The US stock market gained 25% in 2017 and while many investors were waiting for the “correction” few could have anticipated such a volatile two days of trading. Friday saw a fall of over 600 points but today that was eclipsed with a fall of over 1200 points or 4.6% of the index. It would appear that investors are concerned about a potential spike in inflation and a gradual increase in the cost of finance in the US. These are issues which have been around for some time but suddenly, faced with dwindling profits, a growing number of investors are now running for the exit.
Finance costs and property markets
While the US interest rate cycle is a lot further ahead than that in Europe and the UK, the cost of finance is still relatively low compared to traditional levels. This has obviously allowed many real estate investors to make use of low cost finance to lock in significantly higher rental yields. As more and more investors have looked towards the real estate market, in the hope that the US economy will improve in the short to medium term, this has also created significant potential for capital gains.
There is no doubt that Donald Trump has prompted renewed interest in the US real estate market although he has yet to deliver on the vast majority of finance related expectations. The recent tweaking of the tax system will certainly be net positive for the economy going forward but there are concerns that it is those in the higher echelons of the income scale who will benefit most.
Increased mortgage costs
The US mortgage system is very different to that in the UK as the duration of fixed term mortgages is far greater. As a consequence, many people may well be locked into relatively low mortgage rates going forward but others will see their mortgage rates increase in the short to medium term. This will inevitably put pressure on the US real estate market, perhaps increase the number of distressed sales and at least curtail further price increases in the short term. We knew this was coming, the Fed has been warning of the dangers of cheap finance for some time but, until Friday, investors were seemingly uninterested.
While the scaremongers will suggest that we are on the verge of yet another US mortgage crisis, this is not necessarily the case. True, there will be an increase in mortgage rates in the short to medium term but the speed of increase will still be relatively slow. Indeed, expected increases in US interest rates in the calendar year 2018 may well be postponed if the stock market downturn continues, impacting consumer spending and economic growth.
Is this an overdue shakeout?
If you look at the performance of the US real estate markets and the stock market since the inauguration of Donald Trump it has been phenomenal to say the least. Relatively strong economic growth was already being factored into stock market ratings and the value of real estate in various parts of the US. It looks as though these ambitious growth targets may well be under threat and while the stock market has reacted immediately, it will be interesting to see the direction of real estate prices in the short to medium term.
An expected increase in the rate of inflation will also eat into rental yields which will reduce real returns and place pressure on finances. Those who sold into the recent stock and real estate bull markets will be sitting pretty this evening, in an extremely strong position to cherry pick assets if prices continue to fall.