Housing Recovery: Slow but Sustainable

Sheila BonitzSheila Bonitz, Vice President of Investment Management,
Brinker Capital

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:

U.S. Consumer Confidence

Source: FactSet

  • 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:

Mortgage Delinquency Rates

Source: FactSet

  • 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?

Source: “Wells Fargo Lowers Credit Scores for FHA Loans,” National Mortgage News (Feb. 6, 2014)

The views expressed are those of Brinker Capital and are for informational purposes only. Holdings are subject to change.

Investment Insights Podcast – February 28, 2014

Bill MillerBill Miller, Chief Investment Officer

On this week’s podcast (recorded February 27, 2014) we are back to the traditional format of what we like, what we don’t like, and what we’re doing about it:

  • What we like: ISI Homebuilding Survey surged this week, increasing odds that the overall economy will improve as the cold weather improves
  • What we don’t like: Investors don’t know if the recent slowdown is due to the cold weather or if there’s something greater at work beyond that
  • What we are doing about it: No major changes; view remains that markets will grind upwards all year long

Click the play icon below to launch the audio recording.

The views expressed are those of Brinker Capital and are for informational purposes only. Holdings are subject to change.

Monthly Market and Economic Outlook: November 2013

MagnottaAmy Magnotta, CFA, Senior Investment Manager, Brinker Capital

The impressive run for global equities continued in October. While U.S. and developed international markets have gained more than 25% and 20% respectively so far this year, emerging markets equities, fixed income, and commodities have lagged. Emerging markets have eked out a gain of less than 1%, but fixed income and commodities have posted negative year-to-date returns (through 10/31). While interest rates were relatively unchanged in October, the 10-year Treasury is still 100 basis points higher than where it began the year.

After the Fed decided not to begin tapering asset purchases at their September meeting, seeking greater clarity on economic growth and a waning of fiscal policy uncertainty, attention turned to Washington. A short-term deal was signed into law on October 17, funding the government until mid-January 2014 and suspending the debt ceiling until February 2014. With the prospects of a grand bargain slim, we expect continued headline risk coming out of Washington.

The Fed will again face the decision to taper asset purchases at their December meeting, and we expect volatility in risk assets and interest rates to surround this decision, just as we experienced in the second quarter.  More recent economic data has surprised to the upside, including a +2.8% GDP growth rate and better-than-expected gains in payrolls. Despite their decision to reduce or end asset purchases, the Fed has signaled that 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.

11.12.13_Magnotta_MarketOutlook_1However, we continue to view a rapid rise in interest rates as one of the biggest threats to the 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 move high enough to stall the housing market recovery, it would be a negative for economic growth.

We continue to approach our macro view as a balance between headwinds and tailwinds. We believe the scale remains tipped in favor of tailwinds as we approach the end of the year, with a number of factors supporting the economy and markets.

  • Monetary policy remains accommodative: The Fed remains accommodative (even with the eventual end of asset purchases, short-term interest rates are likely to remain near-zero until 2015), the ECB has provided additional support through a rate cut, and the Bank of Japan has embraced an aggressive monetary easing program in an attempt to boost growth and inflation.
  • Global growth strengthening: U.S. economic growth has been sluggish, but steady. The manufacturing and service PMIs remain solidly in expansion territory. Outside of the U.S. growth has not been very robust, but it is positive.
  • Labor market progress: The recovery in the labor market has been slow, but stable. Monthly payroll gains have averaged 201,000[1] over the last three months.
  • Inflation tame: With the CPI increasing only +1.2% over the last 12 months, inflation in the U.S. has been running below the Fed’s target level.
  • Equity fund flows turn positive: Equity mutual funds have experienced inflows of $24 billion over the last three weeks, compared to outflows of -$12 billion for fixed income funds.[2] Continued inflows would provide further support to the equity markets.
  • Housing market improvement: The improvement in home prices, typically a consumer’s largest asset, boosts net worth, and as a result, consumer confidence.  However, another move higher in mortgage rates could jeopardize the recovery.
  • U.S. companies remain in solid shape: U.S. companies have solid balance sheets flush with cash that could be reinvested or returned to shareholders. Corporate profits remain at high levels and margins have been resilient.

