KBRA Financial Intelligence

3 Things in Credit: U.S. Consumer, D.R. Horton, and Bush/Gore Redux?

Listen to Van Hesser's insights on: Spotify | Apple | YouTube MusicWelcome, market participants, to another 3 Things in Credit. I’m Van Hesser, Chief Strategist at KBRA. Each week we bring you 3 Things impacting credit markets that we think you should know about.I got a little chuckle when a commentator this week described what the first hour of trading has tended to look like lately: “The first draft of a Jackson Pollock painting.” Sometimes, a picture is worth a thousand words. And taking a look at today’s jobs report, the market can throw that onto its palette.In any event, I think we’ve finally hit a wall in terms of credit market activity, according to my market sources. Activity has ground to a halt ahead of, what’s that again? Oh, yeah, the election. Not that we expect we’ll know all that much on the night of November 5. More on that in a bit. Let’s get on with the show.This week, our 3 Things are:

1. The U.S. consumer. Is that remarkable resilience about to slow?

2. D.R. Horton. The story behind the miss.

3. Bush/Gore redux? Tuesday is not likely to be the end of this election.

Alright, let’s dig a bit deeper.The U.S. consumer.Old timers will recall once upon a time hearing “as goes GM, so goes the nation.” That quote comes from General Motors’ CEO in 1953. Today, you can substitute the U.S. consumer for GM. And while you’re at it, you might want to replace “the nation” with “the world.” The U.S. consumer is that important.The strength and persistence of consumer spending (along with the earnings of Big Tech) underpins the strong bid for risk assets, something we’ve seen all year long in retail sales, and something we saw in this week’s GDP release. Q3 economic growth of 2.8% (by the way, that’s a full point above where the Fed believes longer-run potential is), is primarily driven by, you guessed it, the mighty U.S. consumer, which grew a whopping 3.7% annualized in the most recent quarter, up from 2.8% in the prior quarter, and solidly above the consensus estimate of 3.4%.For all the talk of slowdown in 2024, expected due to the running out of pandemic-era excess savings, and, for many, dwindling borrowing capacity, the U.S. consumer has continued to spend. In fact, spending growth has accelerated over the course of 2024. Higher spending on services was expected, as that is dominated by flush, wealthier households, but the 6% increase in goods consumption was a surprise. The wealth effect is clearly at work, with strong stock market gains and buoyant residential real estate markets leaving wealthier households, well, wealthier. Consistent with all of this is the latest consumer confidence and expectations readings out of the Conference Board, both of which came in this week stronger than expected.So, what to make of yet another strong data release smack in the middle of the Fed’s cutting cycle? Last time I looked, the Fed tends not to cut into a strong economy. Now, we do believe the economy is set to normalize (i.e., slow) in 2025 as the long and variable lags of restrictive rates are still being felt. Look no further than the housing market, or over-levered and less wealthy consumers having to scale back spending. And largely overlooked in the GDP release is the fact that real disposable income has slowed over the course of 2024, from 5.6% in Q1 to 2.4% in Q2 to 1.6% in Q3. The trend there is not our friend.Still, we ignore the wealth effect created from all of that liquidity out there at our own risk. And that should suggest to the FOMC that the neutral rate is at or above 3.5%, and that means quite possibly fewer rate cuts than the market had penciled in. That means you can add a higher cost of capital to the list of headwinds that will slow output in 2025.Alright, on to our second Thing—D.R. Horton.D.R. Horton, America’s largest homebuilder, reported fiscal Q4 earnings this week that came in 12% lower than the year-ago quarter, missing the consensus estimate by 6%. Sales were 4% lower year-on-year, although homes sold were a touch higher. Sales guidance for 2025 was 4%-7% below Street expectations. The stock fell 7.3% on a day when the S&P 500 was fractionally higher. Management attributed the underwhelming quarter to the belief that potential homebuyers are holding off purchasing, waiting for rates to come down, although that doesn’t explain the guidance shortfall. Maybe the Street was simply too optimistic. Or maybe there’s more to this story.Two things come to mind. One, Horton caters to first-time homebuyers and is a leader in lower price-point homes. We often talk about the “Two Economies,” wealthier households and larger businesses that are flourishing, and less wealthy households and smaller businesses that are challenged. The latter has been particularly hit hard by inflation and higher rates and has had to adjust lifestyle to a post-stimulus-enhanced world. And they have not participated in the wealth effect from rising stock and housing markets. Many of those are potential Horton customers that are waiting for home values and mortgage rates to fall. That wait is extending.The second point worth making is the bite of monetary policy. Mortgage rates, which fell nearly a point over the course of the summer to a recent low of 6.6%, have bounced back up above 7%, reducing affordability, and hope, once again for many potential Horton customers. Blame that move on prospects for a Trump presidency, or deficits or sticky inflation or reduced foreign buying of an ever-growing Treasury financing calendar. These things have a cost.It’s also a reminder to think about Two Economies when selecting credit investments and shaping portfolio construction. The financial fortunes of the more vulnerable are not likely to improve in 2025.Alright, on to our third Thing—Bush/Gore redux?To the extent history is our guide, it probably is worth going back and looking at market reaction to the last U.S. presidential election that took a while to finalize, namely Bush vs. Gore in 2000. From that year’s election day, November 8, until December 12, the day the Supreme Court ended a Florida vote recount forever remembered for “hanging chads,” markets moved. High-yield spreads gapped out 143 bps, or 20%, during the period. The 10-Year Treasury yield plunged 56 bps to 5.30%. The S&P 500 fell 6.7%. Is history likely to repeat?No. In 2000, there were shocks moving through financial markets that had nothing to do with the election, most notably the dot.com bust, which had cut NASDAQ in half over the course of the election year. That would ultimately contribute mightily to the recession in the U.S. which ran from March of 2001 to November of that year. No one was feeling particularly jovial or bullish by the fourth quarter of 2000, and the uncertainty around the outcome of the election proved to be just gas on that fire.That’s a very different environment than today. The economy today is, to quote The Wall Street Journal, “a remarkable growth machine.” Economic growth is running well above potential, and unemployment remains quite low. Financial conditions are highly favorable, with stocks at all-time highs and credit spreads at structural tights. Sure, there are plenty of things to worry about, but most fall into the geopolitical realm, which tend to be discounted by investors as tail events in terms of market-moving impact. And while today’s geopolitical risks are quite possibly tied to the outcome of this election, it will likely take a while for all of that to develop. For now, and in the aftermath of this election, where the result may not be known for weeks, markets will go back to worrying about big tech earnings and Fed rate cuts.So, there you have it, 3 Things in Credit:

1. The U.S. consumer. Keep an eye on disposable income.

2. D.R. Horton. The bite of monetary tightening.

3. Bush/Gore redux? Markets are likely to hold in in Harris/Trump. For a while, anyway.

As always, thanks for joining. If you’re interested in banks, you’ll want to find your way to Washington, D.C., on November 20 for our Bank Symposium. Find out how to sign up on our website under the Events tab. Hope to see you there. On the podcast, we’ll see you next week.