitulation behaviorally. What I often like to say is the, I’ll use a real technical term here, Dave, the puke phase, where everybody is just, “I’m out.”
Dave:
[inaudible], yeah.
Liz:
It wasn’t quite as extreme as times like March of 2009, but you finally had that better balance between pessimism behaviorally and pessimism attitudinally.
Dave:
Oh, that’s so interesting. Thank you for explaining that. I want to shift a little bit to some recent market events, which is, we are recording this on the 17th of August just so everyone knows, and just in the last few days, bond yields have started to run up pretty aggressively. Obviously, that is implications for the equities markets, and for real estate investors, we care a lot about this due to their correlation to mortgage rates. So I’m just curious if you can help us understand why yields have been rising so quickly.
Liz:
Well, some of the economic data has been better than expected. So as a tie in to what’s going on in the economy, you can point there, but you also have to remember, and it’s amazing to me how many investors still don’t grasp the relationship between bond yields and bond prices. They move inverse to one another. So when bond yields are going up, it means prices are going down. So sometimes the yield movement can be driven by what’s going on in the economy, but sometimes supply demand, fundamentals, the aggressiveness of the buyers or the sellers can move the price, which in turn moves the yield.
And I think on the price side of things, what has conspired to bring prices down is increased supply of treasuries in the aftermath of getting through the debt ceiling potential debacle, but we also had the recent Fitch downgrade of US debt. So I think the supply demand issues put downward pressure on prices, all else equal put separate pressure on yields and then you have that, for the most part, better than expected economic data and you’ve seen a breakout on the upside. There’s a lot of money in the equity market that trades off of technicals, speculative money that’s more short term in nature and it might be algo driven or quant based and triggered off certain technical levels.
Well, there’s also money that does that in the fixed income side of things. So sometimes they move down in price and move up in yield, can feed on itself and the speculators will play that momentum at some point. So you could see some momentum-driven trading that has potentially exacerbated the move beyond what the fundamentals might suggest.
Dave:
And do you have any idea or thoughts on whether yields will stay this high?
Liz:
So my colleague, Kathy Jones, is my counterpart on the fixed income side, so she’s our chief fixed income strategist. I say it without really meaning it as a joke, but 15 years ago or so when Schwab brought Kathy on was a joyous day in my life because that’s when I was able to stop pretending like I was an expert on the fixed income side of things. So very important caveat. I don’t spend my waking hours deep diving on the fixed income side, but I can certainly, she’s part of our larger group, compare it some of the thinking there. And for the past year plus, yields have been somewhat range bound, low 3s to low 4s and you’ve been bouncing up and down, but we seem to be breaking out on the upside.
There probably is going to be some pressure at some point where yields don’t go too far higher unless we really see surprising, not resilience in inflation, but a turnback higher in the inflation data or if the expectations around Fed policy start to really shift as a result of that. All that said, what I don’t think, let’s assume 4.3 is a near term high in yields and let’s assume the market is right in pricing in rate cuts starting next year. Now I disagree with the market’s perception of that, but we can talk about that separately. What I don’t think is going to happen is, when yields start to come down, when the Fed is done, when they eventually have to start cutting rates again, we are not going back to what we call the ZIRP world, the zero interest rate, which at the time that the US for many years was a 0% interest rate, a lot of the rest of the world was actually in negative territory.
I think that ship has sailed and the next easing cycle, barring some extreme shock to the financial or economic system globally, I think that experiment in zero interest rate policy and negative interest rate policy is one that for the most part was seen as having more in the fail column than in the success column. I think it bred capital misallocation, lack of price discovery, zombie companies. And so I don’t think we head back to 0% interest rates. I also think we’re also entering into a more volatile inflation secular environment. The great moderation, that term was coined by Larry Summers and it stuck and it defined the period from the late ’90s up until the pandemic where you basically had declining inflation the whole time. And that was because the world had abundant and cheap access to goods, to energy to labor. We were in the massive globalization surge, China coming into the world, economic order. All of those ships have sailed.
