Kristina Hooper, CFP®, CIMA® is head of portfolio strategies for Allianz Global Investors Distributors LLC. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
The U.S. housing market and Europe’s debt crisis—two sources of high anxiety for investors—are spreading cheer for a change.
After months of gloom and uncertainty surrounding Greece’s fate and contagion in the euro zone, and seemingly little hope of a recovery in housing, things are finally looking up. At the latest summit in Brussels, European leaders made significant strides toward recapitalizing banks and restoring confidence. Meanwhile, more Americans are taking advantage of low interest rates by buying new homes, pushing prices higher, which could suggest the long-slumping sector is staging a real comeback. Both developments are good for the stock market, at least in the short run, as evidenced by Friday’s surge.
However, the staying power of this momentum remains a question mark. The euro-zone crisis is complicated and will take time to resolve, whereas the United States is careening toward its own fiscal cliff. Plus, in this volatile environment, encouraging signs of economic progress have been followed by equally disappointing news.
It was no surprise that the big news of the week came out of Europe. But it was the positive outcome of the EU summit that turned so many heads. Initially, stocks sold off ahead of the summit, as investors feared nothing would be accomplished. Then, when news spread that EU leaders made progress and a deal had been struck, there was nothing short of exuberance. The euro-zone nations agreed to allow countries to directly tap the European Financial Stability Facility and European Stability Mechanism in order to recapitalize banks. This provision fueled a rally in spreads in Spain and Italy. Spain’s troubled banks will greatly benefit from direct financing.
New York Times
columnist and economist Paul Krugman explained that the deal sets up “something more or less like a European version of the TARP, in which funds for bank recapitalization will be supplied by a consortium rather than lent to governments already overburdened with debt.” In addition, the euro-zone nations agreed to supervision by a European Central Bank regulator.
The market response was positive, in part, because it helps ease the incredible stress being felt in the euro zone. But it also symbolizes a clear easing of Germany’s rigid stance and brings euro-zone countries another step closer to fiscal unity. This type of flexibility and collaboration appears critical to the long-term success of the euro zone. The impact was swift and very positive: not only did stocks rise on Friday, but also yields on EU periphery sovereign bonds fell significantly.
At home, we’re seeing a similar comeback in the housing sector. Housing weakness has plagued the capital markets for the last few years, giving us several “head fakes” when strategists believed the sector had hit bottom. However, there are indications that recent growth is the beginning of a real recovery. Most notably, the CEO of KB Home, Jeffrey Mezger, said that a turnaround in housing is already underway. “The overall housing market appears to have largely stabilized and is moving into a period of recovery,” he said on the company’s quarterly earnings call. He explained that KB Home has seen significant improvement in nearly all of its 32 regions in the last 90 days.
But it’s not just housing executives that are expressing confidence. Home buyers are showing their conviction too. May new home sales came in at 369,000 (annualized) versus expectations of 346,000. New single-family home sales continue to show improvement, and are up 20% from a year ago. Further, the S&P/Case-Shiller index shows home-price appreciation over the past three months and is nearly constant on a year-over-year basis. In addition, the environment seems conducive for a continued rebound given that mortgage rates are at record lows and U.S. monetary policy seems likely to help keep them there for a while.
It’s encouraging that both the euro zone and the housing sector appear to be on the comeback trail. The key, of course, is for their improvements to continue beyond this week or this month. At first blush, skeptics might say that further improvement is unlikely. However, in the short term, the EU equity rally may have some legs. Positioning is now supportive and expectations going into the summit were low. The ECB is likely to cut interest rates this week, which should help maintain the positive sentiment.
Still, the ECB has an inflation-only mandate, so cutting rates is simply a response to the drop in inflation; it’s not designed to be monetary stimulus. In fact, there’s no sign of an ECB expansion and many details of the summit proposals remain unclear. Although this is a step in the right direction, we are still a long way from achieving true fiscal union. For now, achieving a sustainable debt path will still be a struggle for these countries. The key for the market is to buy into the theory that peripheral bond yields can fall due to ESM funds buying back debt directly with no seniority issues. The result should be lower financing costs, and a more realistic chance of achieving a sustainable debt ratio.
With regard to housing, keep in mind that pending home sales were up 5.9% in May. Typically, there is a short lag between pending home sales and existing home sales. As a result, existing home sales are likely to be buoyant for at least the next few months. And demand for multi-family units is much higher than single-family units because of a robust rental market, driven by the difficulty of getting approved for mortgages.
But given that Europe and housing already surprised us once, they could do it again—and squeeze some upside out of stocks along the way. On tap for next week is a potential interest-rate cut by the European Central Bank as well as a report on construction spending. The news could give investors a good feel for whether the momentum we’ve seen is sustainable. Now more than ever, it’s a confidence game. And nothing inspires confidence like a good comeback.