10yr/Mortgage Ratio Implies Market Rise Coming

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“Davidson” submits:

Looking at the long-term relationship between the 10yr Treasury vs 30yr Mortgage rates which are generally considered in lockstep, shows they tend to track closely with Mtg rates on average 1.75% higher (labeled as the ~1.75% Benchmark in the chart). The history from Aug 1976 thru Aug 1987 (large bracket) is a period of rapid rate rise. The most interesting aspect of this chart is that the Difference between the 30yr Mtg rate minus the 10yr Treasury rate rises when there is a rapid rise in Mtg rates. In other words, the 30yr Mtg rate leads and the 10yr Treasury rate follows with a lag during rapid rate rises.

Mtg Bankers raise and lower rates as they perceive the Real rate of return they need to achieve. The 30yr Mtg rate generally follows the formula:

% inflation + 3% Real return + x% premium = 30yr Mtg% range

The 3% Real rate of return concept roughly matches the Real GDP average over decades. The premium is adjusted by the perceived credit worthiness of the borrower but heavily influenced by the economic risk profile perceived at the time, which is usually wrong. Knut Wicksell identified in 1898 that a long-term ‘Natural Rate’ for investors operated over multiple business cycles.

Today, with rates rising and Mtg rates already at 7.5% range (small bracket), it is the institutional buyers of Treasuries who are out of sync with the rest of the market and need to catch up. Currently, there is an 88% expectation of lower rates in the near term by institutions per the recent Bank of America Fund Manager Survey. They remain rooted in expecting a recession.

The economy is already operating normally with rates well above Treasuries. Companies are profitably passing through inflation cost. The next recession will not occur till consumer delinquencies on credit cards and loans reach levels indicating a fragile financial system. This is when “Black Swan” can tip the system into recession. This appears 2yrs-3yrs in the future.

As the institutions adjust their return expectations, we are seeing capital moving towards companies operating profitably. Most of these companies have been ignored the last 4yrs as Momentum buyers focused almost exclusively on high tech issues perceived to do well under COVID lockdown. As capital continues to shift to equities, the 10yr Treasury rate will rise with the rise in equities.

Article by Todd Sullivan, ValuePlays

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Todd Sullivan is a Massachusetts-based value investor and a General Partner in Rand Strategic Partners. He looks for investments he believes are selling for a discount to their intrinsic value given their current situation and future prospects. He holds them until that value is realized or the fundamentals change in a way that no longer support his thesis. His blog features his various ideas and commentary and he updates readers on their progress in a timely fashion. His commentary has been seen in the online versions of the Wall St. Journal, New York Times, CNN Money, Business Week, Crain’s NY, Kiplingers and other publications. He has also appeared on Fox Business News & Fox News and is a RealMoney.com contributor. His commentary on Starbucks during 2008 was recently quoted by its Founder Howard Schultz in his recent book “Onward”. In 2011 he was asked to present an investment idea at Bill Ackman’s “Harbor Investment Conference”.