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.

When in Doubt, Blame the Weather

Ryan Dressel Ryan Dressel, Investment Analyst, Brinker Capital

The 2013-2014 winter has been nothing short of a worse-case scenario for the eastern half of the U.S. In Chicago, temperatures fell below zero an astounding 22 times (the Chicago record for a winter is 25), and let’s not forget the combined 67 inches of snow. In Atlanta, the city literally came to a halt during what became known as “Icepocalypse.” In Philadelphia, we’ve seen a total of 58 inches of snow (third highest on record) including 11 different snow storms dropping one inch or more.[1]

Source: TheAtlantic.com

Source: TheAtlantic.com

Those three locales give you a pretty good idea of just how wide spread the wrath of winter is this year. While it is difficult to measure the exact impact of the weather on the economy, we can conclude that economic activity will certainly lag in January, February and March. Despite the fact that most economic indices account for seasonal effects, they do not account for outlier years like this one. Weather has been blamed for poor economic reports ranging from job growth, to new housing starts, to manufacturing—but is it justified?

A 2010 study by the American Meteorological Society determined which U.S. states are most sensitive to extreme weather variability as it relates to economic output.[2]

Dressel_Weather_2.21.14_1The research concluded that the location with the most sensitive industries had the largest total economic effect. For example, agriculture is the most sensitive on an absolute basis, but the fact that agriculture makes up such a small percentage of most states’ Gross State Product (GSP) means that extreme weather has a small total effect on sensitivity. Conversely, manufacturing, financial services, and real estate have a large relative sensitivity because of their GSP impact. As you can see on the map, the states where these industries have a significant economic impact, translates in higher sensitivity to extreme weather.

The severity of winter in the states colored red and yellow justifies the weather-related hype, while the ones in blue can be ignored for economic purposes. If you include the effects of the Government shutdown, we’ve had four consecutive months of cloudy data that we can’t put into clear context!

[1] National Oceanic and Atmospheric Administration.
[2] U.S. Economic Sensitivity to Weather Variability. Jeffrey K. Lazo, Megan Lawson, Peter Larsen, Donald Waldman. December 28, 2010.

Investment Insights Podcast – January 31, 2014

Investment Insights PodcastBill Miller, Chief Investment Officer

On this week’s podcast (recorded January 30, 2014):

  • What we like: Acceleration in the sales for companies; Pick-up in housing survey data; States building surplus; Global synchronized recovery.
  • What we don’t like: Emerging markets uncertainty; Investor sentiment too high
  • What we are doing about it: Hedging appropriately in tactical and strategic portfolios; Hedging against emerging market risks; Underlying currents strong.

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.

A Mixed Start to 2014

Ryan Dressel Ryan Dressel, Investment Analyst, Brinker Capital

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.

S&P500 Index - Earnings Growth vs. Predicted

Click to enlarge

There has been mixed data on the macro front as well:

Positive Data

  • 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.[1]
  • 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.

Negative Data:

  • 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.
S&P Performance Jan 2014

Click to enlarge

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.


[1]  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.

Investment Insights Podcast – December 6, 2013

Miller_PodcastBill Miller, Chief Investment Officer

We are entering into a period where good news is bad news.On this week’s podcast (recorded December 5, 2013):

  • Good news: U.S. economy is better with many positive indicators (employment, housing starts).
  • Bad news: Markets are not reacting to the good news, drawing into question Fed policy.
  • What we are doing about it: Remaining bullish for 2014, keeping an eye on interest rates and Fed tapering.

Click the play icon below to launch the audio recording.

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.

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.

Economic Headwinds and Tailwinds

Amy Magnotta, CFA, Brinker Capital

We continue to approach our macro view as a balance between
cyclical tailwinds and more structural headwinds. While we have
seen some cyclical improvement in the economy, helped by easy
monetary policy, we continue to face global macro risks and
uncertainties. The unresolved macro risks could result in bouts of
market volatility and as a result portfolios have a modest defensive
bias, and are focused on high conviction opportunities within asset classes.

Tailwinds
Accommodative monetary policy: The Fed has become even more accommodative with the announcement of further quantitative easing, an open-ended mortgage-backed securities purchase program, and they seem determined to continue until growth picks up. In addition, the Fed has pledged to keep interest rates low into 2015. 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. Emerging economies have room to ease further if growth slows to an unacceptable level. There is the expectation that China will ease further to attempt to engineer a soft landing.

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: There is evidence that the housing market has bottomed and could soon be in a position to contribute to economic growth. Prices have stabilized and sales have increased over last year. Homebuilder confidence is at levels last seen in 2007. Housing inventories have fallen. Low mortgage rates and rising rents have driven affordability to record levels; however, credit remains tight.

Headwinds
U.S. fiscal cliff / U.S. election / U.S. fiscal situation: The current U.S. political environment does not inspire confidence. We face a significant fiscal cliff in 2013 due to expiring tax cuts and spending measures. With economic growth in the U.S. at stall speed, the size of the fiscal cliff could tip us into recession territory. There will be no resolution of the fiscal cliff until after the election is decided, which will result in greater uncertainty. We hope for a short-term extension of some of the measures, setting up for a larger tax and entitlement reform package to be debated in 2013. Fiscal policy uncertainty has led U.S. companies to put plans for additional hires and/or capital expenditures on hold until it is clear what the rules are.

European sovereign debt crisis and recession: While the ECB and EU leaders have pledged support to the Euro, actions need to follow words. Bond purchases by the ECB will not solve the problems in Europe, but it can buy policymakers time to make real reforms. However, growth will continue to weaken in the region. High unemployment combined with planned austerity measures have led to more social unrest.

Global growth slowdown: There is evidence of a slowdown in growth not only in developed markets, but also in emerging markets. Growth in the U.S. continues to be sluggish, leaving the economy susceptible to shocks. Europe is in recession territory. Growth in China has slowed and continues to show signs of further weakening.

Tensions in the Middle East: Geopolitical risks in the Middle East are cause for concern. A sharp rise in oil prices will be a negative shock to the global economy.

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.