Supreme Summer


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Shawn-00397_cmykby Shawn Narancich, CFA
Executive Vice President of Research

While Chinese stocks endured more losses in a week that now puts the A-Shares Index into correction territory, U.S. investors continue to preside over a range-bound market domestically. With U.S. equity indices near record levels and late quarter news flow reduced to a trickle, all eyes were focused on the U.S. Supreme Court decision this week regarding the legality of federal tax subsidies for states not running their own insurance exchanges. A high court ruling upholding a key tenet of the Affordable Care Act (ACA) was greeted with a sigh of relief by investors who own hospital stocks, while sending speculators short names such as HCA Holdings running for cover. While minor tweaks to the ACA are still possible, such as the repeal of the medical device tax, this week’s key ruling all but assures that the key structure of the national healthcare law will remain intact at least until the Obama administration leaves office.

Gathering Pace

As healthcare stocks reacted to the Supreme Court drama, investors with more cyclical leanings received the latest confirmation that moribund first quarter consumption and weak retail sales were transitory. U.S. consumption spending in May rose at the fastest month-to-month rate in nearly six years, and the 0.9 percent surge easily outpaced a smaller increase in consumer income. Indeed, the U.S. consumer has not forgotten how to spend! Coupled with a strong job market confirmed by a surge in May hiring and an upbeat retail sales reported for the same month, we are left to conclude that the U.S. economy has picked up considerable pace from the slight contraction it experienced during the first quarter. Our best guess is that the Federal Reserve will exit zero interest rate policy sometime later this year, and it will most likely be in September.

Greece Ad Nauseum

The melodrama of Greece failed to find a resolution this week, but European stocks seem to have found their footing nonetheless. Regardless of whether ongoing talks with Greece are successful in retaining the country as a solvent member of the Eurozone economy, the European Central Bank (ECB) has demonstrated its commitment to do, as chief Mario Draghi famously observed several year ago, “whatever it takes,” to keep the Eurozone and its currency viable. Exhibit A of this commitment is the ECB’s ongoing program to enhance the European monetary base by purchasing $60 billion of European bonds every month until at least the fall of next year. Exhibit B, key in the latest Greek crisis, is the central bank’s commitment to fund Greek banks with loans to accommodate ongoing deposit flight from these institutions. Our main observation here is that if no acceptable resolution is reached and Greece ends up leaving the common currency, then Europe and its central bank will do what is necessary to keep the region’s banking system and economies liquid, thus preventing any lasting type of contagion from Greece’s exit.

Our Takeaways from the Week

  • The U.S. economy is perking up after a slow start to the year
  • Global capital markets are unlikely to suffer any lasting repercussions from Greece, regardless of how the melodrama concludes

Multifamily Living Multiplies


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by Brad Houle, CFA
Executive Vice President

Demand for commercial real estate from investors has been robust for the past few years. In a world of low interest rates, the relative yield advantage of owning commercial real estate is attractive to investors. In addition, trophy commercial properties in gateway cities like New York and San Francisco are seen as a “store-of-value” to foreign investors. When international investors are faced with a volatile home currency or an unstable government, the thought of owning a landmark building in an American city is a relatively prudent investment. As a result, real estate transactions in coastal cities have occurred at price levels that imply a very meager return for the buyer.

While most categories of commercial real estate have performed well, one of the most robust has been apartment buildings. Home prices have rebounded sharply since the Great Recession, particularly in the “cool” cities that millennials prefer to call home. One would think that the millennial generation is the demographic driving new household formation and should be in their prime first-time home buying years. However, a cultural shift has taken place whereby millennials are waiting longer to get married, start families and often prefer to rent for a number of reasons.

According to the U.S. Census Bureau, home ownership as a percentage of households has declined nationally from nearly 70 percent in 2004 and 2005 to 63.8 percent in 2015. A one-percentage-point change in home ownership rates equates to 1.3 million households, according to Bloomberg data. Lending requirements for first-time home building have been tightened dramatically since the financial crisis and the 20-percent down payment requirement disqualifies many millennial prospective homebuyers.

Home Ownership as a Percentage of Total Households


 Source: Bloomberg 

According to Bloomberg, apartment construction nationally has been rising since 2009. Apartment construction permits, a leading indicator of multifamily construction, was at an all-time high of 557,000 units in May. Permits last approached this level in June 2008.

Broadly speaking, real estate development moves in cycles. Whether it’s the unsold condos following the 2009 financial crisis or the now ubiquitous “selfie stick,” we have seen firsthand that whatever the hot trend happens to be is, it has the potential to … cool down.


This week there continued to be directionless news flow regarding the continued debt crisis in Greece. While it is impossible to determine what the outcome may be, one thing is certain: The market has a high level of Greece fatigue. Investors are weary of the issue and it appears that even the correspondents on CNBC are tired of reporting on it. We are closely monitoring the debt of neighboring southern European nations for any sign of contagion and thus far, the crisis does not seem to be spreading. July 20 is now viewed as a critical day, according to Bloomberg, as Greece owes the European Central Bank (ECB) 3.5 billion euros on that day. If there is a failure to pay, this would put Greece on the way to getting the boot by the EU. Interestingly, Greece will possibly delay payment to the International Monetary Fund (IMF) this month with no real consequences as liquidity will not be cut off to Greek banks. Evidently, not paying back the IMF is something akin to not paying back your in-laws with the only consequence being an awkward Thanksgiving dinner. The impact of not paying back the ECB is similar to not paying back the guy you borrowed money from at the racetrack.

