Is a Correction Coming?

We are approaching almost three years since the last time the stock market underwent a classic correction, which is generally defined as a pullback of at least 10 percent. According to CNN/Money, a correction happens on the average of about every 18 months. Thus, statistically we are more than due at the present time. Note that we are not talking about the end of the bull market which has lasted over six years. The question is: will this correction come in the second half of the year?

For the first half of this year, the stock market has treaded water. This is in contrast to the rest of the bull market in which gains have averaged close to 15% annually for the previous six years. One could argue that this "breather" is a correction, even though there is not a classic loss in value. Another question follows: Why would stocks be stagnating when the economy is picking up steam? Right now there are two factors holding back stocks -- higher rates and international pressures, most recently the crisis in Greece. It is not surprising that stocks are weak in light of the issues Greece and Europe are facing. Interest rates and oil prices have also fallen as the crisis has unfolded.


As for rates, stocks have long benefited from super low rates. Now that rates may be rising in the long run due to a better economy, that benefit may be reduced. Of course, it is not like rates are high right now, especially from a historical perspective. Just keep in mind that rising rates do not affect only the real estate sector. They can have a profound influence on all markets. Right now rising rates are actually benefiting real estate as consumers rush to purchase homes to beat the rate increases.  

Mike Ervin
Branch Manager/Mortgage Banker
NMLS: 282715
O: 650.451-7797
C: 650.766.8500 
mike@mikeervin.com

End of the Quarter

The quarter just ended and it was a very important quarter for the American economy. Especially considering the fact that last quarter was weak due to our long and harsh winter and international economies are slowing. Economists will be looking for a bounce back from the first quarter in which the economy actually contracted. And the first important statistic wrapping up the quarter was reported this past week -- the jobs report. The employment numbers give us a clue as to how we did in the second quarter. Certainly at lowest unemployment rate in seven years is an indication of good news.

Because the numbers were moderately strong, this means that the quarter is likely to have been strong as well. The question is, does that puts us closer to an increase in rates courtesy of the Federal Reserve Board? As we have previously indicated, the Fed is also watching for increases in wages and wage inflation continues to be muted. While higher wages are great for the economy, they also would represent the first spark in inflation. Strong jobs and a rebounding real estate market are hallmarks of the better economy the Fed is looking for. There is no doubt that the real estate markets are getting stronger.

The end of the quarter also means that we are going to see a slew of earnings reports. The stock market often reacts to these reports and if corporate earnings falter, many are expecting to see the stock market correction that we have avoided for quite some time. Mix in international influences and the situation can get very cloudy. Just this past week we have seen how the Greek crisis and China's stock market crash affected movements in our
stock market as well as interest rates. This is why predicting the future is so difficult -- for us and the Fed.

Mike Ervin
Branch Manager/Mortgage Banker
NMLS: 282715
O: 650.451-7797
C: 650.766.8500
mike@mikeervin.com

More On The Fed

As we have discussed, the Federal Reserve Board is moving closer to raising interest rates. We have mentioned several times that the Fed controls short-term rates directly and influences, but does not control, longer-term rates. This topic is important to understand as we watch the economy this year. The Fed sets the "Discount Rate" which the Fed charges member banks to borrow funds in the short run when they are short of reserves. The Fed also sets a target for the "Federal Funds Rate" which is the rate banks charge each other for short-term borrowing.

Without getting into too much technical detail, these are very short-term rates. Thus, when the Fed moved both rates to near zero as a reaction to the recession, rates on short-term instruments, such as six month treasuries, moved close to zero as well. Long-term rates moved down as well in reaction to the same forces that caused the Fed to lower short-term rates. Why is this important? This is important because the Fed is likely to increase short-term rates shortly.

And many are thinking that long-term rates, such as rates on home loans, will move up automatically. Well, rates on home loans have already moved up from their low levels of this winter in anticipation of this move. Therefore, when the Fed moves rates up, if the markets feel that this is the only move coming for the foreseeable future, long-term rates may not move at all. On the other hand, if the economy keeps getting stronger, long term rates will continue to move up regardless of what the Fed does. As a matter of fact, if the markets feel the Fed is not moving quickly enough, rates could move up even faster because nothing spooks the markets more than the specter of inflation.

Mike Ervin
Branch Manager/Mortgage Banker
NMLS: 282715
O: 650.451-7797
C: 650.766.8500
mike@mikeervin.com