Recent data reveals a significant jump in new construction, bringing the number of housing starts to its highest level since February 2008. To put it in perspective, current starts are approximately double the figures recorded during the darkest days of the Great Recession. Although this construction pace remains about 50% lower than the peaks of the housing boom—much of which lacked a sound economic basis—it is evident that the housing market has made substantial progress since its collapse a few years ago.
The robust data presented today helps overshadow recent concerns that had been lingering over the market. Throughout most of 2013, both starts and permits showed a downward trend in year-over-year figures, sparking questions about whether this signified a natural stabilization in the housing recovery or something more troubling. While uncertainty still prevails, the latest starts data indicates that new construction is firmly on an upward trajectory and unlikely to stall in the near future.
While the annual rate of starts saw a notable increase in November, the growth of permits compared to the previous year is approaching its slowest level since 2010. At this point, this isn’t overly alarming, as the year-over-year pace of around 8% indicates a favorable growth environment for homebuilding. In fact, the recent December update from the National Association of Home Builders/Wells Fargo Housing Market Index confirms this, reporting the highest level in eight years. According to NAHB Chairman Rick Judson, “This is definitely an encouraging sign as we move into 2014.” Today’s housing starts data only reinforces his optimistic outlook.
What challenges lie ahead for the housing sector? Potentially rising interest rates. As the Federal Reserve gears up to taper its stimulus program, rates are expected to rise. Already, rates have shown a moderate increase in recent months, reflecting the anticipation of reduced monetary support. Currently, the national average for a 30-year conventional mortgage stands at around 4.4%, up by about 100 basis points since spring. At present, it remains unclear whether these higher rates will hinder the housing recovery. Much will depend on the speed and reasoning behind any rate increases. If the Fed tightens policy due to robust economic growth, this change could actually signal positive progress. For now, that outcome appears to be a logical expectation.
Analyzing recent performance through various proxy ETFs reveals a significant decline across Treasury bonds in recent times. To provide context, let’s compare U.S. government bonds with other major categories of domestic debt over the past 250 trading days (roughly equivalent to one year) as of December 16:
After rebasing the bond ETFs to a value of 100 as of December 18, 2012, it’s evident that the most pronounced losses are incurred in the longest maturities, particularly reflected by the iShares 20+ Year Treasury Bond ETF (TLT), which has experienced a decline exceeding 12% over the last 250 trading days:
Not all segments of the U.S. bond market are suffering, at least for now. Leading the way in profit is U.S. junk bonds represented by the SPDR Barclays High Yield Bond ETF (JNK), which has gained over 5% during the past 250 trading days. Additionally, short-term investment-grade corporates (CSJ) show slight gains, and even short-term Treasuries (SHY) are barely in the green.
This analysis demonstrates the importance of not viewing U.S. bonds as a singular asset class when making portfolio allocation and rebalancing decisions.
An alternative method for assessing relative returns involves calculating a rolling one-year return spread. By subtracting the one-year return of large caps from that of small caps, we can visualize the results daily since the mid-1990s:
The chart indicates that the current small-cap rally has maintained momentum for over a year. Although there has been a slight pullback recently, the small-cap premium remains relatively high at approximately +8 percentage points. While this premium has seen larger values in the past—most notably a brief surge near +40 percentage points in 2000—the current spread appears moderate by comparison.
The dilemma arises: Is it prudent to hold out for even greater gains, or should one consider rebalancing now and taking some profits? Opinions will vary, as always, but the history of attempting to reach for excessively high returns often leads to disappointing outcomes. This doesn’t imply that small-cap stocks won’t continue to outperform large-cap stocks in the coming year. A more balanced approach to rebalancing might be wise. All-or-nothing investment strategies can yield remarkable results, but a miscalculation can be costly.
Ultimately, investment decisions should begin with a strong foundation in fundamental principles before diving into risky territory. Viewing investing as a risk management endeavor rather than merely pursuing high returns often leads to more informed decisions based on data-driven insights.
