The stock market had a sharp rise that sputtered in July, then it washed out during the first week of August, only to climb back to pre-July 4 levels. As we know now, that move in the S&P 500 occurred as international concerns cooled (as best they can in the short term) and as Europe undergoes a sputtering of its own, making U.S. markets a haven of sorts.
Alongside those international happenings, recent economic reports point to a U.S. economy that is far from overheated -- more on that in a bit. In all likelihood, that has pushed out the Federal Reserve's timing for eventual interest rate hikes, thereby making U.S. markets even more attractive in the short term.
The recent flight to safety has led to the 10-year Treasury to trade back down to a 14-month low of 2.3%, going against the expectations of most Wall Street economists who had believed it would end the year at around 3.4%. (It started 2014 at about 3%.) Many well-known economists have found themselves dumbstruck by how Treasury bonds have outperformed practically every major asset class thus far in 2014. The SPDR S&P 500 (SPY), the ETF that tracks the performance of the S&P 500, is up 9.5% since the start of the year, while the iShares 20-Year+ Treasury ETF (TLT) is up 15.8%, and Pimco's 25+-Year Zero Coupon Treasury ETF (ZROZ) is up 27.3%, making this a tough time for anyone in the bond vigilante camp. So much for 2014 bringing the death knell of the multi-decade-long bond bull run.
Additionally, we have seen the yield curve, a widely watched indicator, flatten since the start of the year. Typically when the economy is improving, the curve steepens, while an inverted yield curve typically heralds a recession. Yields for U.S. Treasuries continue to be above those of their compatriots in Europe, but that is a function of higher growth expectations here than across the pond, akin to the U.S. being the best-behaved kid in detention.
On Monday we learned that the National Association of Home Builders/Wells Fargo sentiment measure climbed to 55, from 53 in July, the highest level in seven months. Versace would point out that builder enthusiasm is a lot like mall traffic during the holidays -- just because you see it, that doesn't necessarily mean that consumers are shopping. Had new loan requests for home purchases, a leading indicator of home sales, climbed rather than fallen over the last few weeks to levels not seen since February, the NAHB's finding would likely carry more weight with us. We continue to believe that checking multiple data from multiple sources rather than relying on one data point from one source makes for better investing.
On Tuesday we learned that U.S. housing starts rebounded strongly in July, up 15.7% on a seasonally adjusted annual basis, after two months of declines. Additionally, June starts were revised upward to 945,000 units, from 893,000. Since household income levels are still struggling, it came as no surprise that multi-family home starts jumped 33% in July, to the highest since January 2006, while single-family home starts rose only 8.3% in July, a difference worth noting. Homeownership rates in the U.S. hit a 19-year low in the second quarter of 2014, and rental vacancy rates were also at their lowest level in more than 19 years. Since multi-family buildings tend to attract lower-income earners than single-family homes do, this increase does not generate nearly as much economic activity.
A few weeks ago, Versace capitulated to my (Hawkins) rather pessimistic view of the U.S. housing market, so I struggled to stifle a grin on Monday when Fannie Mae downgraded its outlook for home sales and construction to 1.4 million single-family units in 2014 and 2015, compared with 1.6 million previously estimated. In the same update, Fannie Mae amended its GDP forecast and now expects GDP to grow by 3% in the second half of 2014 and expects full-year 2014 to come in at 1.9%, which implies a positive bump of four-tenths from its prior forecast.
On Tuesday, Home Depot (HD) reported a 6.4% increase in same-store sales and raised its full-year forecast, revealing an encouraging increase in purchases of big-ticket items such as appliances. That is definitely a more positive sign, but it is much too early to say that we will see a significant jump in home sales. This jump could be in part due to pent-up demand from the horrible weather earlier this year, which may have led consumers to postpone purchases of large appliance and delay landscape investments. It could also signal share gains in appliances from the likes of Best Buy (BBY) and hhgregg (HGG).
College graduates continue to be saddled with crushing student loans, and employment and income levels for this cohort continue to incentivize many of them to move back home with Mom and Dad. Without a strong first-time homebuyer, the housing market will struggle to get solid footing. In other words, Hawkins abides by Fannie Mae's view that housing starts will indeed be lower in 2014 than in 2013.
In keeping with Home Depot's results, Lowe's (LOW) also reported its quarterly earnings this morning, and the results beat expectations by $0.02 per share. Even though the company beat top-line expectations, a large factor in the beat was the 6.7% drop in the share count year over year that added more than $0.06 per share to year-over-year EPS comparisons. Lowe's is only the latest company to deliver double-digit EPS growth year over year, and we increasingly believe that investors should be focusing on operating profit and net income growth as they look to reconcile price/earnings ratios. That's the good news, since Lowe's cut its full-year sales forecast to 4.5% from 5% and cut its same-store sales forecast to 3.5% from 4%.
Tuesday also brought us news that consumer prices in the U.S. in aggregate barely rose in July, after a 0.3% rise in June for a 2.0% annual consumer price index, compared with June's 2.1%. Despite all the turmoil in the Middle East and the ongoing crisis in the Ukraine, energy prices fell broadly in July, after having risen for the prior three months; gasoline prices fell 0.3%, after a 3.3% rise in June.
On the other hand, food prices, which we have discussed often here at the Corner of Wall and Main, and which Versace zeroed in on back in early January, rose again, up 0.4% in July, after a 0.1% rise in June, driven in part by the brutal drought in California and a tough growing season across most of the world. Real Money Pro subscribers who heeded Versace's call to examine American Water Works (AWK) shares last February find themselves profiting from water-shortage-related pain to the tune of 23%, including dividends.
Putting it all together, the end of quantitative easing has many people, including us, closely watching for signs of rising interest rates, but the recent spate of weak economic data, such as last week's dismal retail report that showed zero nominal growth, coupled with yesterday's 2.0% annual CPI increase and a multitude of geopolitical challenges, is likely to give the Fed ample cover to keep its benchmark interest rate low for quite some time.
The global growth story is getting more troubling and could keep downward pressure of rates as well, and that does not rule out the possibility of stagflation in the U.S. The stock market still looks awfully pricey to us, particularly when we view stocks on the basis of net income growth rather than EPS growth. We are looking for investment themes that can take advantage of longer-term trends we see as most likely: a cash-strapped consumer, crushing student loan levels, meager wage growth, lack of strong demand for U.S. goods outside of the country while the rest of the world is equally wobbly, and a fresh memory of the housing boom hangover. The recent forecast cuts from Macy's (M), Target (TGT), Lowe's and others simply confirm Versace's bearish views on retailers
Investors who believe this will translate into continued relative weakness in the single-family home market compared with multi-family should consider the smaller apartment real estate investment trusts such as Preferred Apartment Communities (APTS), which enters into forward purchase contracts or purchase options for to-be-built multifamily communities as one of its strategies. Or they could consider Independence Realty Trust (IRT) which has a monthly dividend payout and current yield of nearly 7%.
This Friday, the Fed's annual Jackson Hole central-banker shindig kicks off, and Janet Yellen will deliver the keynote address at 10 a.m. Her topic will unsurprisingly be the job market, while the market's ears will be fine-tuned for any further hints as to when rates could possibly rise. Given the timing, we expect at most a modest reaction to today's FOMC minutes.