Error message

Warning: implode(): Invalid arguments passed in envestnetpmc_mod_views_pre_view() (line 65 of /mnt/www/html/envestnetpmc/docroot/sites/all/modules/custom/envestnetpmc_mod/envestnetpmc_mod.module).

Commentaries

PMC Weekly Review - May 26, 2017

A Macro View: Housing – Back to the Top but for a Different Reason

Housing prices continue to climb and are less than 5% below peak prices in 2006, according to the S&P/Case-Shiller 20 City Composite Home Price Index. Those who either cannot afford or find a home in the next year or two might be disappointed in the short run, but given the strong price appreciation, they might be grateful in the long run. Remember that those who purchased a home at the peak in 2006 are still under water. In 2006, the reason for the large increase in housing prices was sub-prime lending, where anyone willing to sign a mortgage while providing no documentation to their lender could walk away with a set of keys. The mortgages were packaged by Wall Street and sold to investors around the world. When mortgages couldn’t be generated fast enough, traunches were then re-packaged and credit default swaps were written on re-packaged traunches. Anyone could own a home they couldn’t afford as long as the machine kept churning out re-packaged mortgages. But eventually it all came crashing down. Although the reason for today’s rising home prices is different, potential home buyers in today’s market should remember Mark Twain’s saying that “history does not repeat itself, but it does rhyme.”

On the surface, the good news for today’s buyers is that despite prices reaching near 2006 levels, the ratio of house price to income is still 18% below 2006’s peak. In other words, housing prices might be near the top, but income levels have increased since 2006, so the average buyer has more income to spend on a home. That said, the price-to-income ratio is 8% higher than its average since 1980, according to The Economist. The bad news is the average price-to-income ratio since 1980 is distorted by the 2005-2006 bubble, so if you exclude that bubble, people are paying much more for a house compared to their income level. 

The reason for such a spike in housing prices has less to do with cheap and widely available credit, as was the case in 2005-2006, and more to do with low supply and an influx of central bank liquidity. Over the past several years, mortgage rates have dipped to historic lows, so home buyers who qualify for a mortgage pay less in monthly payments for the dollars borrowed than in the 2000s, 1990s, and 1980s. Given such cheap rates, future home buyers can purchase a more expensive home per dollar in mortgage payment, compared to the last 30 years. According to the St. Louis Federal Reserve Bank, the average mortgage rate on a 30-year conforming loan in 2005 was 5.87%, compared to 2016’s average rate of 3.65%. This amounts to a monthly savings of $134 per $100,000 in mortgage loan. In other words, buyers can get a much more expensive house for their average monthly payment, which drives up housing prices.

The second reason for rising home prices is the lack of supply. Since 1980, average housing starts as a percentage of the US population have been 0.51%, according to the Federal Reserve. But since the housing bubble burst in 2006, average housing starts are 0.29%—almost half. So America is building fewer homes per person, depressing the supply of new homes added to the market. According to The Wall Street Journal, home inventory is at a 20-year low and keeps decreasing. For the past 23 consecutive months, supply has decreased each month, so now there are fewer homes for sale, resulting in an increase in prices.

What does all this mean for the housing market? For one thing, it appears we may be approaching stretched valuation territory, although it might not be similar to 2006 levels. In 2006, anyone could buy a home as long as they were willing to sign on the dotted line and lie about their income, resulting in a rapid increase of defaults once the actual mortgage payment came due. In today’s market, a combination of lack of supply and low rates is fueling the increase in housing prices. The question is, what would cause today’s housing market to burst? An increase in rates could reduce the amount people can spend on a house, which should cause prices to cool, or builders could add to the supply. Either one of these events could happen quickly, as rate increases are already priced into the market, and the turnaround time to build a new house is less than a year. Also, last year home builders built 30% more homes than they have averaged since the housing crisis, so the trend for an increase in supply is rising. Future home buyers need to be aware of this issue, as things could change rapidly in less than a year’s time, just like they did in 2006. In other words, future home buyers should brush up on their Latin: caveat emptor.

Download the full PDF

The information, analysis, and opinions expressed herein are for general and educational purposes only. Nothing contained in this weekly review is intended to constitute legal, tax, accounting, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. All investments carry a certain risk, and there is no assurance that an investment will provide positive performance over any period of time. An investor may experience loss of principal. Investment decisions should always be made based on the investor’s specific financial needs and objectives, goals, time horizon, and risk tolerance. The asset classes and/or investment strategies described may not be suitable for all investors and investors should consult with an investment advisor to determine the appropriate investment strategy. Past performance is not indicative of future results.

Information obtained from third party sources are believed to be reliable but not guaranteed. Envestnet|PMC™ makes no representation regarding the accuracy or completeness of information provided herein. All opinions and views constitute our judgments as of the date of writing and are subject to change at any time without notice.

Investments in smaller companies carry greater risk than is customarily associated with larger companies for various reasons such as volatility of earnings and prospects, higher failure rates, and limited markets, product lines or financial resources. Investing overseas involves special risks, including the volatility of currency exchange rates and, in some cases, limited geographic focus, political and economic instability, and relatively illiquid markets. Income (bond) securities are subject to interest rate risk, which is the risk that debt securities in a portfolio will decline in value because of increases in market interest rates. Exchange Traded Funds (ETFs) are subject to risks similar to those of stocks, such as market risk. Investing in ETFs may bear indirect fees and expenses charged by ETFs in addition to its direct fees and expenses, as well as indirectly bearing the principal risks of those ETFs. ETFs may trade at a discount to their net asset value and are subject to the market fluctuations of their underlying investments. Investing in commodities can be volatile and can suffer from periods of prolonged decline in value and may not be suitable for all investors. Index Performance is presented for illustrative purposes only and does not represent the performance of any specific investment product or portfolio. An investment cannot be made directly into an index.

Alternative Investments may have complex terms and features that are not easily understood and are not suitable for all investors. You should conduct your own due diligence to ensure you understand the features of the product before investing. Alternative investment strategies may employ a variety of hedging techniques and non-traditional instruments such as inverse and leveraged products. Certain hedging techniques include matched combinations that neutralize or offset individual risks such as merger arbitrage, long/short equity, convertible bond arbitrage and fixed-income arbitrage. Leveraged products are those that employ financial derivatives and debt to try to achieve a multiple (for example two or three times) of the return or inverse return of a stated index or benchmark over the course of a single day. Inverse products utilize short selling, derivatives trading, and other leveraged investment techniques, such as futures trading to achieve their objectives, mainly to track the inverse of their benchmarks. As with all investments, there is no assurance that any investment strategies will achieve their objectives or protect against losses.

Neither Envestnet, Envestnet|PMC™ nor its representatives render tax, accounting or legal advice. Any tax statements contained herein are not intended or written to be used, and cannot be used, for the purpose of avoiding U.S. federal, state, or local tax penalties. Taxpayers should always seek advice based on their own particular circumstances from an independent tax advisor.

© 2017 Envestnet. All rights reserved.