Ides of March

As the Dow Jones Index continued to hit record highs, and the S&P 500 approached an all time high, trading volume has remained below normal, and gold prices remain muted. During this time,short positions in many companies have soared, as traders look for a pull-back or correction. This comes after several months of declines in short positions. Several major companies have made February 2013 one of the strongest months ever for stock buybacks. Birinyi Associates recorded about $118 Billion in stock buybacks, with a further $827 Billion authorized for 2013 buybacks. Some of the thinking is that reluctance towards capital spending in some companies, especially those with large cash piles, may be fuelling record buybacks. However, it is tough to ignore the ever growing amount of offshore cash, now estimated to be over $1.4 trillion. One very recent change in the indicators we watch has been a large decline in movement of Japanese Yen (JPY) recently. We can see a graphical representation of that in changes within futures markets, with JPY showing one of the largest outflows. Japan is in the process of confirming new central bank appointments, so we may see some consolidation of positions in the near term. Much of the large exodus of JPY has seen funds move to the United States and Europe. This movement of Yen has driven many of the recent stock market gains, as the carry trade is always the first moving indicator of trends. One huge worry with Japan is that central bank purchases of Japanese Government Bonds has exceeded the number of banknotes in circulation. A currency crisis in Japan could undermine efforts there to avoid deflation and hinder the recovery of the Japanese economy. It would also adversely affect markets around the globe, since Japan is still one of the largest developed economies.

The latest Federal Reserve Beige Book report indicates that the US economy continued to grow at a Modest to Moderate Pace. The highlights of economic growth include consumer spending, automotive sales, manufacturing, and residential real estate. Home sales growth was noted for Boston, St. Louis, Minneapolis, Kansas City, Dallas, and San Francisco, while Philadelphia reported high end home prices continuing to fall. Demand for commercial real estate grew modestly in most districts. Industrial vacancy rates, and office vacancy rates declined, while some districts reported tight availability of office space, and some suggestion that a lack of new construction contributed to low availability. Some concern was noted for overbuilding apartment space in the Boston District and office sector. Demand for manufacturing space increased in the Chicago, Cleveland, and Atlanta districts. Loan demand in the Boston District has declined, and the Cleveland District noted some financing difficulties. The Chicago District banks noted very few new home loan originations. There was some concern expressed in most Districts of potential future interest rate increases. While labor conditions appear to have improved, many Districts reported a rise in temporary employment. It was suggested that some of the reluctance to hire permanent employees was due to uncertainty over the Affordable Care Act. It's important to remember that one of the exemptions for businesses under the Affordable Care Act is through the use of temporary employees. Despite improvements in the high school graduation rate, many districts reported a shortage of skilled workers. Construction materials and food costs increased across all Districts, and many Beige Book survey respondents indicated some possible curtailing of activity in the near future, in the event price levels continue to increase. Nearly all districts noted increases in fuel and transportation costs. In the latest Federal Reserve Flow of Funds reports, lending and borrowing activity have increased, but remain below 2008 levels. As indicated in many of our previous articles, increases in temporary employment and pricing pressures, especially increases in gasoline prices, may limit economic growth, and may limit demand for housing. We appear to be in the early stages of a shift towards commercial real estate growth, especially as rental demand remains high in many parts of the United States. To show the Fed is in tune with social media, there is a new Federal Reserve Flickr page.
Despite the extraordinary measures enacted by the Federal Reserve, much of the additional stimulus has gone towards stock markets, instead of spurring additional lending or making it's way into the real economy. Richard Fisher, of the Dallas Federal Reserve, expressed some concern that Mortgage Backed Security (MBS) purchases may be driving housing speculation. Dennis Lockhart of the Federal Reserve Bank of Atlanta prefers to seeasset purchases continue at the Fed, at least through the end of 2013, in the hope of spurring employment. While MBS purchases by the Federal Reserve are boosting the housing market, the affect on employment has been small. Charles Evans of the Chicago Federal Reserve expects the current asset buying program of $45 billion in US Treasuries and $40 billion in Mortgage Backed Securities (MBS) to continue through 2014, or at least until a substantial improvement in unemployment is seen. Federal Reserve Chairman Ben Bernanke recently expressed concern over the Fed creating asset bubbles. After hitting a post-recession high in September 2012, refinancing applications declined 27.9% in February 2013, though some estimates suggest a further $2 trillion to $2.5 trillion homes could still be refinanced. Sales of new homes increased to 437k against 380k expected, though remain far below peak levels seen during the housing boom. Investors interested in improvements in new home building may want to monitor the S&P Homehuilders ETF (XHB), though at the current level it is near a 52 week high. Rental rates have been increasing in some markets, though average wage improvements remain somewhat low. Uncertainty in hiring new workers may be limiting the pace of economic recovery. The latest ADP Employment Report indicates February employment improved to 198k against 170k expected. Previous ADP figures were revised from 192k to 215k private payrolls. Initial jobless claims came in at 340k against an expectations of 355k, while the US trade deficit slightly increased to $44.4 billion. Consumer Credit rose to $16.15 billion in January 2013, against an expectation of $14.5B, which suggests consumer spending may be increasing. While we do not have a good indication of where consumers are spending, the severe drop in restaurant sales in February indicated consumers were going out to eat less often. Non-farm Payrolls surprised with a reading of 236k against an expected 165k, though it should be noted that the prior reading of 157k was heavily revised downwards to just 119k. The unemployment rate declined to 7.7%. A look beyond the raw numbers shows that multiple job holders numbers increased to 340k and the number of long term unemployed increased by 89000. The employment-to-population, and the labor force participation rates, remain much lower than needed for a solid recovery in employment.
