Category Archives: Housing Market

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The Economic News is Very Good, But Keep An Eye On the FED and GDP This Week


  • Housing is showing inflationary signs but still offers an opportunity to profit from the rising trend as a downturn is unlikely and not expected in the short term.
  • Amidst all the positive news, manufacturing turned negative. Yet despite this, stock valuations keep going up, increasing the risk.
  • In the week ahead: the FED’s decision and GDP data. It looks like stable weather in the near future.

Introduction

The last sequence of economic data was very positive. In this article we are going to discuss the important data coming out this week and analyze the information released last week. Then we’ll combine it with the current situation on the market and, as always, analyze the risks and rewards.

Housing

Existing home sales came in at 5.5 million which is the highest in the last 10 years. This is great news and indicates a continuation of the positive trend in the real estate market. Distressed sales from foreclosures are at 6%; down from last year’s 8%.

figure 1 home sales
Figure 1: Existing home sales since 2013. Source: FRED.

Some might think that a new housing bubble is being created. Unfortunately, a clear answer to that can only be given in hindsight. There are several worrying factors, but every bull market climbs the wall of worry. The most alarming factor is that the number of people renting is growing which may indicate that many are already priced out of the market.

In support of a continued uptrend is that fact that home inventory is low as housing starts are at 1.18 million, which is still subdued when compared to the historical average of around 1.5 million, but much higher than it has been over the last 7 years.

figure 2 housing starts
Figure 2: Housing starts. Source: FRED.

According to Bloomberg, another worry is that many homes are being purchased by “mom and pop” investors with less experience, while institutional investors are ducking out of the market. Institutional investors used to account for 50% of investor foreclosure purchases, but in June that number fell to 38%. More troublesome is institutional investors now only make up 2.5% of the market, down from 9.8% in 2013.

Similarly to the situation we had in 2007, more and more foreclosed homes are bought by amateur speculators, which may be over-inflating the market.

figure 3 third party investors
Figure 3: Third-party investors auction home purchases. Source: Bloomberg.

Housing is cyclical and at some point in the future we will see another down market, but the above mentioned worries do not indicate an immediate decline, which means there is still money to be made in the uptrend. Investors might want to look at building and building materials companies that are trading below their real values and still feeling the consequences of the great recession. But beware of the risks, the downturn will eventually arrive. It might be a soft landing as more new homes are built which smooths out the price increases, or a hard landing similar to the one we saw in 2009.

The S&P/Case Shiller home price index will be published today, and prices are still expected to grow at 5.5% year over year which is very high for housing markets, but if low interest rates continue we might see a few more years of such increases.

The S&P 500

The recent S&P 500 breakout is strengthening on the positive housing data and jobless claims at 43 year lows.

figure 4 jobless claims
Figure 4: Jobless claims. Source: FRED.

So far, 25% of S&P 500 companies have reported positive earnings surprises, further fueling the stock market. Earnings are not growing, but 68% of companies have reported earnings above estimates. As of this weekend, the S&P 500 earnings decline for Q2 2016 was expected to be at -3.7%, and unfortunately, expectations for earnings in Q3 2016 have been constantly falling over the last several months.

According to Factset, Q3 2016 will be the sixth consecutive quarter with declining earnings (-0.1%). Positive analysts don’t expect a return to earnings growth until Q4 2016, but the below figure shows how quickly analysts’ forecasts can change.

figure 5 expected earning growth rate
Figure 5: Expected S&P 500 Q3 2016 earnings growth rate. Source: Factset.

With positive economic news and declining earnings, it is difficult to know where the market goes from here. From a fundamental perspective, the market is getting riskier and investors are paying more for lower returns. The current S&P 500 price earnings ratio has now surpassed 25, indicating that in the long term you should not expect stock returns to be higher than 4%.

figure 6 multpl
Figure 6: S&P 500 PE ratio. Source: Multpl.

Reaching full employment means that companies will have to pay more for employees, and thus have higher costs, which should put more pressure on earnings. This should spur inflation, but we will know more on Wednesday when the FED issues its Monetary policy statement.

The Real Economy

As always, life for the FED will be difficult. Low jobless claims, higher house prices and a higher S&P 500 are all good, but there is always the fear that those are just asset inflation repercussions.

The Philly Fed Manufacturing business outlook survey has turned negative again. As manufacturing is the basis of a healthy and sustainable economy, this might push the FED to postpone rate increases, but we might hear a more positive tone.

figure 6 diffusion index
Figure 7: Current and future general activity indexes. Source: Philadelphia FED.

No matter what the FED says, the week will be overshadowed by Friday’s publication of the preliminary data on GDP. A big rebound is expected given the positive economic activities happening in the last few months. GDP is forecasted to grow at 2.5% in Q2 2016.

figure 7 forecasted gdp
Figure 8: Forecasted GDP. Source: Wall Street Journal.

Conclusion

The current environment is one full of positive news and positive expectations which is very good, but as savvy investors we must always look at ways to protect ourselves. More and more indicators are signaling that we are getting closer to the end of the real economic growth period and entering a bubble period.