However, risks facing the economy and markets remain, including:

  • 11.12.13_Magnotta_MarketOutlook_2Fed mismanages exit: The Fed will soon have to face the decision of when to scale back asset purchases, which could prompt further volatility in asset prices and interest rates. If the economy has not yet reached escape velocity when the Fed begins to scale back its asset purchases, risk assets could react negatively as they have in the past when monetary stimulus has been withdrawn.  If the Fed does begin to slow asset purchases, it will be in the context of an improving economy.
  • Significantly higher interest rates: Rates moving significantly higher from current levels could stifle the economic recovery.
  • Sentiment elevated: Investor sentiment is elevated, which typically serves as a contrarian signal.
  • Fiscal policy uncertainty: Washington continues to kick the can down the road, delaying further debt ceiling and budget negotiations to early 2014.

Risk assets should continue to perform if real growth continues to recover even in a higher interest rate environment; however, we expect continued volatility in the near term, especially as we await the Fed’s decision on the fate of QE. Equity market valuations remain reasonable; however, sentiment is elevated. Our portfolios are positioned to take advantage of continued strength in risk assets, and we continue to emphasize high-conviction opportunities within asset classes, as well as strategies that can exploit market inefficiencies.

Some areas of opportunity currently include:

  • Global Equity: large cap growth, dividend growers, Japan, frontier markets, international microcap
  • Fixed Income: MBS, global high yield credit, short duration
  • Absolute Return: closed-end funds, relative value, long/short credit
  • Real Assets: MLPs, company specific opportunities
  • Private Equity: company specific opportunities

Asset Class Returns

11.12.13_Magnotta_MarketOutlook

Why and How Will Housing Finance Be Reformed?

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

The downturn in the housing market affected more than just the banks, but also the U.S. taxpayers. Nearly two out of every three dollars of mortgage debt is owned, guaranteed, or insured by agencies of the U.S. Government. The credit risk on the balance sheets of these agencies exposes the U.S. taxpayer to substantial risk in the event of a housing downturn.

The mandate to promote home ownership coupled with sub-optimal policies resulted in these agencies taking on excessive credit risk leading up to the 2008 financial crisis. Substantial credit losses from declines in home prices damaged the balance sheets of government-sponsored enterprises (GSEs) such as Fannie Mae and Freddie Mac. These companies were effectively nationalized during the 2008 crisis. The U.S. Federal Government was compelled to intervene by making their debt an explicit guarantee backed by the full faith and credit of the U.S. taxpayer.  While private capital withdrew from the market, the Federal Housing Administration (FHA) expanded its mortgage insurance program, especially for first-time home buyers, in the depth of the 2008 crisis. Arguably, it might have prevented the housing crisis from getting worse, but the FHA has also been saddled with credit losses and is gradually reducing its participation in the market.

11.08.13_Quint_Housing_2Rare consensus within Washington exists for promoting housing-finance reform, though details on how to implement reform vary. There is little dissension for reducing the role of the Federal Government in the housing market and thus the liability of the U.S. taxpayer. The common vision is to shift the agencies’ role toward being a lender of last resort and reducing credit exposure to last-in catastrophic exposure. Private capital should be the first line of defense in the event of another housing downturn. Policy emphasis would also change from promoting home ownership for all, to attempting to facilitate financing for home owners and renters via financing of new apartment construction.

Difference among various parties pertains to the speed and extent that this transition should occur. Some advocate an immediate unwinding of the federal agencies, though this proposal appears to have little support from majorities in either party. A more gradual unwinding, which to some extent is already occurring, appears more likely.  Agencies would cease to hold mortgages on their balance sheets while retaining their role as credit guarantors for third-party investors in exchange for a fee.