In commercial real estate markets, Fitch Ratings recently released several research reports uncovering the latest Commercial Mortgage Backed Security (CMBS) market trends. Over the last year Hotel appraisal valuations have increased 7.7%, to lead all categories. Multi-family dwellings appraised valuations increased 4.2%, though retail space appraised valuations declined -2.1% (negative), and industrial space appraisals fell -5.2% (negative). Loans over $50 million saw 5.3% higher appraisals than a year ago, though smaller sized commercial loan appraisals declined -1.7% (negative) on average. Major retailers Abercrombie & Fitch, Best Buy, Sears, J.C. Penney, Office Depot, and Barnes & Noble all announced store closing for this year. Fitch Ratings note that Walmart, Costco, Dollar Stores and Forever 21 are planning future expansion, which may offset some of the store closures in some locations. The continued growth of e-commerce and mobile commerce may limit the future need for retail space. CMBS delinquencies reached a three year low early this year, with late-pays declining to 7.61% in February 2013. Delinquencies in all sectors of commercial real estate saw some improvement, with only industrial space delinquencies increasing over the previous month. Some volatility remains in the CMBS market, with 18% of loan portfolios in the process of foreclosure. New issuance of CMBS totalled $6.62 billion in February, a new post-recession high. The Fitch Ratings delinquency index tracks 31800 commercial loans, with 2014 totalling $29.9 billion at least 60 days delinquent, in foreclosure, or real estate owned (REO), and maintains a Stable outlook on about 82% of CMBS, Negative outlook on 7%, and Fitch considers about 10% of CMBS to be Distressed.
As the housing market recovery continues, but with average wage growth stagnant, the rental market is attracting more investor attention. People working multiple jobs, or in temporary employment, are more likely to rent, than purchase; either for the flexibility and ease of moving, or due to the difficulty in qualifying for a home loan, as lenders have tightened lending standards. A quick look at the market in Phoenix, shows availability of rental properties is placing some pricing pressure on renting, as home prices continue to rise. The own-to-rent ratio in Phoenix increased to 13.6% compared to 10.4% a year ago. Nationstar Mortgage Holdings (NSM) has been increasing mortgage originations activity across the US, and recently bought $215 billion in servicing rights from Bank of America (BAC). Along with private equity companies investing in housing and multi-family dwellings, overseas investors are pursuing investments in housing in the United States. Foreign investors lacking confidence in their home country equities markets, are finding that housing investments in the United States are very attractive. Wealthy Latin Americans looking for stable returns on their investments are increasingly looking into South Florida, especially theMiami rental market. Inflation concerns in Venezuela, Argentina, and Brazil are pushing some investors in real estate investments in the United States. Christie's International Real Estate lists Miami in the top ten luxury real estate markets; the top three luxury markets are London, New York, and the French Riviera. The latest NAHB (National Association of Home Builders) Housing Market Index reading was 44 against 47 expected, with single family home sales falling to 47, and prospective buyers slightly increasing from 32 to 35 over February. A reading above 50 indicates an expanding market, and a reading below 50 indicates a suppressed market. While the recovery in housing markets is a positive improvement in the US economy, there is still potential for even more improvement.
We reported on a housing bubble forming in China in our last article. In China's 70 major cities, home prices in February 2013 rose 2.1% higher than in the year ago period. Home prices have increased in seven of the last eight months. One new policy the government is using to curb speculation is a 20% capital gains tax on home sales. New home prices in Beijing rose 5.9% over the year ago period, and prices in Shanghai increased 3.4%. While the new government initiates some policies to curb further housing speculation, it is not yet clear how China will eventually manage their economy when the bubble bursts. The head of the People's Bank of China, Zhou Xiochuan, indicated possible monetary policy tightening this year, after February data indicated 3.2% inflation. There are signs that China's economy is slowing, such as the large unused inventory of new construction equipment. Analysts at Nomura (NMR) indicate that elevated property prices, a rapid increase in leverage, and declines in economic growth all point towards China tightening financial policies to avoid a systemic crisis. One positive indicator that China may be able to better avoid asset bubbles is an indication that China will eventually allow their currency to freely float, and that China is likely to open their markets to outside investors. It is notable that the same three signs that proceeded the financial crisis in the United States are now appearing in China. Charles Li, CEO of Hong Kong Echanges and Clearing, indicated that China must reform their interest rate system. The first step towards China allowing more outside investments is allowing certain companies holding Yuan to invest those holdings into Chinese markets, which may create more demand for Yuan. Even with some relaxing of currency controls, limited cross-border trading in Yuan only accounts for 9% of overall trade. The United Kingdom is now moving to be the first G7 nation with a currency swap agreement with China, though it is expected other countries will draft similar agreements in the near future. Manufacturing is still one of the main drivers of the Chinese economy, and with demand for electrical power expected to increase 8.5% this year, we may see China start to move faster to control their housing bubble.
While US housing markets are unlikely to see the bubble levels of the past, continuing recovery in housing will lift US GDP this year. Unfortunately employment trends are failing to keep pace with economic recovery. Compared to just about anywhere else in the world, the US economy appears to be leading the path towards growth. At least now few people in the US talk of bank runs, unlike the current situation in Cyprus. While there are some areas of concern to watch in the near future, the potential for long term investors remains positive.
G. Moat