The latest GREED & Fear from Chris Woods of CLSA discusses the housing market. Although Woods has been a bull on the topic, some recent data has given him some concerns. Below is a brief excerpt followed by a summary of the document.
With the Eurozone still on holiday season and with the Chinese data looking a tad better, the obvious risk to financial markets remains renewed “tapering” concerns. Still GREED & fear’s guess would be for no change in policy at the September FOMC meeting, though a marginal decline in purchases is clearly a distinct possibility if only for symbolic reasons. GREED & fear’s fundamental view remains that the American economy is nothing like as healthy as the consensus currently wants to believe, that deflationary pressures remain predominant and that the American housing recovery has been primarily driven by investors.
Trulia data show weakness in housing sector
On housing, recent data has hinted at a certain weakness caused by the backup in mortgage rates triggered by the tapering scare. Most market focus has been on data for July released in early August by Trulia, a leading online marketplace for homebuyers, sellers and renters. This showed asking prices nationwide dropping by 0.3%MoM in July, the first month-on-month decline since November 2012. Drilling down further into the data, in 64 out of 100 US “metros”, the quarterly asking home price gain was lower than the previous quarter with the slowdown most evident in the West Coast, the traditional trend setter for the housing market.
The Trulia data has a following since it is seemingly the first service provider to publish data for the previous month. And clearly housing is at a potentially pivotal point given the selloff in the bond market since early May (see Figure 1). The same impression of renewed softening is also suggested by the fact that the number of homes listed for sale increased by 1.4%MoM in July to 1.96m homes, the highest level since last September, according to Realtor.com. The issue is now whether the increased amount of homes for sale will lead to higher sales volumes or whether buyers are put off by higher mortgage rates.
The 30-year fixed rate mortgage is now 4.39%, up from 3.4% in early May (see Figure 2). On this point, the data so far suggests that rising mortgage rates are having a deterrent effect. Thus, the new mortgage applications index has shown renewed weakness. The index declined by 5.4% last week and is down 17.2% since early May (see Figure 3). Meanwhile, the mortgage refinancing index has not recovered from its recent collapse. The mortgage refinancing index has declined by 59% since early May (see Figure 3).
Bull case for American housing
The longer term bull case for American housing is based on demographics and “affordability”. Both arguments make sense in theory. But “affordability” only works if a would-be buyer has the likely 20% equity downpayment to secure the mortgage as well as the proof of income to service that mortgage. The reality is that first-time buyers accounted for only 29% of home sales in June, down from 32% a year ago and an average of 40% over the past 30 years, according to data provided by the National Association of Realtors. This suggests more of an investor-driven market than usual. As for demographics, many younger people below the age of 35, who traditionally comprise the bulk of first-time buyers, either still prefer to rent to avoid the financial commitment of home ownership or better still, from a cash flow perspective, continue to live at home with their parents. This means household formation is not rising as quickly as many have forecast.
GREED & fear: Pick up in income growth
Thus, the number of households increased by only 613,000 in the 12 months to June, compared with an average annual increase of 1.3m during 2001-2005, according to the Census Bureau’s monthly household estimates. Clearly, this pattern of behavior will change one day. But to GREED & fear it is far from evident why it should suddenly change now given the continuing lack of any evidence of a meaningful pick up in income growth.
What does all this mean for the American stock market? Well in one paradoxical sense if growth in the US is not as robust as hoped for, that means quanto easing continues which should support the equity market. Still at some point common sense takes over and a lack of growth is plain bearish for equities, most particularly in the context of an American stock market which in recent months has been driven far more by multiple expansion rather than earnings growth. Thus, the S&P500 trailing PE has risen from 15.6x in late December to 18.4x (see Figure 4).
GREED & Fear summary
- The obvious risk to financial markets remains renewed “tapering” concerns. Still GREED & fear’s guess would be for no change in policy at the September FOMC meeting, though a marginal decline in purchases is clearly a distinct possibility if only for symbolic reasons.
- GREED & fear’s fundamental view remains that the American economy is nothing like as healthy as the consensus currently wants to believe, that deflationary pressures remain predominant and that the American housing recovery has been primarily driven by investors. On US housing, recent data has hinted at a certain weakness caused by the backup in mortgage rates triggered by the tapering scare.
