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Home Sales Data Reveals Evidence Of Fed Success In Reflating The U.S. Economy And Markets Michael G Thompson Managing Director S&P Investment Advisory Services (1)
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Home Sales Data Reveals Evidence Of Fed Success In Reflating The U.S. Economy And Markets Michael G Thompson Managing Director S&P Investment Advisory Services (1) Robert A Keiser Vice President S&P Global Market Intelligence (1) This report was prepared by S&P Global Market Intelligence. Enabled with cutting-edge data and insights, S&P Global Market Intelligence offers investors valuable new sources for alpha discovery and out-of-the-box thinking through robust data exploration and analysis. S&P Global Market Intelligence's research provides investors with actionable and topical market perspectives that can offer innovative ways to leverage credit and risk intelligence. The timing was uncanny: Less than a week after the release of the minutes of the April Federal Open Market Committee (FOMC) meeting, which suggested investors might be underestimating the chances that the FOMC could raise the Fed funds target rate at its June meeting, April readings on both existing and new home sales and prices were considerably stronger than what was generally expected. U.S. existing home sales rose to 5.45 million units (seasonally adjusted annual rate; SAAR) in April versus expectations for a rise to 5.38 million units. Meanwhile, new single-family home sales exploded to 0.62 million units (SAAR) versus expectations for a much more moderate improvement to 0.52 million units. In addition, the April sales rate for newly constructed homes is the strongest it's been since January Home sale prices were equally impressive. The average existing single-family home price rose to $275,800 in April, up 4.2% from year-ago levels and just below the all-time record of $281,300 from June This puts existing home prices on par with the prior cyclical record of $277,900 from June The new single-family median home sale price set a new record of $321,100 in April, representing a 9.7% price increase from year-ago levels. Furthermore, the monthly median new home sale price is now significantly higher (+22.3%) than the prior cyclical high of $262,600 from March So while the underlying growth rate of GDP has been sub-par since the inception of the ongoing economic recovery, the persistent appreciation of home prices--with support from the Federal Reserve--has been relatively robust (see chart 1). Chart 1 Home price appreciation at a rate that far exceeds that of underlying GDP growth could be one of the factors responsible for the recent hawkish turn in Fed pronouncements and commentary. Some Fed officials have gone so far as to suggest that up to three interest rate hikes could be forthcoming this year. Considering the strength evident in the April home sales data, combined with the hawkish rhetoric coming from multiple Fed officials of late, it is very interesting to note that the slope of the U.S. yield curve remains close to the post-recession cyclical lows set in the aftermath of the May 18 release of the April FOMC meeting minutes. The yield spread between the U.S. 10-year and two-year Treasury notes closed at 93 basis points (bps) on May 23, which is the narrowest spread since November and December 2007 (see chart 2). 2 Chart 2 A flattening yield curve suggests that investors are not quite ready to conclude that inflation is about to become problematic for Fed officials and financial markets. A sustained flattening of the yield curve from current levels would suggest to us that multiple FOMC rate hikes are less likely over the balance of A more disturbing interpretation of a sustained flattening of the curve would be that many fixed-income investors still believe that deflationary forces--as opposed to inflationary ones--remain the predominant concern. Some might also believe that further rate hikes from the Fed would only exacerbate the deflationary influences that briefly boiled to the surface in January and February but have been dissipating ever since. Investors now need to digest upcoming high-profile economic data, predominantly the May employment report, within the context of: Changes in the foreign exchange value of the U.S. dollar and any concurrent influence that the dollar has on industrial sector activity and commodity prices, particularly crude oil (foreign exchange headwinds or tailwinds inflating or deflating raw materials pricing); Changes in the slope of the yield curve as a barometer of whether global fixed-income investors are anticipating inflation, deflation, or essentially price stability for the foreseeable future; and After seven years of recovery, is the U.S. economy suddenly displaying accelerating growth characteristics that would normally be evident in the early stages of expansion? An ideal outcome for investors and the Fed would be that the U.S. economy is now transitioning to a period of modestly improved GDP growth, where