Hey There Income Hunter,
A mining tradition that dates back to 1911, which was just two years prior to the Fed being created, was the use of canary brought down into a coal mine to detect toxic gasses and protect miners from death.
The practice ended in 1986, but the idiom is still often used in financial markets to warn investors of toxic products that are dangerous to their wealth.
I see the bank failures as warning signs of serious trouble in the mortgage market and in particular the commercial real estate (CRE) market …
Today, I’ll share why a collapse in lending by regional banks could trigger a much deeper recession than currently priced in the markets.
A Slow-Moving Train Wreck
The CRE market got hammered during the Covid pandemic as workers were required to work from home and office buildings were left vacant for nearly 2-years.
The problem is after office occupancy collapsed on average 85% across all major US cities, the recovery has only been back to 50% occupied …
What makes the above graph so dire is that office buildings are a long duration asset, meaning they are risky and hard to sell when things go bad.
What makes matters worse for regional bank lenders in the CRE market is this:
CRE loans are non-recourse loans … for example, if a borrower defaults on a CRE loan the bank can only foreclose on the building.
So, if prices drop below the amount of equity borrowers have in the building … They just give the keys back.
Regional Banks Will Be Holding the Keys
This creates a perfect storm for the CRE market once real pricing levels are revealed as banks are forced to sell properties
JP Morgan CEO, Jamie Diamond’s Warning
As the buildings that are at risk need to be sold, that could trigger a chain of events that create a fire sale of assets, which can cause many other banks to fail.
What’s the Trade?
As the CRE market reprices lower mortgage bonds backing the buildings will have to be sold by the banks holding them.
This will put a lot of pressure on bond prices and that will have a negative effect on tech stocks that are valued based on longer-term interest rates.
Tech stocks dominate the holdings in the Invesco QQQ trust ETF (Ticker: QQQ) so when looking to fade broader index rallies consider put spreads on QQQ.
And if looking to buy a new home consider letting this play out in the months ahead, which may save you a nice chunk of change …
Live and Trade With Passion My Friend,
Griff