11.08.13_Quint_Housing_2_2The Senate Banking Committee hopes to issue a bill on housing reform by the end of 2013.  Timing for deliberation by both houses of Congress is tricky, but it does appear that bipartisan support for the general parameters of housing reform exists. If done in a responsible, gradual manner, housing reform could ultimately reduce risk to the U.S. taxpayer and perhaps lessen the risk of another housing collapse. However, a hasty and disorderly exit of the agencies from the mortgage market could end up restricting the flow of capital, and thus the pace of recovery in the housing market.

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.

Monthly Market and Economic Outlook – July 2013

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

Risk assets were off to a decent start in the second quarter but then retreated after Federal Reserve Chairman Ben Bernanke’s testimony to Congress on May 22 laid the ground work for a reduction in monetary policy accommodation through tapering their asset purchases as early as September. While the U.S. equity markets were able to end the quarter with decent gains, developed international markets were relatively flat and emerging markets experienced sizeable declines. Weaker currencies helped to exacerbate these losses.

After starting to move higher in May, interest rates rose sharply in June and into early July, helped by the fears of Fed tapering. The yield 10-year U.S. Treasury has increased 100 basis points over the last two months to a level of 2.64% (through 7/10). The increase in rates was all in real terms as inflation expectations fell. Bonds experienced their worst first half of the year since 1994, in which we experienced four short-term rate hikes before June 30.

7.12.13_Magnotta_MarketOutlook_2While we have seen these levels of rates in the recent past (we spent much of the 2009-2011 period above these levels), the sharpness of the move may have been a surprise to some fixed income investors who then began to de-risk portfolios. In June, higher-risk sectors like investment-grade credit, high-yield credit and emerging market debt, as well as longer duration assets like TIPS, fared the worst. With growth still sluggish and inflation low, we expect interest rates to remain relatively range-bound over the near term; however, we do expect more volatility in the bond market. Negative technical factors like continued outflows from fixed income funds could weigh on the asset class. 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.

After weighing on the markets in June, investors have begun to digest the Fed’s plans to taper asset purchases at some point this year. Should the Fed follow through with their plans to reduce monetary policy accommodation, it will do so in the context of an improving economy, which should be a positive for equity markets.

7.12.13_Magnotta_MarketOutlook_3We continue to approach our macro view as a balance between headwinds and tailwinds. We believe the scale remains tipped in favor of tailwinds as we move into the second half of the year. A number of factors should continue to support the economy and markets for the remainder of the year:

  • Monetary policy remains accommodative: The Fed remains accommodative (even with the scale back on asset purchases short-term interest rates will remain low), the ECB has pledged to support the euro, and now the Bank of Japan is embracing an aggressive monetary easing program in an attempt to boost growth and inflation. This liquidity has helped to boost markets.
  • Fiscal policy uncertainty has waned: After resolutions on the fiscal cliff, debt ceiling and sequester, the uncertainty surrounding fiscal policy has faded. The U.S. budget deficit has improved markedly, helped by stronger revenues. Fiscal drag will be much less of an issue in 2014.
  • Labor market steadily improving: The recovery in the labor market has been slow, but steady. Monthly payroll gains over the last three months have averaged 196,000 and the unemployment rate has fallen to 7.6%. The most recent employment report also showed gains in average hourly earnings.
  • Housing market improvement: An improvement in housing, typically a consumer’s largest asset, is a boost to net worth, and as a result, consumer confidence. However, a significant move higher in mortgage rates, which are now above 4.5%, could jeopardize the recovery.
  • U.S. companies remain in solid shape: U.S. companies have solid balance sheets that are flush with cash that could be reinvested or returned to shareholders. Corporate profits remain at high levels and margins have been resilient.

