Strength in Real Estate Markets Signals Positives for Stocks

Strength in Real Estate Markets Signals Positives for Stocks

With the stock market continuing to post all-time highs, many analysts have posted reports arguing “for” or “against” the idea that we are currently experiencing an asset bubble that is vulnerable to collapse.  Recent strength in labor markets suggests that we are seeing strong improvements in key sectors of the economy, so it will be important to look at other stores of household value in order to determine whether or not the US economy is actually progressing as well as this year’s stock market moves would suggest.  Perhaps the most important area to watch can be found in the housing markets, as this is one of the most significant indicators of net worth and economic stability for families. 

When we look at the broadest measures of growth, GDP data in the US has consistently beaten analyst estimates for most of the year.  Fortunately, these figures have been supported by household wealth as well, as the total net worth in households and nonprofit groups rose by nearly $2 trillion in the third quarter according to data compiled by the US Federal Reserve.  These gains were even stronger than what was seen in the rising value of financial assets held by American households (which include things like pension funds and stock holdings).  Gains in this sector of the economy grew by $1.5 trillion over the same period.  This might be something of a surprise, given that new record highs in the stock market have taken most of this year’s attention in the financial media.  But this also means that is it less likely we are actually seeing an asset bubble in benchmarks like the S&P 500 and that significant losses are unlikely next year.

Economic Data, Earnings

Relative health in the real estate market is vital in ensuring valuation stability in stocks as a whole.  Since difficulties in real estate (sub-prime mortgages, in particular), emerging strength in these areas should be viewed as highly encouraging.  According to this infographic at DebtConsolidation.com, mortgages and home equity loans make up the largest portion of household debt at nearly $9 trillion.  In the early parts of 2013, debt tied to mortgages and home equity loans dropped by more than 3%, as homeowners have been in a better position to repay their balances.  This strength in the once-vulnerable real estate markets bodes well for prospects in 2014 GDP growth -- and, by extension, in stock valuations as well.  Stock gains have yet to match this year’s progress in real estate markets, so all of this suggests further upside in the most commonly watched benchmarks. 

More specifically, it is still important to take stock valuations on a case by case basis, even if the broader environment looks supportive for long-term gains in equities.  But when we look at corporate earnings releases, the supportive picture still holds up.  In the S&P 500, roughly 75% of the companies contained in the index released earnings that surpassed analyst expectations.  And when we look at total valuations on a price-to-earnings basis, markets are still showing prices levels that are well below what was seen in previous stock market bubbles.  One of the best examples of true bubble-like conditions in the stock market can be seen in tech stock valuations in the late 1990s. 

In this case, P/E ratios in the S&P 500 were seen above 25, which is well above the 50-year average for the stock index.  Market valuations today are nowhere near this level, and this ultimately suggests that we are holding at appropriate levels even with the record high closes that marked the month of November.  In order for there to be true concern for those holding assets directly tied to the benchmark stock indexes, we would need to see some major changes in these areas.  That would mean we would either need to see significant declines in fourth quarter earnings or extreme rallies from current levels.  Slowing momentum in holiday thinned trading conditions suggests that the latter is unlikely, and there is still no substantive evidence to suggest that earnings performances will begin to suffer anytime soon -- especially given the underlying macroeconomic strength in the government’s official releases. 

Signs of Stability in Housing Markets

Looking ahead, the best indicator of whether or not the US economy is truly on a path to sustainable recovery will be found in the housing markets, as this will create added potential for gains in consumer spending.  As this filters into new hiring and increased business confidence, buffers against downside corrections in the S&P 500 can be established on the argument that consensus forecasts for corporate earnings will need to be revised higher.  Increases in buying power for American households has helped provide a platform for equities, with the S&P 500 showing gains of 4.7% for the third quarter.  This is the third consecutive quarterly gain for the index, and a sharp increase from the 2.4% gain that was seen in Q2. 

During this period, the S&P/Case-Shiller national home-price index posted gains of 11.2% (on a yearly basis).  These increases in household wealth were the biggest since the beginning of 2006 -- well before the 2008 recession started to set in.  Household real-estate assets were higher by $428.5 billion, and owner equity as a share of total household real-estate holdings rose above 50%.  Household net worth is more than $8 trillion above the $69 trillion peak seen toward the end of 2007, coming in at $75.3 trillion for the June quarter.

Matching Corporate Performances

Not surprisingly, corporate performances have tracked many of these positive trends as well.  Looking specifically at the balance sheets of non-financial businesses, increases of nearly $115 billion were seen during this same period -- with the figures rising to a new record above $1.9 trillion.  From a central bank perspective, the Federal Reserve has maintained a supportive stance, with accommodative policy settings and an apparent willingness to postpone until next year plans for tapering in quantitative easing stimulus.  The fed has made it clear that stimulus programs will need to continue until the US unemployment rate falls to 6.5%.  The latest jobs report showed declines in the unemployment rate, to 7.0%. 

But since we are still well above the Fed’s target rate, it makes sense to base investment decisions on the idea that stimulus programs will continue for the foreseeable future.  Taken in combination, these trends are positive and will continue to support stock markets -- even though we continue to trade at record highs in several important benchmarks.  Strong gains in household wealth continue to filter through the broader economy, positively influencing a broad number of industry sectors.  Household purchases make up roughly three-fourths of the US economy, so this is an important leading indicator for the ways stock market performances will likely unfold in 2014.  More immediately, fourth quarter GDP will give investors a better idea of the extent to which Federal Reserve stimulus programs have had their intended effect and set the stage for gains in equities for Q1 2014.