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Market Digest — Week Ending 7/20

Almost a mirror image of last week, stocks rose through Thursday and fell on Friday. On balance, it was a positive week for major US indexes as corporate earnings outpaced most expectations. For Spain, and Europe in general, it was a case of one step forward, one step back. A previously designed bailout plan for the ailing country’s banks was approved by European finance ministers, but enthusiasm quickly waned as the region of Valencia prepared to seek a bailout from the central government. The Euro fell. Chinese authorities indicated they will continue to actively contain real estate prices. The move is prudent, but disappointed short term focused investors. Treasuries continued to rise, pushing yields back near record lows set in June.

Weekly Returns:

S&P 500: 1,363 (+0.4%)

MSCI EAFE: (-0.3%)

US 10 Year Treasury Yield: 1.46% (-0.03%)

Gold: $1,584 (-0.3%)

USD/EUR: $1.216 (-0.7%)

Major Events:                                                                                                                                                        

  • Monday – US retail sales fell 0.5% in June, falling well short of expectations for a small gain.
  • Monday – Yahoo named 37 year old Google veteran Marissa Mayer as CEO.
  • Tuesday – The National Association of Homebuilders confidence index had its largest gain since 2002, and hit its highest level since 2007.
  • Wednesday – Housing starts rose 6.9% in May.
  • Wednesday – IBM reported better than expected earnings and increased guidance for the rest of the year.
  • Wednesday – The Fed “Beige Book” said the US economy expanded at a moderate pace in June and early July but that jobs growth was “tepid”.
  • Thursday – Existing home sales unexpectedly dropped 5.4% in June.
  • Thursday – Russia and China vetoed a UN resolution to threaten sanctions against Syria’s Assad regime. Violence intensified in Damascus as soldiers responded to a rebel bomb attack Wednesday which killed the Defense Minister. Thousands of refugees fled the city.
  • Thursday – Microsoft raised revenue guidance for the upcoming quarter.
  • Friday – China announced it will not relax property control measures.
  • Friday – Spain said its recession will extend into next year and that the region of Valencia was preparing a request for aid from the central government.
  • Friday – At least 12 people were killed and 50 injured when a gunman opened fire in a movie theater outside of Denver, Colorado.

Our Take:

US interest rates are at all-time lows. This stems in part from a flight to “safer,” dollar denominated bonds, but by and large it’s an active decision by the Fed. The Fed has publically stated a desire to prop up US housing, and it appears to finally be succeeding. The most recent Case-Shiller index showed a 1.3% monthly price increase in April, though year over year prices were still lower. We expect May and June numbers to be even stronger.

Anecdotally, here in San Francisco and the surrounding Bay Area, new home listings are being snapped up quickly, often with multiple bids above offer. Among our nationwide client base, we see a marked increase in the number planning to buy second homes as investments, as well as younger clients beginning the process of purchasing a first home.

It is easy to see why. Low rates have made homes purchased on credit cheap. The National Association of Realtors affordability index hit a record high in the first quarter (it began in 1970) and will undoubtedly do so again in the second quarter. In 2007, the average 30 year fixed mortgage rate was about 6.5%. Today it is 3.5%. Since the peak, home prices have come down about 30%, on average. So assuming a 20% down payment, a $500,000 house in 2007 would have come with a monthly payment of around $2,500. Today, that same house may only require a payment of about $1,250.

A 50% discount makes a big difference.

Better housing affordability helps the general economy immensely. First, it promotes new home construction and existing home turnover, both of which create significant economic activity. Second, lower monthly payments and re-financings provide households with additional money to spend on other goods and services. Third, stable or rising prices are an elixir for the sick members of the banking system who remain on the hook for underwater mortgages. Bank of America jumps to mind.

We feel comfortable joining the growing chorus proclaiming housing prices have bottomed. It is important to remember prices remain artificially supported by government actions, which may be unsustainable over time. But for now, rising prices and increasing sales volume are welcome developments. More importantly, a housing rebound is almost necessary if the US is to avoid being dragged into recession by Europe’s problems.

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