How volatility in the financial markets affects real estate

Raziel Ungar: Hi, everyone, and welcome to Raziel TV. With me today is Mike Treon from PNC Bank, and Mike's been in the lending and finance world for over 25 years. And we're going to have a little conversation that I hope will give you some more context for what's happening with the volatility in the market. Mike, thanks for being with us.

Mike Treon: Absolutely.

Raziel Ungar: Tell us a little bit about your background, too, so people have an idea of where your thought process is coming from.

Mike Treon: I have, I guess, a little more of an eclectic background, if you will, which sometimes could be determined a little bit crazy background. I started cutting my teeth in the commercial underwriting world, so I went through Wells Fargo's credit program back in the 90s, which was a great, great credit program. And then I went from that world into the hedge fund world, and I was in San Francisco and then I was in London. And I was in the hedge fund world for about four years as a convertible bond trader, currency trader. But I would also analyze companies, come up with trading ideas, et cetera, both from the debt side as well as from the equity side.

Mike Treon: You and I started talking about it last year, and I was a broken record with clients and friends, and I also did this internal presentation in November of last year. Basically, I told people, which didn't sit well with a lot of people, the Fed kept using the word transitory and I said, "The Fed is absolutely incorrect. Inflation is not transitory." At that point, the 10-year yield was at one spot four, five, 1.45%. And on that call in November, I told people, "I see the 10-year immediately going to 3% very, very quickly in the late spring, early summer" of last year.

Mike Treon: At that point, everyone thought I was crazy. And I explained to people that, "The Fed had a unique opportunity in the summertime last year to take their foot off the brake and they missed it. Not only did they miss it, they kept their foot on the accelerator." So this idea of no one saw this coming, et cetera, is incorrect. The fact is the Fed stayed too accommodative for way too long.

Mike Treon: Now, I tell people that this is very analogous with what happened in the dot-com period of time. So a lot of people forget what happened in the dot-com period of time and what caused that. The market peaked in March of 2000, but the reason the market peaked was because Alan Greenspan, in 1999, was freaked out about a thing called Y2K. You remember Y2K?

Mike Treon: So Y2K was the digits are going to roll over and then we're going to go road warrior. We're all going to live out in the desert, we're going to be eating our dogs, because the world's going to end. That's what they were preparing for. I was in the hedge fund world at that point. And so Greenspan throttled the system with money, and then it all came, and the world kept moving and it was all good. That money had to go somewhere. What did it do? It gravitated to the equity markets, and you saw the peak, especially in the tech stocks. Then the Fed had to pull the money back out, so that's what happened.

Mike Treon: I always use the analogy, it's like a good party. Now the Fed's coming in and going, "I'm going to take that punch blow away. You guys are all drunk, but I'm going to take the punch bowl away," towards that. Now that's when the absolute party stops, and it's no fun for a long period of time. So they had to pull that money back out. And that led to the market going down, down, down for the next two years. It also causes that point of massive acceleration, upwards of the dollar.

Mike Treon: Now let's look at right now. COVID hits and they come in and they just throttle the system with money, and they throttle it and they throttle it for too long of a time period. Now that money, where does it go? Goes into speculation across the board. Zoom the stock goes crazy, all the tech go nuts, Bitcoin goes nuts, et cetera. That's because the system's awash in capital. Now, that capital is going to find a home, but now the Feds have to pull the money back.

Mike Treon: In the meantime, and this is what I was trying to tell people, why I saw this coming, and the net effect of what it was going to do to the market because I lived through it before. Once that money comes out, Warren Buffet says, "It's like it's the tide, as soon as the tide goes out, you see who's swimming naked." Money is what I call the oxygen in the room. When you take that oxygen out and you start seeing people labor in their breathing, that's the effect of those people who need that free money.

Mike Treon: So that's what's happening now is that the market is fast adjusting to this inflation is out of control and the Fed missed their opportunity, and you can't put that genie back in the bottle very, very quickly. Because we have structural inflation, which is very different than what I call traditional inflation.

