Sheila Bonitz, Vice President of Investment Management,
As we enter into the busiest selling season of the housing market (March – June), we are seeing signs of improvement within the housing industry as a whole. While many believe that the housing market is sustainable, it has not been a “V-shaped” recovery. Instead, it may be a long, slow road as the effects of the 2008 housing crisis are still fresh in everyone’s mind.
Positive signs for the housing industry:
Mortgage delinquency rates are trending down, which is a positive for the economy.
Home prices are firming and increasing in some areas. The S&P/Case-Shiller Home Price Index increased +13% over the last 12 months.
Overall consumer confidence is increasing, and potential homebuyers are feeling better about buying a home.
Pent-up demand–we are well below the average of household formation since the 2008 crisis. Kids are living on the couch versus moving out.
What is different with this recovery? Developers are much more strategic than what they were in 2006/2007. They are making purposeful, strategic decisions and are concentrating. Developers are focused on the A-market where the focus is on move-up buyers that are less sensitive to price and who have acceptable credit scores. Within the A-market, developers have flexibility with the price of the home. Slightly higher prices help to drive steady volume, which helps control inventory levels and provides steady work for the construction crews. The slightly higher home prices also give a lift to the developers’ operating margins.
Credit is still tight. The average FICO score for approved mortgage loans is 737, well above the 690 average we saw in the 2004-2007 period.
Potential homebuyers enter the housing market cautiously. With home prices on the rise again, they have concerns that their newly-purchased home value may fall sharply. 2008 clearly showed the world that there is no guarantee of generating a profit on the investment of a home. That being said, with interest rates at historic lows and with the cost of buying more advantageous than renting, we will see more people tiptoe their way back into the housing market.
Things to watch:
Does credit remain tight? Currently credit is tight. Wells Fargo* announced on 2/26/14 that they dropped their FICO minimum on FHA Loans to 600; Will other lenders follow Wells Fargo’s lead in lowering FICO minimums? If they do, we may see an increase in potential homebuyers.
Mortgage delinquency rates. Do they continue to trend down? If so, banks may be willing to lend.
Interest rate increase – gradual or sharp? The Housing market can absorb gradual interest rate increases, however; if we see another sharp increase like we did last summer, it will definitely have a negative impact on the housing market as a sharp increase in interest rates creates concern among potential homebuyers.
Monthly jobs report is trending up. As employment increases, the perceived pent-up demand will gradually bring more homebuyers to the market.
Supply. Housing supply has been low. Will there be an increase in supply for the spring selling season? Will it be met with increased demand to keep prices up?
With 2013 in the rear view mirror, investors are looking for signs that the U.S. economy has enough steam to keep up the impressive growth pace for equities set last year. This means maintaining sustainable growth in 2014 with less assistance from the Federal Reserve in the form of its asset purchasing program, quantitative easing. Based on economic data and corporate earnings released so far in January, investors have had a difficult time reaching a conclusion on where we stand.
To date, 101 of the S&P 500 Index companies have reported fourth quarter 2013 earnings (as of this writing). 71% have exceeded consensus earnings per share (EPS) estimates, yielding an aggregate growth rate 5.83% above analyst estimates (Bloomberg). The four-year average is 73% according to FactSet, indicating that Wall Street’s expectations are still low compared to actual corporate performance. Information technology and healthcare have been big reasons why, with 85% and 89% of companies beating fourth quarter EPS estimates respectively.
Despite these positive numbers, two industries that are failing to meet analyst estimates are consumer discretionary and materials. Both of these sectors tend to outperform the broad market during the recovery stage of a business cycle, which we currently find ourselves in. If they begin to underperform or are in line with the market, then it could indicate the beginning of a potential short-term market top.
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There has been mixed data on the macro front as well:
Annualized U.S. December housing starts were stronger than expected (999,000 vs. Bloomberg analyst consensus 985,000).
U.S. Industrial production rose 0.3% in December, marking five consecutive monthly increases.
U.S. December jobless claims fell 3.9% to 335,000; the lowest total in five weeks.
The HSBC Purchasing Managers’ Index (PMI) was above 50 for most of the developed and emerging markets. An index reading above 50 indicates expansion from a production standpoint. This data supports a broad-based global economic recovery.
The Thomson Reuters/University of Michigan index of U.S. consumer confidence unexpectedly fell to 80.4 from 82.5 in December.
The average hourly wages of private sector U.S. works (adjusted for inflation) fell -0.03% compared to a 0.3% increase in CPI for December, 2013. Wages have risen just 0.02% over the last 12 months indicating that American workers have not been benefiting from low inflation.
