Market Update

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photo-1427751840561-9852520f8ce8Market Update

7/25/16

Stock Market traded to (or near) new highs this week as investors edged away from a defensive stance. The S&P 500 sits at a new high, while the Dow set a new high on Wednesday before easing off at week’s end. The NASDAQ is still about 50 points away from its high of last December. It’s hard to pinpoint the exact reasons for the rally. Some investors are moving away from extremely low bond yields, while others are heartened that the slew of Q2 earnings reports are not as bad as anticipated, and expectations for futures sales are rising. We also saw a pick-up in takeover activity. What’s encouraging is that there has been a marked rise in “cyclical” stocks (like commodity and technology stocks) that tend to fare better in strengthening economic conditions. Tech, financial, and health care stocks have been hit hard over the first half of the year and investors may be taking advantage of “bargain” prices in these sectors.

Several weeks ago, we saw a rare phenomenon where both stock and bond prices set then-record highs. The high bond prices pushed long-term interest rates to record lows for bonds with maturities from 7 years all the way out to 30 years (bond yields fall when bond prices rise). We suspected that it wouldn’t last.

Since then, the S&P 500 has risen nearly 50 points and bond prices have fallen – pushing the yield on the 10-year Treasury Note up nearly a quarter-point (0.25%). While we are certainly not offering investment advice, we expect this trend to continue and for US stocks to outperform US bonds over the near term. Why?

While the US economy plods ahead, instead of running, economic growth is creeping higher. The economy has been buffeted by a perfect storm of headwinds as a result of the recession:

Consumers, who drive the economy, were forced to deleverage as household assets shrank thanks to falling home and investment portfolio values, and spending slowed.

The housing market acted as a drag on growth from 2008 – 2014 (the housing sector typically leads the economy out of a recession)

Fiscal stimulus was removed, as falling tax receipts caused the largest layoff of government employees (especially on the state and local levels) since the GI’s returned home from WWII.

Global growth since the recession (excluding developing nations) has been weak.

Most of these headwinds have dissipated. In addition, as we saw last week, inflation is picking up along with energy prices. Inflation drives interest rates higher. The chart below shows an update on the stock rally since the Brexit vote. The market’s blood pressure (red line = volatility) has returned close to normal after the spike following the Brexit vote. While we are not suggesting a huge rally for stocks, we expect that the normalization to the markets following Brexit and Turkey will see investors easing away from “safe” investments (like Treasuries), and into “riskier” assets like stocks, corporate bonds, and commodities.

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The US housing market finished the first half strong. Housing Starts (Blue Line below) rose 4.8% in June, giving Q2 the best quarterly showing for starts since 2007. Even though overall starts are 2% below a year ago, June 2015 saw a surge in multi-family starts which made it the strongest month for home building last year. Starts this June were 7.3% higher than the monthly average for all of 2015. In addition, the shift from multi-family construction to single-family homes continues. Single-family building permits are up 5.1% from a year ago while multi-family permits are down 34.3%. We highlight this because, on average, construction of single-family units contributes twice as much to GDP as does a multi-family unit. Given the demand for housing, we expect the trend to continue in coming quarters.

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The NAHB Index (Red Line, above – which measures sentiment among home builders) slipped to 59 in July from 60 in June. However, as a 50/50 index, 59 remains a very strong reading. More jobs and faster wage growth are making it easier to buy a home and builders are responding.
In the largest sector of the US residential real estate market, Existing Home Sales rose 1.1% in June – the fourth consecutive gain – to its fastest sales pace since 2007. Sales rose to a 5.57 million annual rate and are up 3% from June 2015. Impressive, too, was the share of first-time buyers, which reached its highest level since 2012. Tight supply remains an impediment to sales. Inventories fell 0.9% in June and are down 5.8% from a year ago. There is only a 4.6 months’ supply of existing homes available. In June, 48% of properties sold in less than 30 days. The tight supply has helped boost the median price for an existing home to a new all-time high (up 4.8% versus a year ago). The price bump is both good and bad, as it hurts some lower-end buyers, but it also should help ease some of the supply constraints as more sellers take advantage of higher prices and bring more existing properties onto the market.

Weekly Claims for Unemployment benefits declined 1,000 last week to 253,000 (the 72nd straight week below 300,000), while continuing claims declined 25,000 to 2.13 million.

An interesting factoid on the growth of the “new” economy reported this week: It took ride-sharing service Uber six years to complete 1 billion rides, which occurred last December. It only took them 6 months for them to get to 2 billion rides (from December thru June).

The dog days of summer are here and the markets are a bit “lighter” in terms of activity vis-à-vis the rest of the year. Stocks are enjoying a “Post-Brexit” reversal from the steep sell-off in late June. That’s not to say that the rally can’t continue – particularly if economic data continues to point to GDP growth in the 2.25% to 2.75% range for the rest of 2016. If this trend continues, we expect the upward pressure on longer-term (5 years and beyond) interest rates to continue. Stay tuned.