Mike Treon: Traditional inflation is too many dollars chasing too few goods. Structural inflation, we have labor issues, we have things that we can't get from China, because they're in a zero COVID policy, and we don't know what's going on there. We have other problems around supply chains, energy, blah, blah, blah. So this inflation, which was caused by that massive injection on capital is not going away anytime soon.

Mike Treon: The problem the Fed is having right now is they're raising short-term rates, and they have one lever to pull, which is the short-term rates. They've also got what they can do with operation twists and what they could do with selling bonds, which is what they're supposed to be doing, but they may have to go back to buying soon if they cause too much of a pullback. So they're trying to watch this dance.

Mike Treon: I always say, "The Fed is trying to keep this pendulum in a tighter range. When they let it swing out too far here or one particular direction, that it creates that volatility of how much it swings back from one extreme to the other extreme." So now we're in extremes, which is not as central banker where you want to be.

Mike Treon: So what happened in the springtime, this was critical, was that the yield curve inverted. Now, when the yield curve inverts, it's the fancy way of saying, short-term rates crossed long-term rates, the thing that was scary was how fast it happened. It happened, literally, within 45 days and probably less time period. It was incredibly fast. And as soon as that happened in March, I did a podcast. I said, "We're going to be in a recession by September, October." And that was primarily because how fast that happened.

Raziel Ungar: Mike, talk to me about how that relates to now, and what we can expect moving forward.

Mike Treon: And I think that really is talking about the last 90 days because the last 90 days we saw a very big jump up in range. And that-

Raziel Ungar: It's put a huge dampening, obviously, on the market, fewer buyers, fewer sellers, or slower velocity. And so I think that's definitely pertinent.

Mike Treon: The velocity's a great word, because velocity is always a measurement of how quickly something affects the market and how deep that effect will be. So I've never seen rates move up this quickly in this shorter period of time, in 25 years. So that's been a little bit scary, and it pertains to where we're going, because what the bond vigilantes, a lot of people say, "The bond vigilantes are back," et cetera, whether they're back or not, what it is the bond market wants a higher rate of return for the risk it's taking based off of our massive debt. And so what happened is we saw a big movement up in rates in August, because the bond people got worried that Manchin was going to go with the "Inflation Reduction Act." And the bond people were thinking, "There's nothing here that's going to reduce inflation, it's going to stimulate more inflation."

Mike Treon: So basically, you'd have the Fed trying to make progress with short term rates, but then all of a sudden every time we're like, "Oh, we have a printing press, but what we're actually doing is creating debt, which is all very inflationary." If all of a sudden you come out and say, "I'm going to unilaterally forgive student loans," which will get held up in the courts, that is immediately viewed as inflationary because that's one way of taking that money that should be going to be paid down [inaudible], and it's putting back into the economy.

Mike Treon: So how that affects things going forward is you see volatility in the stock market, which affects this particular market, because of all the people being tied to their portfolio, their RSUs, et cetera. I've always said, "If you want to understand real estate and the Bay Area, you can overlay a chart of the S&P and the NASDAQ, and you will be able to see lagging by a two to three-month period of time that particular trajectory."

Mike Treon: So what's happening now is you have two effects. One is that rates are a lot higher, so it's decreasing people's ability to what they can buy. If we were sitting here a year ago, on a 30-year rate, you're getting 2.75 on a $2 million loan. Now lenders are quoting you six, six and a quarter, six and a half. We're more than double, more than double in a very, very short time. So that is affecting people's willingness to go out on the risk curve in terms of the amount of debt that they're willing to take.

Mike Treon: What's also going to start happening is we're going to start seeing more companies begin to cut FTE. They're going to go after margins, and they're going to cut labor. So you're going to see more layoffs, and you're going to see more controlling of expenses. And so that's the part that we have to muddle through right now. Let's lead up to the elections. So we have the midterms coming up. These midterms are going to be very, very interesting. I'm not a fan of Republicans or the Democrats, I'm an independent, et cetera, but I look at this all from the bond perspective.

Raziel Ungar: And by the time some of you're watching this, this could be easily after the elections.