House flippers are inflating house prices, stocks are reaching new highs even as earnings are declining—and still expected to decline further—while the real manufacturing economy is not growing. All this mixed data indicates that we are close to a recession and a bear market, but the good times could still last for a while as the FED continues to keep interest rates low. We will watch this week’s news releases and earnings carefully and update you on the new developments. Stay tuned.

 

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A Positive Note From Housing


  • Housing starts, positive homebuilders and a pickup in Chinese building all create a good feeling about the economy and markets.
  • Average house prices have increased but median prices show that the current situation is not even close to a bubble.
  • Rent prices are rising and therefore more buying is expected as people switch to buying instead of renting.

Introduction

Recent news about housing is positive. On Monday, the National Association of Home Builders reported the housing market index at 58 where a reading above 50 means that home builders have a positive feeling about the single-family housing market. Two days earlier, on Saturday, the Chinese National Bureau of Statistics reported that property investments in the first four months of 2016 rose 7.2% and construction starts gained 21.4%. And on Tuesday new housing starts came in at 1.17 million or 6.6% higher than in March. All of this is very positive news but the most important thing for investors is how this affects the economy and markets. As housing ignited the great recession, it is important to constantly be aware of what is going on in the housing market.

Housing, the Economy and Markets

Housing is an essential sector in an economy but it’s also one that has been the source of crises. The environment for house buying is cyclical as it is related to interest rates and employment. The result is that house prices also have boom and bust cycles. Economists and policy planners have to be aware of the cycles and try to keep things stable as stability is preferred. As there is not yet a clear policy toolkit on how to manage housing booms or on how to evaluate if the housing market is overvalued, investors might still get the short end in an eventual housing crisis.

In relation to the economy, a stable housing market is what enables mortgages and labor mobility. Labor mobility is essential for the reach of full employment and mortgages are essential for a healthy monetary policy. International monetary fund (IMF) research shows that more than two thirds of the systemic banking crises in recent decades were influenced by housing.

Current Housing Situation

The current housing situation is still below the highs experienced in 2007 but showing good signs for a strong recovery.

1 figure shiller home prices
Figure 1: S&P/Case-Shiller U.S. National Home Price Index from 2006. Source: S&P Indices.

The low of the home price index was reached in 2012 at 134 points, or 28% lower than the peak reached in 2006 at 184.62 points. The current value is 175.61 and up 5.2% year-over-year. An indication of the overvaluation of a housing market can be extrapolated by looking at rent to price ratios. House prices and rent should move in tandem, if one gets high people tend to switch between renting and housing.

2 figure price to rent ratio
Figure 2: Gross rent price ratio 1960-2015 Q3. Source: Lincoln Institute.

The last available rent to price ratio (Q3 2015) was exactly 4% which is still good when compared to the 3.13% reached in Q3 2006, but the declining trend creates some concerns as house prices do not move along with rents. It is especially strange that rent prices do not go up as fast as home prices as the ownership rate has declined and keeps falling.

3 figure homeownership
Figure 3: US homeownership rate. Source: United States Census Bureau.

The above might create some concerns, but don’t be fooled by statistics. The above gross rent price ratio uses average prices (figure 2), but by using median prices (median shows the middle point of a number set) the results differ.

4 figure median asking rent
Figure 4: Median asking rent for vacant rent units 1995-2016. Source: United States Census Bureau.

Median asking rent has constantly increased, especially in the last 5 years while median asking house prices have rebounded a bit, but not much since the 2012 lows.

5 figure median asking price
Figure 5: Median asking sales price 1995-2016. Source: United States Census Bureau.

The difference between average and median rent and home prices shows that there is a segmentation in the US housing market where some properties skew the market index and make it look overvalued in relation to rent. From a median perspective it looks like the housing market still has plenty of room to grow as rents are soaring and not house prices. This might be the result of the great recession and tighter mortgage regulations, but with strong employment the outlook is positive and is confirmed by recent housing data that shows a 6.6% April increase in residential starts (1.17 million seasonally adjusted). Also, from an historical perspective there is still a huge gap to be filled with new homes as residential starts are still far from the historical average of 1.5 million.

6 figure housing starts
Figure 6: New privately owned housing units started. Source: FRED.

Housing in China

As China is the world’s second largest economy, it is also important to see what is going on there. China is a developing country and therefore its housing sector has a strong influence on commodity prices around the world. The good news is that property prices are increasing as a result of the government monetary policy.

7 figure china real estate
Figure 7: Chinese housing. Source: Wall Street Journal.

This might keep the Chinese economy growing at expected levels and keep the global markets stable.

Conclusion

It is interesting how similar statistical data can tell a completely different story. As Benjamin Disraeli used to say: “Lies, damned lies and statistics.”

Median rent prices are still surging and therefore house prices should not be considered in a bubble just because the average house prices increased in the last 4 years. Median house prices show that there is plenty of room to grow and that the recent growth is a sustainable one, especially with high employment. The situation in the Chinese housing market is also improving and therefore the outlook for the economy and financial markets should be positive from a housing perspective.