However, risks facing the economy and markets remain, including:

  • 7.12.13_Magnotta_MarketOutlook_4Fed mismanages exit: If the economy has not yet reached escape velocity when the Fed begins to scale back its asset purchases, risk assets could react negatively as they have in the past when monetary stimulus has been withdrawn.
  • Significantly higher interest rates: Rates moving significantly higher from here could stifle the economic recovery.
  • Europe: The risk of policy error in Europe still exists. The region has still not addressed its debt and growth problems; however, it seems leaders have realized that austerity alone will not solve its problems.
  • China: A hard landing in China would have a major impact on global growth. A recent spike in the Chinese interbank lending market is cause for concern.

We continue to seek high conviction opportunities and strategies within asset classes for our client portfolios. Some areas of opportunity currently include:

  • Domestic Equity: favor U.S. over international, dividend growers, financial healing (housing, autos)
  • 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 Returns
7.12.13_Magnotta_MarketOutlook_1

Economic Headwinds and Tailwinds

Magnotta @AmyMagnotta, CFA, Brinker Capital

We continue to approach our macro view as a balance between headwinds and tailwinds. The scale tipped slightly in favor of tailwinds to start the year as we saw a slight pickup in the U.S. economy, some resolution on fiscal policy, and even more accommodative monetary policy globally. However, we continue to face global macro risks, especially in Europe, which could result in bouts of market volatility. The strong market move in the first quarter, combined with higher levels of sentiment, and a potentially disappointing earnings season, may leave us susceptible to a pull-back in the near term, but our longer-term view remains constructive. While the second quarter may bring weaker growth in the U.S., consensus is for economic activity to pick up in the second half of the year.

Tailwinds
Accommodative monetary policy: The Fed continues with their Quantitative Easing Program and will keep short-term rates on hold until they see a sustained pickup in employment. The European Central Bank has also pledged support to defend the Euro and has committed to sovereign bond purchases of countries who apply for aid. Now the Bank of Japan is embracing an aggressive monetary easing program in an attempt to boost growth and inflation. The markets remain awash in liquidity.

U.S. companies remain in solid shape: U.S. companies have solid balance sheets that are flush with cash that could be put to work through M&A, capital expenditures or hiring, or returned to shareholders in the form of  dividends or share buybacks. While estimates are coming down, profits are still at high levels.

Housing market improvement: The housing market is showing signs of improvement. Home prices are  increasing, helped by tight supply. The S&P/Case-Shiller 20-City Home Price Index gained +8.1% for the 12-month period ending January 2013. Sales activity is picking up and affordability remains at high levels. An improvement in housing, typically a consumer’s largest asset, is a boost to confidence.

Equity Fund Flows Turn Positive:  After experiencing years of significant outflows, investors have begun to reallocate to equity mutual funds. Investors have added over $67 billion to equity funds so far in 2013 (ICI, as of  3/27/13), compared to outflows of $153 billion in 2012. Investors continue to add money to fixed income funds as
well ($70 billion so far this year).
shutterstock_112080815
Headwinds

European sovereign debt crisis and recession: The promise of bond purchases by the ECB has driven down borrowing costs for problem countries and bought policymakers time, but it cannot solve the underlying  problems in Europe. Austerity measures are serving only to weaken growth further and cause higher unemployment and social unrest. After how it dealt with Cyprus, there is again risk of policy error in Europe.  We are also closely watching the Italian elections in June after February’s elections were inconclusive.

U.S. policy uncertainty continues: After passing the fiscal cliff compromise to start the year, Washington passed a short-term extension of the debt ceiling and more recently agreed on a continuing resolution to avoid a government shutdown. The sequester, which was temporarily delayed as part of the fiscal cliff deal, went into effect on March 1. The automatic spending cuts have not yet been felt by most, but it will soon start to show  up in the second quarter and will shave an estimated 0.5% from GDP. In addition, the debt ceiling will need to be addressed again this summer.

Geopolitical Risks:
Recent events in North Korea are cause for concern.