expanding consumer demand largely offsets the potential deflationary influences associated 3 with a further normalization of U.S. monetary policy. Consumer price inflation under this scenario would remain largely in check, limiting the need for a prolonged string of potentially disruptive future Fed rate hikes and allowing the existing GDP and corporate profit cycle to run unabated for the foreseeable future. The upcoming May employment report, to be released on June 3, should provide important clues on the health and vigor of the U.S. recovery cycle. The previous jobs report revealed that nonfarm payrolls grew by just 160,000 in April, the weakest gain since August and September The three-month average rate of nonfarm payroll employment growth has now dipped to 200,000, the lowest level since October 2015 (see chart 3). Any further deceleration of jobs growth would not support the contention of some Fed officials that multiple interest rate hikes are possible in 2016, whereas a sharp rebound in job creation could end up making these prognostications a reality. Chart 3 Inside This Issue: Macroeconomic Overview: Home Sales Data Reveals Evidence Of Fed Success In Reflating The U.S. Economy And Markets The timing was uncanny: Less than a week after the release of the minutes of the April Federal Open Market Committee (FOMC) meeting, which suggested investors might be underestimating the chances that the FOMC could raise the Fed funds target rate at its June meeting, April readings on both existing and new home sales and prices were considerably stronger than what was generally expected. Home sale prices were equally impressive. Home price appreciation at a rate that far exceeds that of underlying GDP growth could be one of the factors responsible for the recent hawkish turn in Fed 4 pronouncements and commentary. Some Fed officials have gone so far as to suggest that up to three interest rate hikes could be forthcoming this year. The upcoming May employment report, to be released on June 3, should provide important clues on the health and vigor of the U.S recovery cycle. Economic And Market Outlook: As Q1 Earnings Close, The Outlook Improves A few major retailers and technology companies have surprisingly helped boost first-quarter earnings in the past two weeks as the earnings season comes to an end. The projected earnings growth rate for the S&P 500 is still the weakest since the Great Recession at negative 5.6%, but it's better than the 6.0% decline expected two weeks ago and the 8.3% decline anticipated on April 13. About 67% of the index has beat consensus expectations, which is in line with the historical average beat rate of 66%. The size of the beats, however, has been smaller than the historical average. Leveraged Commentary And Data: Privately Placed Second-Lien Loans, By The Numbers The volume of second-lien loans launched to market is down by a staggering 75% in 2016 through May 17. More specifically, arrangers have launched $937 million of second-lien loans, down from $3.78 billion for the same period last year, as issuers and sponsors have largely been placing this debt privately. S&P Dow Jones Index Commentary: For The S&P 500 Industrial (Old), Cash Remains King With more than 90% of the data in, the S&P 500 Industrial (Old) could set a new cash and equivalent record for the first quarter of 2016; the current record is $1.33 trillion in the fourth quarter of Even if the first quarter of 2016 falls short of the record, there's no question companies have enough cash and access to debt and shares to do whatever they want, with want being the key word. Mostly, it seems companies want to buy back stock. Dividends and capital expenditures are also still in vogue, with some caveats. R2P Corporate Bond Monitor In the U.S., the latest murmurings from the FOMC of a possible rate hike as early as June or July were complemented by more positive data in the last two weeks. The FOMC made clear that it would favor a June rate hike if conditions allowed and if the economy continues to improve--a statement that seemingly halted the tightening of corporate spreads. Capital Market Commentary: IPOs, M&A, And Debt The lackluster initial public offering (IPO) market so far this year might soon see some bright spots. Coming ahead of the Memorial Day holiday, six offerings were poised to be priced in the week ending May 27. Headlining the upcoming docket of deals is a $1 billion offering by private-equity-controlled food distributor US Foods Holding, which is the largest non-reit IPO in 2016 to date. Economic And Market Outlook: As Q1 Earnings Close, The Outlook Improves North America A few major retailers and technology companies have surprisingly helped boost first-quarter earnings in the past two weeks as the earnings season comes to an end. The projected earnings growth rate for the S&P 500 is still the weakest since the Great Recession at negative 5.6%, but it's better than the 6.0% decline expected two weeks ago and the 8.3% decline anticipated on April 13. About 67% of the index has beat