Mike Treon: Correct, so we don't know.

Raziel Ungar: Yes.

Mike Treon: Let's say that the house were to flip, the bond market is going to look at that as a positive, not a positive, who win or that, just the fact that there will be log jam. Just the fact that there will be a counter force that will be pushing against one party versus the other dictating the continual outcome, and the market likes that log jam. So the market wants to see that. So that could allow rates to settle down as people feel like, "Well, at least these guys are going to be fighting each other, but it's like tug of war, we're just not going to move too far."

Raziel Ungar: And what's kind of the Fed's relationship to setting interest rates that home buyers are seeing in the marketplace? A lot of people kind of see the headlines, but it's not a direct correlation.

Mike Treon: It's a great question, because today was a Fed meeting. So today was a Fed meeting, I got, I don't know, seven, eight different texts from people that are very knowledgeable. They're like, "Well, what do you think about the Fed Day? Et cetera." This is what I always tell people, "The Fed movement today was baked in the cake a month ago. The bond market is where real money goes to back. The Fed is a bunch of academics. They're going to come out and make an announcement."

Mike Treon: So the bond market is already discounted made, its predictions. So oftentimes you'll see rates do the opposite of what the Fed does on Fed Day. Today was an interesting day though, because at first when they came out with the announcement, it looked like the Fed was alluding to that they would be slowing down the trajectory of rate movements in December. The market liked that and that was in line with the planted story about two weeks ago by The Wall Street Journal. The market liked that, initially.

Mike Treon: The press conference comes out and people, I had several bond guys would text me, "Could someone tell Powell to shut up?" Because in the press conference, Powell is trying to be tough. And he's being much more like, "We're going to be data independent, dah, dah, dah." And then people are looking for the Fed to make a clearer message that, "Look, we're going to slow down and see the effect of this." Because these are movements that are dealt like with aircraft carrier. We're just now starting to see if something is done six months before that, how long does it take to bleed through the system?

Mike Treon: But in the meantime, we've got a Fed supposedly offloading their balance sheet and putting out. And we don't have China buying those treasuries like we've had in the past. So there's just a lot of conflicting forces right now, in terms of how that affects the current rate, and what rates will look like in December. So today had huge swings, rates were down, and then they were up. And then the equity markets were rallying and then they dropped almost a 1,000 Dow points intraday. So that tells you there's just a lot of volatility out there.

Raziel Ungar: And what can someone expect for the next few months, continued volatility, interest rates kind of stay more or less roughly where they are? Can a home buyer today say, "Oh, maybe, is it possible in three or six months rates could be where they were six months ago"? Is that a possibility? Or unlikely, we're going to see that again for a while.

Mike Treon: So I think the Fed using The Wall Street Journal is trying to tell the market that they are willing to take a step back. However, every time they do stuff, they get kneecapped by the administration who comes out with another piece that is viewed as creating more debt. So the Fed is basically dealing with a shift in policy that negates kind of what they're doing to slow things down.

Mike Treon: For example, oil. We're draining the SPR right now. They're doing that to buy votes, and they're going to look at filling that after the election. That's very inflationary if they're going back in the oil market and having to be forced to buy oil at 88 bucks or 92 or 95 or 100, and that's going to be immediately going against the middle class that needs to use their car for means of production. It's going to take that money out of the system. So a lot of these things could have unintended consequences.

Mike Treon: Christmas time, the holiday season, you can't get labor, you can't get these positions filled. Like look at a Starbucks when you go in, they're down one or two barista, two of them are in the back crying, because they've had too many orders that day, because they don't have enough people. People are stretched. So there's this weird thing, too, where the Fed, yeah, we're trying to slow things down, but then these other businesses who can't fill those positions. Then you have food inflation and food inflation's not coming down. Because even if they do get a discount on their wings, if that store is paying for less than wings, they're getting killed on labor.

Raziel Ungar: I mean, from what I'm reading though, or I read an article, I think it was in The Wall Street Journal yesterday, they're talking about there's a huge amount of corporate profits that are being made in addition to just the inflationary costs. What are your thoughts on... I mean, I guess it's certainly a capitalistic system.

