Forget Cyprus: Focus on the Big and Slow
In nature, some animals have very poor eyesight, such that they can hardly see anything that isn't moving. In the film Jurassic Park, as Sam O'Neill strategized how to avoid becoming lunch for a T-Rex, he aptly remarked, "stay still, he can't see us if we don't move." A similar dynamic can be observed in the investing world, afflicting both bulls and bears alike.
Investors are prone to add unnecessary significance to the latest piece of fast-moving market noise, while underestimating or missing large and slow-moving shifts that have huge impact.
The past week has been a good example. Cyprus, an economy with a GDP around half the size of Tulsa, Oklahoma's, is dominating the headlines and the minds of traders and retail investors. But, it would make a lot more sense to be talking about the recent and hugely important signals that the $20 trillion U.S. housing market has entered a sustainable upswing.
Of course, there have been valid reasons for concern about Cyprus; a proposed bail-in of depositors expecting to be covered by the 100,000 euro deposit guarantee scheme risked a wider public mistrust of bank deposits in the euro area. And in fairness, markets have been relatively well-behaved, with the euro stoxx down less than 2 percent last week. But a 37 percent jump in options prices underscores where the market's focus has been.
Now that it appears the bail-in will exempt those within the guarantee threshold, investors should take another look at the bigger picture.This means looking again at the single most important factor in the global economy, the U.S. consumer. And with 65 percent of these consumers owning homes, with equity worth close to $7 trillion, the performance of the US housing market is instrumental in determining their mood.
Last week, a raft of new data confirmed that the U.S. housing market is gaining momentum and is poised to become an important contributor to both labor market strength and broader economic growth.
Single family housing starts are up nearly 30 percent compared to February of last year. And building permits at a near-five year high suggest that starts should continue to grow strongly in the coming months. This growth in construction is backed by good sales figures too, as last week also showed existing homes sales rising for the twentieth consecutive month, to 4.98 million annualized in February.
Even the "bad news" on construction can be interpreted positively if we look beneath the headlines. The NAHB home builder sentiment index fell, with the weakness in current sentiment attributed to supply chain bottlenecks, and the increasing cost of labor. But this is probably indicative of construction companies squeezing workers to a point such that weekly hours worked are now at record highs. From here, continued strength in the housing market should provide even more jobs in a sector which already represented almost a quarter of all new jobs in February. For context, construction employs 2 million fewer people today than it did at its peak in 2007.
Outside of the direct impact on construction, rising house prices should boost consumer confidence. February's rise in home inventories could be read as a potential negative for prices. But, housing stock had reached such low levels that it represented just 4.2 months of existing home sales, a level low enough to actually restrict sales, according to realtors.
And prices remain on a strong upward path; the FHFA confirmed last week that the 6.5 percent increase in prices last year has been followed up by another 0.6 percent in January. Last year's rally helped 1.7 million US families regain positive home equity. This is a big deal because that is 1.7 million families who will now feel more optimistic about their wealth and increase spending on other goods and services, helping drive the U.S.' mighty consumer economy. According to CoreLogic, a further 1.8 million families could be lifted out of negative equity with another 5 percent increase in prices. At last year's pace of price rises,this could be achieved by September. And let's not forget that this consumer economy alone is bigger than France and China's entire economies combined.
In the months ahead, investors will probably face more Cyprus-like distractions. Structural problems in Europe remain unresolved, and until we are past the German elections in the fall, it is doubtful that Chancellor Angela Merkel will champion major new initiatives to address deposit insurance or further fiscal integration.
But, unlike Michael Crichton's T-Rex, we are blessed with eyes that can clearly see things which are slow, as well as fast, moving.Investors would do well to use them to watch the slow moving, but critical changes in the US housing market. Ignoring it in 2006 proved costly for many.Ignoring it now would be unwise too, as it looks set to deliver a significant boost to the world's largest economy in the years ahead.
Alexander Friedman is global chief investment officer at UBS AG and Kiran Ganesh is a cross-asset strategist for UBS Wealth Management, overseeing $1.6 trillion. The opinions expressed are their own.