Europe is in Crisis

European energy costs are 10X the norm… not only aren’t home prices expected to crash, they’re headed up … the War on Affordability is crushing consumers

The situation in Europe is alarming – and growing worse.From Bloomberg:

British households were told on Friday that their power and gas bills will increase from Oct. 1 by 80%.The so-called energy price cap was set at £3,549 ($4,189) per year, up from £1,971 over the past six months and £1,277 during last winter……The problem is broader than just rising costs. Increasingly, the words “emergency” and “shortages” are being used, with participants focusing on when, rather than if, a crisis will hit. 

And this comes from Reuters:

No more ironing, limited oven-use and showering at work – Europeans are trying to keep their energy use down but the bills keep climbing.As wholesale gas and electricity prices surge, millions of people in Europe are now spending a record amount of their income on energy, data show.

The European benchmark for gas prices has exploded 550% in the last 12 months.At these prices, it’s expected that Britons will spend, on average, 10% of their entire income on gas and electricity bills.It’s not just the U.K.According to the International Energy Agency (IEA), gas prices for households in most leading European economies have now exceeded the peak of previous crises, going all the way back to the 1970s.The scope of these increases is staggering. On this note, here’s Bloomberg:

German benchmark power prices for next year rose above 800 euros ($800) per megawatt hour, nearly 10 times higher than the same period last year.French year-ahead power rose above 1,000 euros for the first time.UK day-ahead electricity is trading at 10 times its two-decade average.

Look for mass social unrest as we head into the cold winter months

From BusinessDay:

Europe is facing a major social test ahead of winter as it juggles rising discontent fueled by soaring energy prices and pressure to meet climate goals as Russia’s war in Ukraine drags on.British grassroots group “Don’t Pay UK” is calling for people to boycott energy bills from October 1, while the trade union-backed “Enough is Enough” campaign kicked off a series of rallies and actions in mid-August calling for pay rises, rent caps, cheaper energy and food, and taxes on the rich.A worsening cost-of-living crisis across Europe has already seen workers in France, Spain and Belgium go on strike in the public transport, health and aviation sectors, pushing for higher wages to help them cope with rocketing inflation……The coming winter is set to be plagued by social unrest, warned Naomi Hossain, a professor of development politics at the American University in Washington who is studying energy, fuel and food riots.

Hossain goes on to note that, at a conservative estimate, 10,000 such protests have taken place worldwide since November, with more expected to come.She added, “if I were a politician, I’d be really worried.”

All signs point toward Europe deteriorating into a recession

A few weeks ago in the Digest, we highlighted another recessionary influence on Europe: the drying-up of the Rhine River, and its painful consequences on trade and supply/demand balances.U.S. investors need to be mindful of these issues because if/when Europe falls into a recession, the pain won’t be limited to “over there.” Many U.S. investors will feel it here.From our past Digest:

If Europe falls into a deep recession which hurts the European consumer… and if the euro continues to weaken against the dollar because of different central bank policies… then U.S. investors with lots of foreign exposure need to expect contagion.

Almost 30% of the market-weighted sales of the S&P 500 are international. And in our Digest from a few weeks ago, we highlighted many widely-owned stocks with huge international exposure.A few examples include Tesla, Alphabet, Netflix, Meta, Qualcomm, Aflac, and Schlumberger.Here was our bottom-line, which we can double-down on given Europe’s growing energy crisis:

Look at your portfolio today. If your stocks have greater global exposure than you’re comfortable with, it’s time to do some pruning. The international situation is not headed in the right direction.

Meanwhile, here at home, mortgage rates have reversed and surged higher

This time last year, the 30-year fixed-rate mortgage came in at 2.87%.As the Fed began raising rates, mortgage rates exploded, hitting a high of 6.11% in mid-June.But in the last two months, mortgage rates fell, in part due to the same reason that stock prices climbed – the belief that the worst is behind us, and the Fed was going to turn noticeably dovish.Influenced by this optimistic sentiment, the 30-year fixed rate mortgage dropped to 5.13% in mid-August.But leading into last Friday’s central bank symposium in Jackson Hole, Wyoming, the market had grown jittery. Traders worried about Federal Reserve Chairman Jerome Powell growing hawkish (which he did).Based on these fears, the 30-year mortgage surged back to roughly 5.8% last week.As I write Monday morning, Forbes reports that the rate has now pushed even higher to 5.91%.This jump basically offsets the slightly lower home prices that would-be homebuyers have seen in recent weeks.Pulling back, the explosion in the cost of being a homeowner over the last year has been jaw-dropping. To get a sense for this, you need to see it visually.The chart below comes from Redin. It shows the growth of homebuyer mortgage payments, dating back to 2015. We’re seeing the effect of higher listing prices and the growth in mortgage rates.

Chart showing the explosive rise in homebuyers mortgage payments her in 2022
Source: Redfin / MLS data

The housing market has screeched to a halt.From Fortune:

On a year-over-year basis, new-home sales and existing-home sales are now down 17.4% and 20.2%, respectively. While single-family housing starts and mortgage purchase applications in July were 18.5% and 18.4% below levels they hit a year ago.Simply put: One-fifth of housing activity just got shaved off.

The question is: “Where does the market – and home prices – go from here?”Zillow just updated its 12-month outlook and predicts that U.S. home prices will rise just 2.4%, down from its 7.8% forecasted rise issued just a month ago.And yes, while this forecast is lower, don’t miss the takeaway – home prices will actually rise.From CNBC:

Despite talk of a “housing recession,” don’t hold your breath waiting for home prices to suddenly decline any time soon. In fact, prices are expected to grow through 2023, according to several housing forecasts.

After noting that the median price for an existing home in the U.S. dropped from a record high of $413,800 to $403,800 last month, CNBC continues:

Housing prices are still expected to be up 11% for 2022, followed by 2% in 2023, according to NAR’s most recent forecast. 

Last Friday, Federal Reserve Chairman Jerome Powell said:

While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses.

This is part of what that pain looks like. You might call it “the war on affordability.”Frankly, it’s a war that consumers are losing.

Before we wrap up, one quick illustration of this war on affordability

Electric vehicles are our future.But for many Americans, today, they’re out of reach financially – even with government-funded incentives from the Inflation Reduction Act.This reality became even more acute last Thursday when Ford announced it’s hiking the starting price of its electric Mustang Mach-E crossover by more than $8,000 on some models.From CNBC:

…The markups – ranging between $3,000 and $8,475, depending on the model and battery – are due to “significant material cost increases, continued strain on key supply chains, and rapidly evolving market conditions.” …The starting prices for the 2023 Mustang Mach-E will now range from about $47,000 to $70,000, up from roughly $44,000 to $62,000 for the 2022 model year. Prices exclude taxes and shipping/delivery costs.

This comes after Ford raised the price on its electric F-150 earlier this month.It’s happening across the entire industry. Other automakers significantly raising prices on their electric lineup include General Motors, Rivian, Lucid, and Tesla.Now, this doesn’t diminish our enthusiasm for investing in the EV sector. We expect enormous returns from top-tier EV plays this decade. We’d point you toward research from our own Luke Lango who has documented huge opportunities here.But this is a reminder that in the near-term, there are increasing headwinds blowing against the U.S consumer.However, this is the path Powell has chosen. As we noted in last Friday’s Digest, let’s hope he can stop the pain before it spirals beyond his control.

Have a good evening,

Jeff Remsburg

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