- The longer term bull case for American housing is based on demographics and “affordability”. But “affordability” only works if a would-be buyer has the likely 20% equity downpayment to secure the mortgage as well as the proof of income to service that mortgage. As for demographics, many younger people below the age of 35 either still prefer to rent or to continue to live at home with their parents.
- If growth in the US is not as robust as hoped for, that means quanto easing continues which should support the equity market. Still at some point common sense takes over and a lack of growth is plain bearish for equities.
- The lack of any concrete confirmation of accelerating cyclical momentum in the US economy is why the financial markets will remain very nervous at any hint of a change in the style of leadership at the Fed. GREED & fear continues to believe that if the market believes Larry Summers will be Fed chairman it will trigger a further sell-off in the bond market.
- GREED & fear’s fundamental view remains that it is much easier to enter quanto easing than to exit from it. The recent back up in British gilt yields in the past week since Mark Carney offered his much anticipated “forward guidance” is presumably the opposite of what Britain’s new Bank of England governor had intended to happen.
- In GREED & fear’s view Carney’s forward guidance is bordering on meaningless waffle and so creates the risk of confusing markets more than it clarifies. Indeed the net effect is to make monetary policy even more “data dependent”.
- The latest Chinese data has confirmed a slight rebound in activity which has further encouraged an asset allocation switch back into Chinese stocks and related China geared stocks. Still GREED & fear would use this as an opportunity to shave positions in the resource related area.
- The downward trend in the China producer price index remains intact while the A share market remains below its 200-day moving average and H share bank stocks are now back trading at a premium over A share equivalents. The growth in “social financing” also continues to slow sharply.
- The one clear positive from a policy easing standpoint is the recent loosening of rules regarding developers’ ability to raise equity financing in the domestic stock market. This again suggests that the new PRC leadership is prepared to let the property market become more market driven, and so less policy driven.
- GREED & fear will initiate an investment in China Vanke in the Asia ex-Japan long-only portfolio this week. This will be paid for by removing the investment in Maruti Suzuki and by reducing the investment in IDFC by one percentage point.
- Japan’s preliminary GDP data for 2Q13 has not provided clarity on the growing debate on the sales tax issue. Domestic demand is improving but there continues to be the lack of any evidence of a pickup in investment.
- The obvious compromise for Shinzo Abe is to hedge the proposed sales tax hike with some sort of corporate tax cut or other incentive scheme to encourage investment. Another possible approach is to modify the sales tax increase to a staggered 1ppt increase annually over the next five years.
- GREED & fear would advise investors in Japanese equities to continue to hedge the yen since sooner or later the BoJ will be taking more action, be it increased purchases and/or verbal commitments in a Japanese version of forward guidance.
- There is also the potential for increased public works spending in Japan. The public works spending theme is an obvious positive for the construction sector, as are the related hopes for so-called “private finance initiatives” (PFI) in the infrastructure area, a policy which is meant to be another aspect of Abenomics. The other near-term potential catalyst for renewed focus on the construction space is the potential for Tokyo to host the 2020 Olympics.
- GREED & fear would be more encouraged if gold bullion rallied independently of the commodity complex since GREED & fear views gold as money and not as a commodity. Gold will also remain vulnerable to any resumption of “tapering off” fever, just as it will benefit from a growing conviction that tapering is not happening.
- There is an interesting disconnect in the gold bullion market. This is that the gold sell off has occurred in the context of a collapse in Comex gold inventories during 2013. This is a powerful bullish signal for gold. A steep fall in the price of a commodity is normally associated with a surge in inventories of that commodity, not a collapse in them.
- The increased financial gearing in Newcrest Mining is primarily the result of asset writedowns, reduced production and ongoing capex commitments. This raises an issue which GREED & fear should have focused more on in recent times but which was, hopefully, discounted in the massive sell off this year in gold mining stocks. This is the difference between reported cash costs and the so-called “all-in sustaining cash cost”.
- So long as gold remains below, say, US$1,400 per oz, those mining companies with vulnerable balance sheets will be under pressure to reduce production. But the flip side of this is reduced supply which is gold price positive.