This commentary is intended to provide opinions and analysis of the market and economy, but is not intended to provide personalized  investment advice. Statements referring to future actions or events, such as the future financial performance of certain asset classes, market segments, economic trends, or the market as a whole are based on the current expectations and projections about future events provided by various sources, including Brinker Capital’s Investment Management Group. These statements are not guarantees of future performance, and actual events may differ materially from those discussed. Diversification does not ensure a profit or protect against a loss in a declining market, including possible loss of principal. This commentary includes information obtained from third-party sources. Brinker Capital believes those sources to be accurate and reliable; however, we are not responsible for errors by third-party sources on which we reasonably rely.

Housing Market a Reason for Optimism

Magnotta@AmyMagnotta, CFA, Brinker Capital

After detracting from economic growth for a number of years, the U.S. housing market is in a position to be a positive contributor to growth.  The supply and demand dynamics in the housing market are attractive.

Supply is at low levels.  According to the National Association of Realtors, the supply of available homes is currently 4.2 months, down from over 12 months at the worst of the market.  New housing starts have improved, but are still at levels last seen in the early 1990s.  There are also fewer foreclosed properties on the market. CoreLogic reported that 1.2 million properties were in some stage of foreclosure in January, a 21% year-over-year decrease.  Finally, investors (both individual and institutional) have been snapping up properties in previously distressed markets.

Source: FactSet, National Association of Realtors

Source: FactSet, National Association of Realtors

Some owners are waiting for higher prices to put their homes on the market.  However, prices are firming by a number of measures.  The S&P/Case-Shiller National Home Price Index gained +7.3% in 2012.  CoreLogic’s Home Price Index gained +9.7% year over year in January, the eleventh consecutive monthly increase.
Tighter levels of inventory have likely led to higher prices in recent months.  However, rising prices will eventually encourage homeowners to sell and builders to build, adding to inventory and thereby slowing the rise in prices.

Source: FactSet, U.S. Census Bureau

Source: FactSet, U.S. Census Bureau

The demand side of the equation is also positive.  There is pent-up demand for new housing that has built up over the last few years as households have been formed.  Additional job growth will create more demand.  Affordability is still at very high levels with interest rates at record low levels.  If interest rates start to move higher, it could be a trigger for fence sitters to move. Guidelines are strict for obtaining a loan (I can attest to this with my personal experience over the last month), but credit is being extended.

The constructive dynamics in the housing market should be a positive for the economy over the intermediate term.  There are additional benefits to the economy that stem from an improvement in housing – consumers spend on appliances, home improvement (I’ve visited Home Depot or Lowes every other day in the last few weeks), contractors, architects, etc.  In addition, stable and rising home prices will also serve as a boost to consumer net worth and confidence.

Housing Recovery Will Be Slow-going

Amy Magnotta, CFA, Brinker Capital

There has been much talk about a recovery in the housing market.  Sales have been decent, albeit volatile.  Prices have inched higher.  Inventories are down.  Homebuilder confidence has improved.  The Fed is certainly trying to boost the housing market with their latest mortgage-backed security purchase program.  Affordability is at record levels as the 30-year mortgage rate has fallen to 3.4% (bankrate.com).  Refinance activity has surged in response but purchase activity hasn’t yet followed.

While there are undoubtedly positive signs in the housing market, the chart below from David Rosenberg at Gluskin Sheff puts the recent increase in housing starts into perspective.  While starts have increased meaningfully over the last two years, they remain very depressed when you look at historical levels.

The demand for housing should slowly improve as employment picks up and the pace of household formation increase.  However, despite the recent decline in inventories, the supply side will pick up as well.  Potential sellers may be sitting on the sidelines waiting for firmer prices.  There are also a significant number of delinquent and foreclosed properties – so-called shadow inventory – in the pipeline.

We don’t expect a sharp turnaround in housing starts or sales, but any improvement will be an incremental positive to growth after acting as a detractor from growth for some time.  Stabilization in housing prices will also serve as a boost to consumer confidence. For this reason we recently added the improvement in the housing market as one of our positive tailwinds for the U.S. economy, acknowledging this is a long-term view and will likely be played out over many quarters, not months.