Why Care About Housing Reform

QuintStuart Quint, Sr. Investment Manager & International Strategist, Brinker Capital

Housing is a major component of the U.S. economy and the largest source of wealth for many Americans. Despite the recent rebound, home prices in the U.S. have declined a cumulative -16% since 2006. That masks significant declines in Sunbelt markets hit by the housing bubble collapse (FL -37%, AZ -32%, CA -26%, NV -45%).
(Freddie Mac. September 2013)

Roughly 50% of the stock of housing in the U.S. is financed by mortgage debt. Consequently, the availability and cost of mortgage debt has a direct relationship on the value of housing. Indeed, the 2008 financial crisis exacerbated the downturn in housing as the financial system had sharply cut mortgage credit. The downturn in home prices also damaged consumer confidence for the two-thirds of Americans who owned their home. Many homeowners saw their savings reduced and consequently cut back on their consumption. Additionally, the housing downturn left nearly one out of five Americans underwater on their mortgage debt, (i.e. the resale value of their home in the current market would be less than the mortgage debt they owed). This resulted in higher credit losses for banks, which in turn reduced credit availability across the board.

One reason for sub-par economic growth following the 2008 financial crisis stems from the sub-par recovery in housing. Housing accounts for one out of every six dollars of economic output. (National Association of Home Builders)

9.27.13_QuintAdditionally, the housing downturn has impacted the job market. Approximately 2.5 million lost jobs between 2006 and 2013 were lost because of the housing downturn. Residential construction accounts for 1.5 million jobs including the financial sector and real estate. Housing-related employment amounts to as many as one out of every twelve jobs in the U.S. economy. (Bureau of Labor Statistics. September 6 and The Bipartisan Policy Center)

The issue of how to finance the largest asset for many Americans is of critical importance to future growth prospects for the U.S. economy.

Morning Comment from Tower Bridge Advisors

pic-meyerJames M. Meyer, CFA, Principal and CIO, Tower Bridge Advisors

Stocks finished mixed in a relatively quiet session the day after the Fed decided not to begin reducing its bond buying program.

If you never put a lid on the cookie jar, eventually your kids, and probably your dog, will get fat and sick. If your doctor prescribes an antibiotic every time you have chills or a fever, half the time there will be no benefit and eventually your body will develop a resistance to the antibiotics. If the Fed keeps dropping $85 billion every month out of helicopters, stock and bond prices will go up in the short run but eventually we will all have to face a set of unintended consequences.

9.20.13_TowerBridge_ComentaryWith that said, I don’t want to overstate any reaction to the Fed’s decision to keep its full bond buying program in place. Another couple of months of buying $85 billion per month instead of $70-75 billion won’t make a big difference. Stocks and bonds reacted Wednesday afternoon and that’s about it for the reaction. However, buying $85 billion of bonds every month is rather similar to persistently giving a strong antibiotic, whether it is needed or not. There may not be immediate harm but there will almost certainly be unintended consequences the longer the process persists. How long is too long? No one knows yet. But with the Fed’s balance sheet closing in on $4 trillion and the fact that soon it will own 40% of all government debt maturing five years out or longer, the problems in the future unwinding what it has created are only going to get more difficult if the Fed doesn’t stop adding to its balance sheet soon.

I understand that the government could shut down in October for a few weeks and that Republican conservatives might create a similar debt ceiling crisis to the one it created two years ago. But the Fed isn’t going to solve that problem with an extra $10 billion in bond purchases. In fact, the Fed isn’t going to solve those problems at all. I get the possibility that the Fed was concerned that real interest rates were getting too high and wanted to scare the bond vigilantes with a surprise. It get the possibility of delaying the start of tapering until the Fed knows who the next Chairman might be to make sure he or she is on board with the game plan. So I am willing to give the Fed a couple of months grace period. But with that said, QE is a much more effective crisis policy than a policy designed to maintain economic growth. Flooding the economy with money doesn’t create demand. Certainly, recipients will gladly take the money but the choice of spending it or investing it depends on market conditions. Given the very slow velocity of money both before and during QE, the market has said rather loudly that it would rather invest than spend. That means investors benefit with much stimulation of economic growth or job creation. Here once again is an example of misguided policy whose unintended consequence is to widen the gap between the wealthy and middle classes.