Preliminary Chinese PMI fell to 49.6 in January, compared to 50.5 in December and the lowest since July 2013.
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The mixed corporate and economic data released in January has led to a sideways trend for the S&P 500 so far in 2014. We remain optimistic for the year ahead, but are managing our portfolios with an eye on the inherent risks previously mentioned.
 The statistics in this release cover output, capacity, and capacity utilization in the U.S. industrial sector, which is defined by the Federal Reserve to comprise manufacturing, mining, and electric and gas utilities. Mining is defined as all industries in sector 21 of the North American Industry Classification System (NAICS); electric and gas utilities are those in NAICS sectors 2211 and 2212. Manufacturing comprises NAICS manufacturing industries (sector 31-33) plus the logging industry and the newspaper, periodical, book, and directory publishing industries. Logging and publishing are classified elsewhere in NAICS (under agriculture and information respectively), but historically they were considered to be manufacturing and were included in the industrial sector under the Standard Industrial Classification (SIC) system. In December 2002 the Federal Reserve reclassified all its industrial output data from the SIC system to NAICS.
This is part two of a two-part blog series. Click here to view part one.
What are the signposts?
Japan also might be recognizing its opportunity for major change out of years of frustration with both voters and the political establishment. Current Prime Minister Shinzo Abe assumed office in December 2012 on a platform of promoting economic growth with the use of “three arrows”: monetary, fiscal, and structural economic reform. So far, he has won positive reviews on the “first arrow”. Naming a new head of the Bank of Japan with support from both ruling and opposition parties has resulted in an aggressive acceleration of quantitative easing in Japan. The goal is to change price expectations from deflation to inflation, and thus improve prospects for savings, investment, and economic growth. Major companies also gave employees small positive wage increases for the first time in many years. Consumer sentiment and financial markets thus far have responded positively.
Monetary policy is not enough to solve Japan’s woes. Structural reform must be tackled, though it will not be easy and could take more time. On the political front, the government must undertake electoral reform in accordance with a ruling from the Supreme Court that could potentially rebalance voting power to younger, urban voters who benefit from more reform. The question is whether leaders on both sides have the political will to implement a real reform. If not, Prime Minister Abe could lose approval and momentum to reform.
Additional structural reforms include trade, energy, tax, health care, and agriculture. Agriculture is key not only to the economy, but also to national security. As an example, the average age of the Japanese farmer is around the mid-sixties. Very few large farms with economies of scale exist. The acreage of farmland in Japan is also declining. Japan is vulnerable to rising food prices, particularly if other countries restrict exports, such as what occurred several years ago when rice prices spiked.
Each quarter, we conduct a survey among financial advisors to gauge their confidence and sentiment regarding the economy, retirement savings, investing and market performance. In our most recent Brinker Barometer, we asked respondents to reflect on key financial issues, including their clients’ retirement readiness, investing and the nation’s debt problems.
Consumer confidence fell to extremely low levels during the financial crisis. While improving in the 2010/2011 period as economic conditions stabilized and markets rebounded, consumer confidence had still remained at levels previously associated with recessions. Confidence retrenched again in the summer of 2011 when S&P downgraded U.S. debt; however, it has been steadily improving since.
While consumer confidence is strengthening, business confidence has weakened. Companies have downgraded their growth expectations. Despite healthy balance sheets, policy uncertainty in the U.S. is causing companies to hunker down and delay capital spending and hiring. CEOs of U.S.-based companies have urged policymakers in Washington to act “to end the crippling uncertainty that is stifling business investment and hiring” (Source: Business Roundtable). On November 18, the Wall Street Journal reported that “half of the nation’s 40 biggest publicly traded corporate spenders have announced plans to curtail capital expenditures this year or next” (Investment Falls off a Cliff).
It is clear that the paralysis in Washington is keeping business investment muted. Until the rules of the game are settled by Congress and President Obama, capital expenditures and hiring will likely remain on hold. Companies have the ability to invest for the future and drive economic growth in the process, but we must wait until fiscal policy uncertainty is removed.
Source: Thomson Reuters, Conference Board
While consumer sentiment has improved, we remain concerned that consumers have not prepared for a fiscal drag that may hit next year. Even if a deal is reached to extend a number of the tax and spending provisions for 2013, it seems that there is very little support in Washington to extend the 2% payroll tax cut. Even if current rates are extended for most taxpayers, everyone will see their take home pay decrease as a result of the expiration of this temporary tax cut. Consumers have already drawn down their savings rate to a level of 3.3%, so there is limited cushion to fall back on. If the fiscal cliff does hit, it could result in further pressure on consumers, and serve dampen confidence.