consensus expectations, which is in line with the historical average beat rate of 66%. The size of the beats, however, has been smaller than the historical average. Coming 5 in about 230 bps ahead of projections at the start of the reporting season, growth hasn't been close to the typical beat of 400 bps to 450 bps. This is now the second quarter in a row for the index to post a below-average beat size. Six of 10 sectors have negative growth rates in the quarter, a phenomenon that also hasn't happened since The energy sector continues to weigh the most heavily on growth given its profit loss and the lowest earnings beat rate (only 14% of the companies that have reported announced better-than-expected results). Excluding the energy drag, first-quarter growth is still in negative territory at negative 1.0%, though it's better than the negative 3.8% estimated at the start of the season. Chart 4 While oil and commodity price declines (West Texas Intermediate oil prices dropped 31% on average in the first quarter) weighed on the energy (Q1 earnings growth of negative 106.6%) and materials sectors (Q1 earnings growth of negative 11.4%), they weren't the only sectors with weak growth rates. Financials, technology, industrials, and utilities also posted earnings declines. Low interest rates, a still-strong dollar, and a global growth slowdown have weighed on several sectors. Leading for the fourth quarter in a row are the consumer discretionary, telecommunications, and health care sectors. Consumer staples crossed into positive growth on Thursday, May 19. Consumer discretionary is the only group with double-digit growth at 21%, while telecommunications growth is at 9% and health care is at 8%. Consumer discretionary growth was driven by automobiles and Internet retailers. Strong earnings reports from Home Depot Inc., Lowe's Cos., Walmart Stores Inc., and TJX Cos. Inc. also helped the sector's growth rate improve over the course of the past two weeks, bucking the trend for disappointing retailer results. Consolidation (AT&T Inc. acquired DIRECTV last July) and a 6 reduction in competitive pressures benefited the telecommunications sector. Biotechnology once again was a key driver of health care's robust growth rates, even as growth for the industry has slowed. Health care providers and services industry companies--including HCA Holdings Inc. and United Health Services Inc.--also benefited the overall growth for the sector. Chart 5 Even as companies have been able to beat the bottom-line estimates, revenue growth is once again settling in at a lower rate than was anticipated at the start of the reporting period. The dollar only appreciated 2.5% on average year-over-year in the first quarter, based on the U.S. Dollar Index (DXY), as we finally started cycling the sharp rise in the dollar. In the fourth quarter of 2015, the average increase in the DXY was 12%, and the dollar rose 17% in the third quarter of It seemingly takes some time for the reduced level of appreciation to benefit companies. The S&P 500 generates 47.8% from overseas, according to S&P Dow Jones Indices, with the information technology, energy, materials, and health care sectors having the largest exposures. Sales growth of negative 2.0% makes the fifth quarter in a row for a decline, though that is an improvement from the 2.9% average decline in the preceding four quarters. Excluding the energy drag (negative 31.0% sales growth), total index sales growth would be positive 1.7%. Six sectors are expected to finish with sales lower than last year. Historically, sales growth has averaged 6%. The sectors that have led sales growth continue to be the EPS growth leaders: telecommunication services, health care, and consumer discretionary. On the other hand, energy, utilities, and materials are the largest laggards. Without top-line growth, earnings growth has been tough to come by. 7 Chart 6 As we look to the remainder of 2016, earnings estimates are finally starting to move higher. While the trend is early, and many management teams have reduced their outlook for the full year, we are encouraged by the move. Since the start of the month, earnings growth rates for the third and fourth quarters as well as for the full year have improved by 20 bps to 30 bps. While that doesn't seem like a large move, it is the first time growth rates reversed the trend for deterioration since the start of the year. The second half of the year is expected to be the driver of growth, with third- and fourth-quarter earnings projected to grow 2.7% and 8.4%, respectively. When coupled with the weak first half of 2016, with both the first and second quarters posting declines in growth, full-year 2016 growth will be just better than flat at 0.1%. Table 1 Quarterly S&P 500 EPS Growth Estimates (%) 1-Jan 1-Apr 1-May 26-May Q (2.51) (4.69) (4.98) Q Q FY (0.08) 0.12 Source: S&P Global Market Intelligence. 