9.20.13_TowerBridge_Comentary_1We are almost certainly not going to see economic data over the next 1-3 months that is going to move the needle enough by itself to change forward outlooks. Indeed, our economy has been adding about 180,000 jobs per month for almost four years and the pace has remained remarkably consistent if you look at a three or six month moving average. Jobless claims are back to pre-recession levels. Existing home sales, which are about 15x new home sales, are booming. So are car sales. Ladies and gentlemen, we are not in a sick economy and everyone who voted to maintain the status quo yesterday should know that. And those who were unsure yesterday are likely to still be unsure next month or next quarter. Economics is never an exact science and there isn’t a formula that will determine tomorrow’s rate of growth. Federal Reserve forecasts of future growth have been persistently too high since the recovery began. Every subsequent forecast adjustment has been downward, including the adjustment announced on Wednesday. Yet forecasts of job creation and unemployment rates have been pretty accurate. The missing ingredient has been weaker than expected productivity, a function of weaker than expected investment. Tax policy, regulatory policy, fiscal policy and uncertainty created by a dysfunctional government all contribute to lack of investment spending.

With that all said, the Fed didn’t move and that leaves us with the question, “What now?” First of all, there is no need to change any economic or earnings projections. There is no need to change outlooks for Europe or China. Interest costs might be marginally less but the economic impact will be negligible. Obviously, throwing more money at financial assets raises asset prices. The impact of Wednesday’s surprise was felt Wednesday afternoon. There isn’t likely to be much follow through. Again, does anyone really believe that a change of $10 billion in Fed bond purchases would move any needle by a whole lot? I certainly don’t. Just as so many government programs in recent years (e.g. first time home buyer credits or cash for clunkers) pulled benefits forward without creating long term value, Wednesday’s decision created a pop in asset prices that probably simply borrow from future gains. No more or no less.

The true facts are that this economy is what it is, an economy growing about 2% per year, despite significant headwinds created by fiscal policy and Congressional gridlock. The headwinds may be a bit less next year as we anniversary the payroll tax increase but housing growth rates will decline next year and one can’t count on the trickle down impact of a 15-25% growth in stock prices to continue indefinitely. As noted, the Fed has persistently forecasted future growth that was too high. As Fed Chairman Bernanke noted yesterday, the fly in the ointment has been weak gains in productivity. With capacity utilization below 80% and incentives to invest virtually non-existent, one shouldn’t expect productivity to improve until investment spending accelerates. Certainly the uncertainty the Fed created this week surrounding monetary policy won’t help in that regard.

The bottom line is that my near term economic and stock market outlook don’t change. By near term, I mean through 2014. I don’t even see a storm that is likely to hit in 2015 at this time, but no crystal ball is that clear looking two years out. Eventually, and that means within five years, as the Fed does exit and interest rates return to normal levels, there will be problems. Big ones. Government debt service costs are going to skyrocket. That will not only cause further cuts in government spending and entitlements.

9.20.13_TowerBridge_Comentary_2Let me make one point very clear. Nothing has been done about entitlements to date because Congress wasn’t forced to act. When debt service costs rise by $200-400 billion per year, it will be forced to act. Market forces can overwhelm politics. Just look back to 2008. When Congress is forced to act, it will raise the starting age and/or means test Social Security more than it does today and it will cost shift Medicare so that recipients must pay some of the costs. Congress won’t do this because it is the right thing to do or because it is good politically. It will do this because it will be left with no other option. Again, it will happen this decade and the timing will be directly tied to the sharp increase in costs to service our Federal debt. Parenthetically, every developed nation plus China will face the same dilemma; how do you offset rising debt service costs. The responses may differ but the problem is widespread.

That storm is at least 2-3 years away. It may be 4-5 years away. But it isn’t 10 years out. Problems ultimately get solved when markets force them to be solved. Look at the health of U.S. banks today. Markets forced that. Markets made railroads efficient after the Penn Central bankruptcy. Mini-mills saved the steel industry. Japan and German car makers forced the U.S. Big Three to enter the 21st century. The good news is that crisis not only forces change, it forces change for the good because that is the only path to survival. Politicians almost always lack the courage to make changes ahead of crisis. That point transcends both borders and political parties. It takes crisis to force change.

Futures point to a flat opening.

The views expressed above are those of Jim Meyer and Tower Bridge Advisors and are not intended as investment advice.