And I think we’re going back to what was the 30-year period or so prior to the great moderation. There’s no coined term for it, the one I’ve been using. Maybe it will take off like great moderation is the temperamental era, which wasn’t a, “Inflation is high and stays high in perpetuity,” there was just a lot more volatility inflation, and in turn, more volatility in terms of what the Fed had to do to combat the problem. And I don’t think this is the 1970s, but I think we’re in a more volatile inflation backdrop.
Dave:
So in addition to maybe the zero interest rate policy being somewhat of a failed or controversial, at best, experiment, you think the Fed needs to keep some ammunition, if you will, by even if there is a pullback in the labor market, keeping rates a little bit high so that they have some wiggle room if there is some volatility in inflation.
Liz:
So not only wiggle room to come lower, but I think the lesson that the current Fed and Powell specifically, I think, takes from looking at the experience of the 1970s was not so much the playbook of the drivers being similar, they’re quite different, is that the problem in the 1970s was declaring victory a couple of times prematurely, easing policy only to see inflation get let out of the bag again, scramble to tighten policy again, hang the Mission Accomplished banner, rates go down again, inflation’s let out of the bag again. And that’s ultimately what led to Paul Volcker having to come in and pull a Paul Volcker by just jamming up interest rates, almost purposely bringing on the back-to-back recessions of the early ’80s in the interest of really finally breaking the back of inflation.
And I think that’s really … That’s why I think there’s a disconnect between what we’re facing here in the current environment in terms of growth and inflation and the market’s expectation right now that the Fed could cut at least five times next year. And I think the market hasn’t quite come to grips with the message the Fed is trying to impart, which is, once we pause, once we get to the terminal rate the stopping point, the inclination is to stay there for a while, not to quickly turn and start easing policy again because they want to make sure that inflation has not only come down, but it is likely to stay contained.
Dave:
Yeah, and they have cover to do that, right? Because the labor market continues to show pretty good strength. GDP is not amazing, but it’s still up. So it feels like, unless-
Liz:
They not only have cover.
Dave:
There’s no impetus for them to do it.
Liz:
Right. That’s the better way to think of it. That’s where I think the disconnect is. It’s almost a, “Be careful what you wish for,” because an environment that suggests the Fed has to, as soon as the beginning of next year, go into fairly aggressive rate cutting mode, that’s not a great economic backdrop. And this idea that simply if inflation continues to come down that that represents a green light for the Fed to cut doesn’t make a lot of sense. It does support a pause, but the pivot to rate cuts, I think that the Fed’s bias, especially with a 3.4% unemployment rate, is once they get to the terminal rate is to stay there for a while.
Dave:
Yeah, that makes total sense to me. Unless there is a reason, an economic driver for them to cut rates, they’re not just going to do it just to supercharge the economy, at least it doesn’t seem like.
Liz:
Well, the only, I think, rational thought behind why the Fed could start cutting next year without there being a clear recession in sight, without significant deterioration in the labor market is, if disinflation persists at the point the Fed is no longer raising rates and they’re holding steady, the fact that inflation continues to come down means real rates are going up. And so some are thinking that they don’t want to establish the conditions for restrictive policy getting more restrictive even though they’re not doing anything, but with inflation continuing to come down, it means real rates are going up. So there is some rational thought there.
Dave:
That makes sense.
Liz:
It’s just a question of whether real rates going up and being restrictive, whether the Fed views that as starting to represent potential damage for the economy. All else equal, I think the Fed’s inclination is to sit tight for a while.
Dave:
And does that mean you’re not forecasting a break in the labor market or a recession anytime in the near future?
