At the end of 2011, PFS Group began investing in Financials and Homebuilders for the first time since the 2009 market recovery. We advised the public and our clients to stay clear of the group when we began to talk about the coming demise in financials and housing in 2005 and 2006. Even when Wall Street said Financials were at a bottom in 2007 and 2008, we stayed away. Since housing data began to improve towards the end of 2011, we stepped into financials and housing stocks in our aggressive portfolios. As we have become more convinced, these holdings have spread. We continue to support the investment we’ve chosen based on the continuing economic recovery in housing and the earnings results of the financials.
The Puplavas (Jim, Chris, and myself) have a long list of articles we’ve written since we took Financial Sense from a private newsletter to our clients to a public commentary website in the 90s. Because our archive is organized by date, it might be hard to filter through the articles searching for a particular topic. Concerning the top in housing and the financials, here are some of our past articles:
| Jim | Ryan | Chris |
The Day After Tomorrow The Next Rogue Wave 12/15/06 Forecast 2007: Disinflation then Reinflation | Hinging on Housing 12/27/06 The First to Turn Down 6/21/07 | Running Out of Fuel 7/26/06 Housing Update 2/07/07 Fragile, Handle With Care 8/08/07 Reality Setting In? 08/15/07 Proceed With Caution 8/22/07 Credit Erosion: The Worst is Yet To Come 8/29/07 Will Financials Be to This Bull Market and Economy What Tech Was to the Last? 9/05/07 |
All of this is to say that we didn’t like housing stocks, we didn’t like financial stocks, and we felt there would be a coming financial crisis in the U.S. due to the credit crunch caused by a top in housing. No longer could the U.S. consumer tap the refinancing ATM machine, called their house, as rates climbed and credit requirements tightened. It has been six years since the top in the housing bubble and four years since the bubble wreaked havoc through our financial markets. However, now things have changed. We continue to see the signs of a bottom in housing.
In past U.S. recession, economic activity weakened as central banks tightened credit. Once rates dropped and credit was loosened, housing and consumption would typically bring the economy out of a recession. That hasn’t been the case so far for the Great Recession, but that has changed this year. Despite the hiccup in many manufacturing economic indicators this summer, housing data has continued to improve all year.
Some of the very economic indicators we followed in 2005-2007 that showed a top in housing have reversed trend, and are on the rise. I started to comment on these indicators on the Financial Sense Newshour in December of last year with updates throughout the market drivers segment this year. Please also see my article in March titled, Five Reasons Why Financials, and Stocks, are Breaking Out.
Residential Investment as a % of GDP at Extreme Low and Turning Up
Source: Bloomberg
The S&P/Case-Shiller Home Price Index is the most widely tracked indicator for the health on housing. As released on September 25th, the index made its second consecutive annual increase in price. Month over month prices increased 1.6% for the 20-City Composite for July over June. Additionally, the annual returns were positive, showing an increase of 1.2% in July versus a 0.6% rise in June over a year ago.
Housing prices and housing construction are the two widely followed indicators in housing. The constructions and permits number was released this week, with housing starts well above estimates for September (rising 15% from August) with a 11.6% boost in permits over last month. As you can see from the chart below, starts and permits have shown that conditions have bottomed and a bullish trend has begun.
Construction and Permits Have Bottomed
Source: Bloomberg
Another indicator we focus on is the National Association of Home Builders (NAHB) Market Index. It is a broad survey that tracks a number of components to sum up the condition of housing. It gauges the mood of the building industry and is therefore a good indicator of future conditions. This indicator bottomed in 2009, but it wasn’t until late 2011 that it achieved escape velocity, and a bullish trend.
NAHB Market Index Trending Higher
Source: Bloomberg
As the housing market has improved, so has the economic situation of the financials who own mortgages and in some cases, investments or asset management services. If Bank XYZ no longer has to write down as many bad loans and they meet Basel III capital levels, then the financials can go back to concentrating on profitability and less on damage control and raising capital. With short-term interest rates as low as they are, the Financials have a lot of wind at their sails.
One of the issues that has hurt financials as of late has been litigations. Recall in my March article that there was a $25 Billion mortgage settlement? The suit was ongoing for years and there was a lot of confusion on how much exposure each bank had to the litigation. With it out of the way, the foreclosure process could resume but I forecasted this would be less of an issue in 2013 with a Zero Interest Rate Policy (ZIRP) and an improving economy, thanks to housing and QE. Now that QE will be focused on mortgages again, it is clear the Fed is trying to reinvigorate housing and the financials – and it shows in earnings.
Financials Got the Beat
We have started to hear the beat from financials beating earnings estimates, and by a wide margin. Out of the 97 S&P 500 companies that have reported (including Aug-end reports like Discovery Financial and Nike), the announced earnings have beat estimates by 6.2% on average. Who’s beating analyst estimates by the widest margin? It’s none other than the financials. According to Bloomberg, Goldman Sachs beat by 25%, Morgan Stanley by 40%, Bank of America by 46%, and Travelers today by 39%, which invigorated the insurance stocks. Insurance, Cards, Brokers, Banks, and Asset managers - the whole sector is getting buoyed.
When picking sectors or stocks, I like to pick favorable stocks in favorable groups. That means that I want to see a majority of the stocks in that group with bullish trending charts. That typically means there’s wind in the sails and catalysts favoring the group. Such has been the case with oil refiners this year. Across the board, the group has done well. We’re seeing that take place now in housing and financials. Whether you’re looking at credit card companies, brokers, banks, asset managers, or insurance companies, the sector has performed well versus the broad market. Homebuilders, construction materials, and home goods stores likewise have shown performance across the board. There may be a straggler here and there, but as a whole, the housing group has bottomed and a new, bullish trend has formed. We steered our clients clear of this group at the top, but since the beginning of the year, we’ve found this an attractive area to invest. The economics continue to support this thesis.