# – This security is owned by the author of this report or accounts under his management at Tower Bridge Advisors.
Additional information on companies in this report is available on request. This report is not a complete analysis of every material fact representing company, industry or security mentioned herein. This firm or its officers, stockholders, employees and clients, in the normal course of business, may have or acquire a position including options, if any, in the securities mentioned. This communication shall not be deemed to constitute an offer, or solicitation on our part with respect to the sale or purchase of any securities. The information above has been obtained from sources believed reliable, but is not necessarily complete and is not guaranteed. This report is prepared for general information only. It does not have regard to the specific investment objectives, financial situation or the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed in this report and should understand that statements regarding future prospects may not be realized. Opinions are subject to change without notice.


Joe PreisserJoe Preisser, Portfolio Specialist, Brinker Capital

The drums of war, which resounded so strongly from our nation’s Capital during the past few weeks, have quickly been muffled by the possibility of a relinquishment of the Syrian government’s chemical weapons stockpile to an international force.  The hastily, cobbled-together diplomatic effort led by the Russian government is dangerously scant on detail, but has offered, as German Chancellor Angela Merkel observed on Wednesday, “a small glimmer of hope” that these weapons of mass destruction can be seized peacefully (New York Times). The delay, and possible aversion of a military strike by the United States, brought about by this development has temporarily allayed tensions around the world and added strength to the current rally that has brought equities in the United States back within sight of the historic heights reached earlier this year.

9.13.13_Pressier_Quagmire_2The long march of the United States back toward armed conflict in yet another nation in the Middle East began with Secretary of State, John Kerry’s emphatic denunciation of the heinous chemical weapons attack perpetrated by the Syrian Government on August 21, which killed an estimated 1,429 people including at least 426 children (New York Times).  Mr. Kerry was quoted as saying, “the indiscriminate slaughter of civilians, the killing of women and children and innocent bystanders by chemical weapons is a moral obscenity…And there is a reason why no matter what you believe about Syria, all peoples and all nations who believe in the cause of our common humanity must stand up to assure that there is accountability for the use of chemical weapons so that it never happens again” (Wall Street Journal). The possibility of American intervention sparked a precipitous decline in stocks listed around the world, with those in the emerging markets having been sold particularly aggressively, as fears of a spillover into a broader regional conflict containing the potential to disrupt the price of crude oil, weighed on investors.

The unprecedented vote by the British Parliament on August 29 to decline the government’s request for an authorization of military force (Telegraph U.K.), began a tentative rebound in global equities, which was furthered by President Obama’s decision on August 31 to seek Congressional approval before embarking on an attack, as both decisions led to the ebbing of worries about any immediate action.  The recent emergence of the potential diplomatic solution to the crisis in Syria, brokered by Russia, has provided further fuel to the reversal in indices around the globe, as concerns of the unintended negative consequences which surround any military conflict have, for the time being, abated.

Chart representing MSCI Emerging Markets Index.

Chart representing MSCI Emerging Markets Index.

Though the President has requested that Congress delay any vote related to the authorization of force until this avenue of diplomacy is fully explored, the potential for United States military action lurks in the shadows and may have in fact been strengthened by this development.  Democratic Whip, Steny Hoyer of Maryland commented on the potential failure of Russia’s endeavor to Bloomberg News, “People would say, well, he went the extra mile…He took the diplomatic course that people had been urging him to take—and it didn’t work.  And therefore under those circumstances, the only option available to us to preclude the further use of chemical weapons and to try to deter and degrade Syria’s ability to use them is to act.”

The suffering in Syria, where the United Nations estimates the death toll to be in excess of 100,000 lives, with half of those lost being civilians and an untold number of injured and displaced, is a tragedy of unfathomable depth.  The fact that it has taken the use of some of the most hideous weapons on Earth to spur the international community to action in an effort to stop the slaughter is deeply regrettable, however it has brought with it the promise of an end to the conflict now in its third year.  Although a diplomatic solution is certainly preferable to military action, if the current negotiations fail to bring Bashar al-Assad’s store of chemical weapons, which is the largest active stockpile in the world, (Wall Street Journal), under international control, the use of force will be a necessary recourse, as the killing of innocents must be stopped.

9.13.13_Pressier_Quagmire_3It’s easy … to say that we really have no interests in who lives in this or that valley in Bosnia, or who owns a strip of brushland in the Horn of Africa, or some piece of parched earth by the Jordan River. But the true measure of our interests lies not in how small or distant these places are, or in whether we have trouble pronouncing their names. The question we must ask is, what are the consequences to our security of letting conflicts fester and spread. We cannot, indeed, we should not, do everything or be everywhere. But where our values and our interests are at stake, and where we can make a difference, we must be prepared to do so.” –William Jefferson Clinton

The views expressed above are those of Brinker Capital and are not intended as investment advice.