Liz:
So for more than a year now, we’ve been calling this a rolling recession, rolling sectoral recessions. And that is somewhat unique, certainly unique relative to the past two recessions, which were bottom falls out all at once across the economy, different drivers each time. Obviously, the pandemic caused a bottom falls out all at once because the world shut down our economies. So that was unique, but that was an all at once, everything all at once. To some degree, that was the same thing in ’07 to ’09, particularly the worst part of the financial crisis with the combination of the Bear Stearns failure and the Lehman failure and the housing bubble bursting.
And because of the trillions of dollars in the alphabet soup of derivatives attached to the mortgage market in a massively over leveraged global financial system, the housing market busted and it took down the entire global financial system with it. So that’s sort of everything-all-at-once-type recessions. This one, not that any of us want to relive the last three and a half years associated with the pandemic, but it’s important to go back to that point, the point where the stimulus was kicking in, courtesy of the Fed, courtesy of the fiscal side of Treasury and Congress. And that money, the demand associated with it, all that stimulus at that time, was forced to be funneled into narrow segments of the economy, particularly the goods side of the economy, housing, housing-related, consumer electronics, Peloton machines, Zoom equipment, etcetera because we had no access to services.
That was the launch for the economy to come out of the recession, but it was heavily goods-oriented. That was also the breeding ground of the inflation problem we’re still dealing with and it was exacerbated at the time by the supply disruptions. So that was the initial stage of this. But since then, those categories, manufacturing, housing, housing-related, a lot of consumer-oriented goods, electronics, etcetera, leisure, those have gone into recessions. It’s just been offset by the later strength and services. Same thing has happened within the inflation data. You had a massive surge in inflation initially on the good side, then you went into disinflation and in some categories were an outright deflation, but we’ve had the later pick-up on the services side. Services is a larger employer, which helps to explain the resilience in the labor market.
So we’ve seen the weakness roll through. It hasn’t yet hit to a significant degree, services or the labor market. To me, best-case scenario is not so much soft landing because that ship already sailed for the segments of the economy that have had their hard landing, is that, if and when services and the labor markets start to get hit, that you’ve got offsetting recovery in some of the areas that have already gone through their recessions. So I just think you have to look at this cycle in a more nuanced way. That said, if somebody said, “All right, feet to the fire, Liz Ann, you’ve got to say yes or no in terms of, will the NBER at some point say, ‘Okay, recession?’” I would say yes.
Dave:
Okay. Well, I liked your much more nuanced answer anyway. I think we’ve talked on the show a few times that the label recession has almost lost its meaning in a way because it doesn’t actually describe the conditions that we’re seeing and doesn’t actually give you any actionable insight that you could base your decisions off of.
Liz:
Well, it’s so lagging too. The NBER, the day they make the announcement, it’s a recession. And the NBER, the National Bureau of Economic Research, they’ve been the official arbiters of recession since 1978. It’s not two-quarters in a row of negative GDP. That’s never been the definition. I don’t know why people think that’s the definition, but it’s not. They look at a lot of different variables, but simultaneous on the day the NBER says, “Okay, it’s a recession,” they announced the start, which is by month, not by day. They go back to the peak in the aggregate of the data that they’re tracking, which is why, if you were to look at a whole roster of data points, looking back at what we know were the start points of each recessions, the data actually at that time looked pretty good.
What you did know at that time was the descent would be significant enough that it reached a low level sufficient enough to say, “Okay, it’s recession,” the dating it then goes back to the aggregate peak. The average lag in terms of the NBER saying, “Okay, it’s a recession,” and when they backdated as having started is seven months and sometimes it’s even longer. The NBER came out in December of ’08 and said, “Okay, we’re in a recession. By the way, it started a year ago.”
Dave:
“Right, yeah, thanks for letting us know.”
Liz:
And when the NBER announced recession associated with the pandemic, when they announced that, “There was a recession and here’s when it started,” it was actually already over at that point, but it was another 15 months before they said, “Okay, it’s over,” and it ended 15 months ago. So this idea of, “Well, why don’t I just wait as an investor? Why don’t I just wait until the coast is clear? We know we’ve had a recession. We know it’s over. It’s been declared as over. Stock market’s a leading indicator,” man, you have missed a lot of the move on the upside.