8 Europe This week, eurozone finance ministers agreed to provide Greece with $11.5 billion in bailout funds to be used to make debt payments that are due starting in June. As things currently stand, Greek public debt is 180% of the country's gross domestic product. Earnings growth rates for the Euro 350 continue to fluctuate, with 2016 expected to decline 4.5% (versus a 4.3% decline a month ago) and to increase 14.4% in 2017 (versus a 13.9% gain a month ago). Five of the 10 Euro 350 sectors are expected to report growth in Health care (2.9%) leads, followed by telecommunication services (2.4%) and consumer discretionary (1.8%). Energy (negative 28.6%), financials (negative 9.9%), utilities (negative 8.2%), information technology (negative 7.5%), and materials (negative 6.7%) are all expected to report declines in growth. Table 2 Calendar-Years 2016 And 2017 Euro 350 EPS And Growth Rate --Calendar-year Calendar-year EPS ( ) Growth (%) EPS ( ) Growth (%) Consumer Discretionary Sector Index Consumer Staples Sector Index Energy Sector Index (28.60) Financials Sector Index (9.90) Health Care Sector Index Industrials Sector Index Information Technology Sector Index (7.50) Materials Sector Index (6.70) Telecommunication Services Sector Index Utilities Sector Index (8.20) S&P (4.50) Contact Information: Lindsey Bell, Senior Analyst--S&P Global Market Intelligence, Follow S&P Global aggregated consensus earnings news on Twitter for earnings insights & results. Leveraged Commentary And Data: Privately Placed Second-Lien Loans, By The Numbers The volume of second-lien loans launched to market is down by a staggering 75% in 2016 through May 17. More specifically, arrangers have launched $937 million of second-lien loans, down from $3.78 billion for the same period last year, as issuers and sponsors have largely been placing this debt privately. 9 Chart 7 In 2016 through May 17, LCD has reported on more than $2.6 billion of second-lien debt that has been placed privately, up from just shy of $1 billion in the same period last year. Although the high-yield market has opened up this year after a sluggish start, the amount of unsecured debt that is placed privately is also up considerably--to approximately $3 billion versus $534 million for the same period last year. 10 Chart 8 Following the market volatility late last year that sent secondary prices sharply lower and upended the primary market, banks backed away from underwriting the second-lien and junior debt components of transactions. At the same time, business development companies and hedge funds, which had been big buyers of second-lien paper, shied away from new deals after realizing large mark-to-market losses. In turn, sponsors seeking junior debt reached out directly to buy-side firms, often existing relationships, to place this debt. With market conditions strengthening considerably in recent weeks, there are signs that the broadly syndicated second-lien market has also begun to thaw. The first- and second-lien financing backing Bain Capital and Vista Equity Partners' acquisition of Vertafore, which was announced earlier this month, is said to be fully underwritten. Generation Brands and Verisk are also syndicating the second-lien components of their LBO deals, while Vencore and National Veterinary are syndicating second-lien add-on deals. The improvement is more tangible in the secondary market, where the average price of performing second-lien S&P/LSTA Index loans (excluding oil and gas credits) had run up to after slumping to at the end of February, though it is still well below where the paper was trading at the same time last year. 11 Chart 9 Even though the market is opening back up after a frigid start to 2016, players expect to see some sponsors continue to place second-liens privately even if a broadly syndicated deal is an option. Amid a dearth of supply in the new-issue syndicated loan market, there is plenty of demand from certain buy-side investors to take a large position in a second-lien, and private equity firms are also in the game, sources say. Private equity limited partners have also stepped in as large-scale buyers of junior debt, effectively doubling down on their equity commitments to individual private equity transactions. With expectations lowered on equity returns, the debt begins to look more interesting as an alternative investment, especially in an environment of decreased buyout activity. With sponsors and buy-side firms now working directly on more transactions, the framework exists to place this debt privately, and the pool of investors interested in these transactions has grown. Also, pre-placing the debt provides issuers with more certainty about the cost of funding because the pre-placed debt is not subject to flex language. Although conditions in the second-lien market have improved, they are hardly robust. Given regulatory requirements, a changing buyer base, and a lower appetite for risk among the underwriting banks, participants are by no means expecting a return to 2014, when nearly $36 billion of broadly syndicated second-liens priced. Contact Information: Kerry Kantin, Vice President--Leveraged Commen
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