10-15 Associates

From Housing to Stationary Bikes, the Markets Have a Lot to Tell Us.

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September started with hurricane Dorian bringing devastation to the Bahamas and threatening a broad part of the East Coast.

After nearly four days of hurricane force winds and torrential rain, Dorian moved on to the U.S. with much less power, causing minor damage compared to what most forecasters had originally predicted. Little did we know this was the first of many headlines to grip the country, including the attack by drones on Saudi Arabia oil infrastructure, new allegations against President Trump leading to the speculation of impeachment, and another round of rate cuts by the Federal Reserve. Through all this, the markets struggled to find direction and ended the month with some gains across the board. The S&P 500 advanced by 1.72%, the Dow was up 1.95% and the Nasdaq gained .45%. Interest rates were once again the center of attention, bringing relief to many as rates moved off their lows. Several economic data points, including GDP housing starts and durable goods data, revealed an economy struggling to stay on the path of expansion. This lack of direction was highly evident in recent voting from the Federal reserve with three dissenting votes. The interesting thing: the three dissenters were not unanimous in their opinion, with two voting not to cut, and one voting to cut by more than the quarter point that the Fed elected to do.

Come this time of year, it is a great time to check in on the state of the housing market for any clues it may give us about the health of the economy. With the spring and summer selling season now in the books and record low long-term interest rates, housing can give us a glimpse into the attitude of consumers. Therefore, it was a relief when the report from the Department of Commerce was released, showing new home building had surged to more than a 12-year high in both single family and multi-family housing. Housing starts jumped 12.3% to a seasonally adjusted annual rate of 1.364 million units last month, the highest level since June 2007. Up until now, the housing market, the most sensitive sector to interest rates, had shown few signs of benefiting from the Fed’s monetary policy easing which has pushed down mortgage rates from last year’s multi-year highs. The 30-year fixed mortgage rate dropped more than 130 basis points to an average of 3.56%, according to data from mortgage finance agency Freddie Mac. Firmer demand for housing was underscored by a separate report from the Mortgage Bankers Association, showing that applications for home loans increased for a third straight week last week. The recent improvement in housing data has raised optimism that the housing market could be regaining its footing after hitting a soft patch last year.

Affordability is the key to a strong real estate market. The younger generation and the potential source of new home buyers has faced many challenges. For one, millennials aren’t as well off as their parents were at the same age. Their net worth is lower and they’re not making more money. According to Pew Research Center, “individual earnings for young workers has remained mostly flat over the past 50 years.” In some way, this can be tracked back to the high cost of an education. The lack of an education is tied to a significant divide in income. For millennials, the difference of household income with a bachelor’s degree versus a high school diploma is over 100% ($49K vs $105K), for baby boomers, that gap was only 45%. Millennials also tend to owe more and start out already in debt.

Another way to gauge sentiment is to interpret some of the things we see in the markets today to assess investors’ appetite for risk. While we remain near all-time highs, we have been near or at these levels for almost a year now. This could be telling us investors are still willing to assume the risks of the market. With interest rates as low as they are, many question if investors are really willing to accept the risk or if they simply feel there are few other alternatives. If we look to the recent IPO market, it could be telling us that investors are not willing to accept risk at a high premium. During the past month, two noteworthy events unfolded in the IPO market. First, was the unraveling of the public offering of WeWork, which was originally scheduled to go public in August with a valuation of over 40 billion. After multiple rounds of re-valuation, the offering was ultimately pulled as the valuation dropped to less than 10 billion. Was the valuation initially over inflated or was it more of a reality check of how much risk investors are willing to bear in this environment? Then came Peloton, a stationary bike business beloved by many but with lack of a clear vision of profitability, shares declined by over 10% when they opened for trading on the debut on August 26th. Based on the initial pricing of the shares the company was valued at over $8 billion, more than double its most recent valuation in the private market of $4.15 billion. For the year ended June 30th, although the company reported $915 million in revenue, it posted a net loss of $195.6 million. After just 6 trading days the stock is down more than 20% from its initial public offering price.

Is the news in the IPO market good or bad news for investors? According to an article in Barron’s, the publication views the IPO activity as good news, proof that investors are acting rationally. After a blazing start to the year, a University of Florida finance professor noted that during the first half of the year the average new issue traded up 25% on its listing day, the highest first day average return since 2000. However, the trend has shifted, and the Renaissance IPO exchange traded fund—which invests only in new issues—is down 15% since late July. Of the 114 U.S. IPO listings in 2019, 63 have had positive returns. Companies that are losing money are customer-facing businesses that are receiving the cold shoulder on promises of future profitability. However, companies offering a clear path to profitability with low capital requirements are being well received by the market. According to the Barron’s article, “Amid the headlines about IPO disappointments, there is a broader takeaway: Investors have become more discriminating, and that’s good for everyone.”

Good news also came to investors in the form of announcements of reduced trading costs. In what has become a highly competitive market, Charles Schwab announced that they would cut their current trading costs from $4.95 per trade to $0. That is not a typo: as of October 7th, online equity, option, and ETF trading at Charles Schwab will be free. Other major brokerages, including TD Ameritrade and E-Trade, followed suit. Once considered a barrier to entry for those looking to just get started, trading costs are evaporating across the platform. For those of us looking for any efficiencies that can be derived, this is a positive move and one more sign that deflation is alive and well!

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