Dave:
Yeah, like you said, it is by definition a retroactive label. You can’t use it to make decisions, which is an excellent transition to the last topic I wanted to get into, which is, for our audience, people who are probably mostly investing in real estate, but I would hope are still considering investing into bonds and stocks as well, what strategy would you recommend in these confusing and uncertain times?
Liz:
There is no one cookie cutter answer that’s right for all investors and that’s really important because I think, particularly in the world of financial media, there is either a desire for the cookie cutter answer or there’s just not a willingness to provide the time for the real answer to questions around, “How do I invest? What should I do with my money?” The financial media, in particular, it’s all about, “Should I get in? Should I get out?” And I always say, “Neither get in nor get out is an investing strategy. That’s just gambling on two moments in time.” So the first thing is to actually have a plan and that plan has to be tied to your own personal circumstances. The obvious ones like time horizon, but also risk tolerance. And sometimes people make the mistake of equating the two, meaning, “I’ve got a long time horizon. Therefore, I’m risk-tolerant. I should take a lot of risk.”
What then comes into play is the other really important thing you need to do is try to assess before you make the mistake and learn the hard way, whether your financial risk tolerance, “What’s on paper? How much money do I need to live on? How much do I want to try to save? Do I need to live on the income associated with my investments or I just want the appreciation to grow the sum, the retirement nest egg?” That’s your financial risk tolerance. But if you get the first 15% drop in your portfolio because you go into a bear market and you panic and sell everything, your emotional risk tolerance is entirely different from your financial risk tolerance. So trying to gauge that.
Then those other facets of … What I always say when somebody will say to me, “What are you telling investors to do?” and I always answer that, even if I had a little birdie land on my shoulder and tell me with 97% certainty what the stock market was going to do over the next, whatever year or two, what the bond market’s going to do, what commodities are going to do and I had that information, very high conviction, but I was sitting across from two investors. Investor A, 75 years old, retired, built a nest egg, can’t afford to lose any of it and needs to live on the income generated from that. Investor B is 25 years old, they go skydiving on the weekends. They inherited $10 million that they don’t need. They’re not going to open their statements every month and freak out at the first. So one high conviction view, almost perfect knowledge of what the markets are going to do, what I would tell those two investors is entirely different.
So it all is a function of your personal situation, your risk tolerance, your need for income, the emotions that come into play and so you got to have a plan.
Dave:
I absolutely love that. I’m smiling, because in real estate, we talk about that a lot as well because people want to know, what, buy for cashflow, buy for appreciation, buy in different types of markets and there is no one-size-fits-all advice for any type of investment. If you’re approaching your retirement, “Are you 22 years old? Do you have a high income? Do you have a low income?” it’s completely different. And like you said, with media, people want a quick answer, but if you want to be a successful investor, you have to root your strategy in your own personal desires, and to your point, your own psychology and behavior.
Liz:
That’s right. And maybe it’s a little more boring to talk about things like diversification across and within asset classes and have a plan and be diversified and periodic rebalancing. Maybe it’s not as exciting as, “The market is really expensive here. I think a crash is coming and I think it might happen by next Tuesday and then you want to be an aggressive buyer.” That’s just gambling on moments in time and investing should be a disciplined process over time.
Dave:
Yeah, one gets a lot of YouTube views and the other one’s actually a good investing strategy. Sometimes those are at odds.
Liz:
Yeah, and don’t get investment advice from TikTok or YouTube. It can be a component of good information, but make sure it’s in the context of an actual plan and the education associated with that.
Dave:
Absolutely. It could inform your strategy, but you can’t take their strategy.
Liz:
Right.
Dave:
I think there’s a difference between those two approaches.
Liz:
100%.
Dave:
All right. Well, Liz Ann, thank you so much for being here. This was a fascinating conversation. We really appreciate your time.