Meanwhile, recent statistics are impressive. The 1.1% increase in industrial production in November marks the highest monthly growth rate seen in the past year. The gradual rise in manufacturing activity during November strengthens the argument that expansion within the industrial sector is broad-based.
More importantly, recent year-over-year figures indicate a significant rebound in industrial production. For the first time since mid-2012, the Federal Reserve’s industrial production index has recorded annual growth rates exceeding 3% for three consecutive months. The slowdown observed earlier this year, notably a low point of 1.5% in July, has transitioned to considerably stronger comparisons.
Today, we also learned that the preliminary estimate of the U.S. Manufacturing PMI for December signals a healthy growth trajectory as we approach the new year. According to Markit’s chief economist, the “flash PMI remained surprisingly high in December, suggesting strong growth momentum in the goods-producing sector.” This is a positive indication that the encouraging trends seen in the November industrial production data may carry over into the next month, when the Fed releases its subsequent report.
Some might be surprised to discover that industrial activity has been maintaining growth above 3% annually in recent months, but the broader implications for the business cycle are more expected. Although some analysts tend to focus on anecdotal evidence or outlier data points from regular economic updates, a comprehensive review of the overall trends continues to show a generally optimistic outlook, as reminded by the monthly assessments of the Economic Trend & Momentum indices (for example, here’s last month’s report).
While the strong industrial production increase in November is just one piece of data, it is part of a broader collection of indicators suggesting that the risk of a business cycle downturn remains low in the U.S. This has been the prevailing message, even during periods of volatility. An objective search for credible signs indicating an approaching recession has yielded few compelling warnings in recent times. Today’s industrial production results certainly do not alter that narrative.
The U.S. industrial production report for November, set to be released on December 16, is forecasted to show a 0.3% increase from the previous month, according to The Capital Spectator’s average econometric analysis. This anticipated rise follows an October decline of 0.1%. Notably, the Capital Spectator’s projection for November is slightly below the consensus estimate derived from a survey of economists.
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Europe’s economic crisis could be evolving
Barry Eichengreen (The Guardian) | Dec 10
The main issue may be shifting from debt to deflation – and there’s little indication that the ECB is adequately prepared for this challenge.
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Today’s economic insights present quite a contrast. Starting with the positive news: retail sales increased a solid 0.7% in November compared to the previous month, slightly exceeding The Capital Spectator’s averaged econometric forecast and aligning with the consensus anticipation. Conversely, this morning’s update on initial jobless claims reveals a concerning rise: filings surged by 68,000 last week to a seasonally adjusted total of 368,000, marking the highest level since early October. What does this signify? Should we react positively, negatively, or perhaps adopt a balanced perspective amidst this mix of signals? Let’s delve deeper into the figures.
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Growing expectations suggest that the Federal Reserve will begin to taper its bond-buying program in the coming days, coinciding with the conclusion of its FOMC policy meeting on Wednesday, December 18. A notable drop in the U.S. stock market yesterday indicates that investors are preparing for a shift in monetary policy. However, one should remain cautious: inflation rates continue to remain low relative to the Fed’s targets.
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The overall trend of the U.S. economy, which showed improvement from late October to mid-November, has recently pulled back from its recent peak based on a comprehensive assessment of macroeconomic conditions in the markets. The Macro-Markets Risk Index (MMRI) registered at 13.0% on Tuesday, December 10, indicating that business cycle risks remain low. This 13.0% figure is considerably higher than the year-to-date low of 7.5% recorded in mid-September, and well above the 0% threshold that signals elevated recession risk. Readings above 0% suggest an inclination towards economic growth.
U.S. retail sales are projected to increase by 0.5% in the upcoming update (December 12) for November compared to the previous month, according to The Capital Spectator’s average econometric forecast. This prediction slightly exceeds the earlier reported increase of 0.4% for October. Additionally, the Capital Spectator’s average projection for November falls marginally below consensus estimates from recent surveys of economists.