Mike Treon: Sure.

Raziel Ungar: And even McDonald's, I think, on the earnings call, the CEO said in the last day or two, "People are willing to tolerate this," meaning our customers are willing to pay more.

Mike Treon: So there's an old adage in commodities that say higher prices cure higher prices. So the point is, you're going to go to a point where you're going to get pushback. Chipotle's a great example. People love Chipotle, et cetera, well, the stock-

Raziel Ungar: I love Chipotle, yeah.

Mike Treon: Right, but the stock started to drop because people are like, "You know what? I don't want to pay $18 for my Coke and my burrito bowl." And there comes a point where people's behavior will start changing. [inaudible]-

Raziel Ungar: And that's when the prices drop.

Mike Treon: Yeah, because the prices are too high. There was a great thing where someone put out a Walmart shopping list from, I think it was three years ago. It was just a standard list that they had of the stuff that they buy. That list of what was, I think it was two and a half to three years ago, in that ballpark, was up almost 80%. Now, we have a government who's showing a CPI that's up, what, 13 to 14%? Where's the rest of the inflation? We all see it. We see it in the prices we pay in terms of that, and the idea...

Mike Treon: Because the government pays social security benefits based on CPI. So they tend to be more towards fudging on that number versus what people are paying. So everyone else can tell you, everything's more expensive. And so there'll come a point, there's that old joke that, it is a slow-down when your neighbor loses his job, but it's a depression when you lose your job. It's all local. So that labor piece, it depends on how much we get into a lay-off cycle, and I think that will be critical to answer your question. How many layoffs are we going to have to go through? And like I said, I absolutely believe we are already in a recession. And just because they changed the definition of a always-accepted recession, what we're seeing is in behavior.

Raziel Ungar: I mean, Mike, I remember reading, I think recently, that Meta did some layoffs or they're going to do some layoffs, but they grew their headcount over the last 12, 18 months by like 30%. So they brought on so much, but then maybe they just were too ambitious with their hiring, then they have to let some folks go. Obviously, that's very sad. But they also brought in a ton of people that maybe weren't necessary.

Mike Treon: That was a bet on Zuckerberg's Meta plan. And right now the market is giving the Caesar thumbs down on it, so far, and I'm not saying that's going to occur. But the market is saying, "We need to see an ROI on this and what that will look like." So you're going to see, what I think will happen is a lot of that headcount begin to be shaved down with a lot of companies because they're going to have to be beholden to the shareholders. You'll get a couple of passes, but if it continues on, we've seen a massive crushing of the capital of Metal and you'll see people begin to vote with their feet via the sell button, which they've been doing for a while.

Raziel Ungar: Obviously, [inaudible]-

Mike Treon: You could see that in Tesla, right? Tesla, Elon Musk, brilliant, et cetera. You're a Tesla shareholder, you're like, "Hey, Elon, I know this Twitter thing is a nice sparkly thing for you to go look at, but can you make sure that we don't lose your brilliant leadership over here?" So that's another situation where you could see people voting with their feet if they're not happy. And that's where I think we're at right now is a lot of equity holders are just under a lot more stress. And that stress I think is going to be here for a while. And that is where we look at the housing market and can affect housing because it has to do with high net worth, and consumer confidence.

Raziel Ungar: So Mike, obviously, this is a macro issue from a national and global perspective. I like to think in the Bay Area, especially San Francisco, the peninsula, parts of the East Bay, and Marin, it's a very affluent area. What are you seeing with your clientele? And what do you see how this might affect them, if at all?

Mike Treon: So this area is unique because it's got a very elastic job market. So we're not like Allentown, Pennsylvania, where it's dependent upon one industry. This place is amazing in terms of biotech, social media, finance, et cetera.

Raziel Ungar: Healthcare, biotech.

Mike Treon: Healthcare, innovation, I mean, it's amazing in terms of that area. So that multi-layered nature of that creates that elasticity. The one downside though is that we become extremely dependent upon equity payouts, in terms of people that are willing to do startups, because they're looking to be bought, or people that are willing to work for tech companies, because of those RSUs, et cetera.