Monthly Market and Economic Outlook: September 2013

Magnotta@AmyMagnotta, CFA, Senior Investment Manager, Brinker Capital

The U.S. equity markets experienced a modest pullback in August, with a -2.9% decline in the S&P 500 Index, fueled by concern over the anticipated Fed tapering of asset purchases as well as a U.S.-led military strike on Syria. However, the index is still up +16.2% through August, the best start since 2003.

International equity markets fared better than U.S. markets in August despite the headwind of a stronger U.S. dollar.  So far this year, the return of developed international equities has been about half of the S&P 500 return while emerging market equities have declined -8.8%.  Both Brazil and India have experienced declines of more than -20.0%, suffering from significantly weaker currencies and slowing growth.

Fixed income outperformed equities in August on a relative basis, but the Barclays Aggregate Index still fell -0.5%.  Interest rates continued their move higher, and the yield curve steepened further. The yield on the 10-year U.S. Treasury note has increased 140 basis points from a low of 1.6% in early May, to 3% on September 5, fueled by the Fed’s talk of tapering asset purchases.  The technicals in the fixed income market have deteriorated markedly.  The rise in rates has not yet lost momentum, and investor sentiment has turned, causing large redemptions in fixed income strategies. Our portfolios remain positioned in defense of rising interest rates, with a shorter duration, emphasis on spread product and a healthy allocation to low volatility absolute return strategies.

Interest rates are normalizing from artificially low levels, but still remain low on a historical basis.  Despite slowing or ending asset purchases, the Fed has signaled short-term rates will be on hold for some time. Rising longer-term interest rates in the context of stronger economic growth and low inflation is a satisfactory outcome. In addition, the fundamentals in certain areas of fixed income strategies, including non-Agency MBS, high-yield credit and emerging-market credit, look attractive.

However, we continue to view a continued rapid rise in interest rates as one of the biggest threats to the U.S. economic recovery.  The recovery in the housing market, in both activity and prices, has been a positive contributor to growth this year.  Stable, and potentially rising, home prices help to boost consumer confidence and net worth, which impacts consumer spending in other areas of the economy.  Should mortgage rates to move high enough to stall the housing market recovery, it would be a negative for economic growth.

Outside of the housing market, the U.S. economy continues to grow at a modest pace.  Initial jobless claims, a leading indicator, have continued to decline.  Both the manufacturing and service PMIs have moved further into expansion territory. U.S. companies remain in solid shape and valuations do not appear stretched. M&A activity has picked up. Global economic growth is also showing signs of improvement, in Europe, Japan and even China.

However, risks do remain.  In addition to the major risk of interest rates that move too high too fast, the markets are anticipating the end of the Fed’s quantitative easing program.  Should the Fed follow through in reducing monetary policy accommodation, it will do so in the context of an improving economy.  Washington will again provide volatility generating headlines as we approach deadlines for the budget and debt ceiling negotiations.  However, unlike in previous years, there is no significant fiscal drag to be addressed.  In addition, the nomination of a new Fed Chairman and geopolitical risks (Syria) are of concern.  The market may have already priced in some of these risks.

Risk assets should do well if real growth continues to recover despite the higher interest rate environment; however, we expect continued volatility in the near term. As a result, in our strategic portfolios we remain slightly overweight to risk.  We continue to seek high conviction opportunities and strategies within asset classes.

Some areas of opportunity currently include:

  • Domestic Equity: favor U.S. over international, financial healing (housing, autos), dividend growers
  • International Equity: frontier markets, Japan, micro-cap
  • Fixed Income: non-Agency mortgage backed securities, short duration, emerging market corporates, global high yield and distressed
  • Real Assets: REIT Preferreds
  • Absolute Return: relative value, long/short credit, closed-end funds
  • Private Equity: company specific opportunities

 Asset Class Returns9.6.13_Magnotta_MarketOutlook

Brinker Capital Launches Brinker Investment Services

We are happy to announce the official launch of Brinker Investment Services—a division of Brinker that will be dedicated to serving the audience of independent Registered Investment Advisors. Heading up the BIS team is Bill Simon, Managing Director.

Concurrent with the launch of BIS, we are also happy to announce our partnership with Schwab and the availability of our offerings on their Advisor Services platform. To support this new distribution channel, we’ve brought Frank Pizzichillo on board as RIA Regional Director.

Please click here to read the official press release.