Liz:
My pleasure.
Dave:
If anyone wants to follow your work, where should they do that?
Liz:
Well, interestingly, our research, everything that I write, videos that I do, my counterparts in international and fixed income, all of our research is actually on public site schwab.com. You don’t have to be a client, you don’t have to have a login. So all of our research is on schwab.com, but I’m also on, I guess, we don’t call it Twitter anymore, so I’m on X and I post everything that I write, all the videos that I do, TV appearances, promote podcasts and day-to-day, minute-to-minute charts and information and reaction to economic reports coming out. So that’s probably the most efficient way to get everything, but I’ve had a rash of imposters, so just make sure …
Dave:
Oh, that’s the worst.
Liz:
… you’re following the actual @LizAnnSonders.
Dave:
We will put a link to your profile in the show. I’ve been following you on Twitter. That’s how I first found out about you. Excellent. Well, X, I’ve been following you on X, whatever you say now. But yeah, great information just about the economy, super digestible as well, so highly recommend it.
Liz:
Thank you.
Dave:
Liz Ann, thanks again. We appreciate it.
Liz:
My pleasure. Thanks for having me.
Dave:
All right, another big thank you to Liz Anne Sonders for joining us. Honestly, that is truly one of my favorite interviews that I have ever done. I think Liz Ann does an incredible job just explaining what is going on in the economy and what’s going on in the stock market. And I know not everyone who listens to the show is super invested into the stock market, but I think there’s some really interesting and important takeaways here. One thing I was really fascinated about was just about how much investor sentiment really drives behavior and drives the economy.
And it’s not always all of these technical, financial, monetary policy things that I definitely am always obsessing over like Fed policy or what’s going on with certain indicators. And it just makes you realize that obviously the economy is just an amalgamation of human behavior and so you should just be paying attention to, as much as you can, sentiment. I think that is broadly applicable to the real estate market. Just think about something like, for example, the lock-in effect. That is something that is, sure, it’s financial, it is rational in some ways, but it is, in a lot of ways, psychological and behavioral and that is really driving a lot of what’s going on in the market right now. Or people’s feeling of competition in the housing market, that might be driving demand right now. Not everything is entirely rational and a lot of it is based on market sentiment. So I absolutely love that thing.
And then the second thing I just wanted to call out was her explanation of the “rolling recession”. I think it was the best explanation of the economy that I’ve heard to date. I slacked because Kailyn, our producer and I, we have a little chat going to make sure the show flows well and I said to her, “I think I finally understand economics,” during that part of the show because it was just so … It really helped understand that there’s these waves of economic activity and not everything is the same. We saw this uptick in goods inflation and that calmed down, but then we saw this uptick in service inflation and that is starting to calm down, but that’s a strong employer and why we haven’t seen as much of a decline in the labor market as you might see.
So I thought this was so interesting, and absolutely, if you couldn’t tell, loved her comments at the end about how strategy, whether you’re a real estate investor or a stock market investor, really just has to come from you and your own personal circumstances. I was nerding out about that and very excited about that because I’m actually writing a whole book about that topic for real estate investors. It’s due in two weeks, so it’s all I’m thinking about right now and it comes out in January, so you’re probably going to want to check that out, hopefully.
Thank you all so much for listening. If you love this show as much as I did, please give us a five-star review either on Apple or on Spotify or share this with a friend. Maybe you have someone who’s interested investing in the stock market or just wants to learn more about the economy. I think this is a great episode to share with really anyone. Thanks again for listening. We’ll see you for the next episode of On The Market.
On The Market is created by me, Dave Meyer and Kailyn Bennett, produced by Kailyn Bennett, editing by Joel Esparza and Onyx Media, researched by Puja Gendal, copywriting by Nate Weintraub, and a very special thanks to the entire BiggerPockets team. The content on the show, On The Market, are opinions only. All listeners should independently verify data points, opinions and investment strategies.
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