Mike Treon: So when those particular payouts become affected by a down market, then it decreases the amount of the money those people are being paid. So that compounds it great in good times, causes everything to go crazy. In these bad times, basically, it slows down very quickly, and people get more skittish because they don't know if they're going to be making what they've been used to making.

Mike Treon: So that's how things can be adversely affected. This market though is oftentimes the first to come back. But when it dips, it'll have some sharp dips. But if you look at the time periods where we've had these, usually the Bay Area is the first one to lead in terms of the bounce out of it. A lot of times, I believe, because the equity market is a forward-looking indicator. And oftentimes you'll see the bounce. Maybe it doesn't hit the real economy for six to eight months. The equity market sees that and you start seeing the guys maybe in the semiconductor cycle or this particular tech company that is feeling much better because they're seeing their businesses getting better, they're feeling more confident, et cetera. But it takes time for that to happen.

Raziel Ungar: I remember reading a number of years ago, about 2008 to 2010, kind of the financial crisis, and you looked at places like Sacramento, Vegas, Phoenix, I know you're from Arizona, and the market had dropped 50 to 70%, the real estate market in those areas. And then you looked at San Mateo County from the highest point to the lowest point dropped about 26% on average. And then you saw the higher price point areas like Burlingame, Hillsborough, Atherton, and Palo Alto, where it dropped about 13, 14%.

Raziel Ungar: Now, we're starting to see that too. And we haven't seen a 26% drop, but it's fair to say we've seen a 10 to 15% drop depending on where it is. A lot of people are wondering, "Well, can it drop further?" Obviously, none of us know, but I wonder kind of your thoughts on that in relation to other parts of the country, too, from a real estate perspective.

Mike Treon: So the thing about this area is what I call land mass. You can't build a lot here. You're contained by the last 70 years in terms of how these places have been laid out, and what can be built on it and what can't be built on them.

Raziel Ungar: And in fact, 72% of San Mateo County is in protected land, like west of 280, I mean, for example.

Mike Treon: And then even a lot of places you're limited in going vertical.

Raziel Ungar: It's a whole other conversation.

Mike Treon: So you're dealing with this whole supply thing that's being affected by the structure in that particular area, which also maintains values. I think that's what also adds to why this area is less affected. When you're in Nevada and you're in Arizona, et cetera, land is an easier obtained commodity. You can build out and you can spread and you keep building out and out. You can't do that here. So it doesn't mean that we don't get affected, we don't have dips, we do. We do. It just means that oftentimes we're going to come back faster, and those dips are going to be more contained by the inherent wealth in the area.

Raziel Ungar: Just to wrap things up, Mike, obviously, it's crazy out there, it's a volatile time. We all read the news. How can we kind of end this on a positive note?

Mike Treon: Sure. So I think that and this is my own experience of going through a lot of markets and having ups and downs, and the good news is after the dawn, the sun rises. And there's opportunity. There's great opportunity. A lot of times, too, with the houses, I tell people, like I said, about the Apple stock, "You're not going to live in your stock. You're going to find a place to build your family. And that's the most important thing."

Mike Treon: People want to time markets to me and come to me, and I just ask them, "Is it right for your family?" Because in the Bay Area, maybe you have to ride things out for a year or two, and that's just the way it is. But you can be Mr. Market timer, good luck with that, in terms of that. I have lots of husbands who went sleeping on the couch, because the wife said to them two years ago in 2015, "You need to buy,"

Mike Treon: And they thought it was too expensive. The point is, it's oftentimes about what's more important to your family. And there's going to be great opportunities. We're going to come through this. It's going to take some time. I'm not going to lie to you, we've got a lot more volatility ahead of us. But once a lot of that access clears out the market, it opens up for the next expansion cycle.

Raziel Ungar: Yeah, that's great. Well, thanks for joining us today, Mike.

Mike Treon: Any time.

Raziel Ungar: And thanks for watching Raziel TV.