In addition, the Federal Open Market Committee minutes were released this week. Parsing every word of the Fed minutes revealed that interest rates may rise in September and December of this year. This quote possibly has been the most over-analyzed and highly anticipated Fed rate hike of all time. Ultimately, this is good news: The Fed thinks the economy is robust enough that they need to tap the brakes to keep it from getting overheated.

Our Takeaways for the Week

  • Expect interest rates to make small movements upward in the fall
  • The multifamily housing market is robust and is likely to peak this year


Stuck With You


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by Ralph Cole, CFA
Executive Vice President of Research

Stuck With You

We all know too much of a good thing is no longer a good thing: that has been the case with interest rates in recent years. Coming out of the financial crisis, banks needed lower interest rates so they could repair their battered balance sheets. Short-term rates came down even faster than long-term rates and allowed banks to pay virtually nothing on deposits and make loans at a substantial profit. As long-term rates have come down, banks have had to lower what they charge for loans, thus reducing their profit margins (otherwise known as net interest margins). For the last couple of years, banks have been hoping for higher rates. Thus far this quarter they have received their wish and we can see that regional bank stock prices have responded well.


Source: FactSet

The correlation between U.S. 10-year Treasury yields and the regional bank index has been remarkable. The theory is that as long-term rates rise banks will be able to charge more for the loans than they make. They will also get higher returns on bond investments that they offer. These improved profit margins will help bank earnings. Much like the relationship between oil and gasoline prices at the pump, banks will be slow to raise interest on deposits and much quicker to increase what they charge on loans. We expect rates to continue to move higher throughout the rest of the year.

Every Little Thing Is Going to be Alright

In a year when the Fed is expected to raise interest rates every piece of economic data is parsed and picked apart. This week it was retail sales and consumer comfort. Retail sales were strong, whereas consumer comfort came in weaker than expected … So let’s just step back for a moment.

Employment gains have resumed their 200,000+ trajectory from 2014. Wage growth is finally starting to flow through the economy. Consumers and corporations continue to benefit from generationally low interest rates. We believe the consumer and the economy are on solid footing and that bodes well for whenever the Fed starts raising rates – be it June, September or December. We caution all not to worry too much about the daily economic numbers or the daily movements in the stock market.

 Takeaways for the week:

  • Banks are a beneficiary of higher long-term interest rates
  • “Main Street” is finally feeling the positive effects of this economic expansion


You’re Hired!


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Shawn-00397_cmykby Shawn Narancich, CFA
Executive Vice President of Research

Green Shoots

 A week chocked full of economic insight concluded with a bang, as a strong jobs report for the month of May provided more assurance to investors that a contraction in first quarter GDP is likely to be transitory. The U.S. economy created a net 280,000 nonfarm jobs last month, nearly a third better than what Wall Street was expecting. Good news on the jobs front was widespread among various industries and accompanied by more evidence that wage gains are firming. After being hamstrung by the West Coast ports strike, an exceedingly strong dollar and another harsh conclusion to winter, the U.S. economy now appears to be gathering speed.

In its attempt to determine the right time to begin raising interest rates, the Fed will triangulate today’s bullish job report with additional evidence of gathering momentum in manufacturing released earlier this week, that coming in the form of an ISM report showing that activity has picked up for the first time since last fall. As well, construction spending perked up in April and previous months’ activity was revised upward. Finally, Yellen & Co. would observe that U.S. light vehicle sales posted another strong number in May, rising to a seasonally adjusted annual rate of 17.8 million vehicles sold, a 10-year high. The plurality of this week’s data reveals an economy no longer in need of unconventional monetary policy and leads us to believe that the Fed will achieve lift-off from zero interest rate policy this fall, most likely in September.

Raise Rates in 2015 … Mais Non?

As investors were digesting the good news domestically, the International Monetary Fund was busy revising down its estimate of how fast the U.S. economy will grow this year. In an unusual move, Managing Director Christine Lagarde urged the Fed to hold off on raising rates this year, arguing that doing so would lead to an even stronger dollar and threaten the rate of expansion globally. The French may be opinionated, but even her admonition is likely to fall on deaf ears. We have said repeatedly that when the Fed raises rates, it will be for the right reasons, and the data we are beginning to see affirm for us that the U.S. economy is rebounding in the second quarter. Like last year, we see a second quarter reversal carrying through with strength into the second half of 2015.

Markets on the Move

Although the IMF might not be convinced, bond investors have responded in dramatic fashion, selling longer dated issues in mass and sending benchmark U.S. rates to their highest levels of the year. Equities in the financial sector are doing the opposite, rallying in anticipating of higher rates boosting banks’ net interest margins. In anticipation of rising rates, we recently increased our weighting to financials, while further trimming our exposure to a consumer discretionary sector that appears closer to full value.

Our Takeaways from the Week

  •  The U.S. economy appears to be perking up, solidifying expectations for Fed action later this year
  •  The bond market is responding, with rates rising to their highest levels of the year