REALTOR® Sales Tip: Trying to Make the Horse Drink the Water


 Sara J. Walker, CFA  |    April 05, 2013
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Federal Reserve Chairman Ben Bernanke is a man on a mission. He is determined to pull the U.S. economy away from the brink of deflation by enticing businesses to invest and consumers to spend. His strategy includes keeping the target federal funds rate near zero while expanding the Federal Reserve’s balance sheet to over three times its former size.

By employing such an accommodative monetary policy, he certainly has led the horse to water. Now, can he make the horse drink? Recent market activity indicates at least a partial quenching of thirst.

The resulting low-yield environment is driving a hunt for yield by consumers and institutions with excess cash. That hunt is leading investors to both the real estate market and the stock market. The U.S. stock market is hitting new highs, and home sales are back to 2007 levels. Interestingly, the pace of mortgage originations is only half its 2007 level. According to DataQuick, 36 percent of home sales last year occurred without mortgage financing compared to 15 percent in 2007. In their quest for yield, investors with cash are entering the residential housing market driven by attractive rental income.

Does this activity portend another bubble? If left unchecked, it will at some point in some market. Anytime government policy is so skewed in favor of one outcome, for example economic growth, it results in distortion. Fortunately, both the real estate market and the stock market are supported by strong, albeit not perfect, fundamentals at this time.

What do we mean by “strong, albeit not perfect”? We admit this sounds like an assessment of the latest California cabernet sauvignon vintage. There are headwinds against both markets, but there always are. Steady economic growth is the best antidote for these headwinds, and the U.S. economy is growing steadily — but modestly.

The employment report for February 2013 highlights this predicament. Normally at this stage of recovery, especially when a Federal Reserve chairman is as accommodative as Dr. Bernanke, we should see monthly job creation of at least 400,000. The February report indicated job creation at 236,000. This was about 70,000 to 100,000 better than expected. And, the average monthly pace for all of 2012 was about 180,000. One month does not make a trend, but the labor market is showing steady improvement even as business owners deal with the uncertainty emanating from Washington, D.C.

One of the best supports for the U.S. economy, and therefore the residential real estate market, is employment. We are a consumer-led economy with consumption explaining almost 70 percent of U.S. Gross Domestic Product (GDP) growth.
You might be wondering if the Federal Reserve is about to raise its target interest rate given this economic improvement and attendant inflation concerns. This is where “steady and modest” is beneficial. Our economy is growing, but it is operating well below its potential. Business owners face numerous sources of uncertainty, and they are used to running lean and mean. Furthermore, the Federal Reserve recently raised its inflationary target at which it may begin to tap the brakes.

Certainly interest rates can and do change even if the Federal Reserve does nothing. In the week of the February employment report, for example, the 10-year U.S. Treasury Note yield ranged between 1.84 and 2.04 percent. This type of range is expected to continue, however, as economic growth, fiscal policy developments and geopolitical concerns continue their “one step forward, two steps back” routine. 

Our low interest rate environment will continue for some time, and investors will continue to react to it in both the stock and the real estate markets. Their reactions are rational — rental income is attractive, housing affordability is near record levels, corporate profits are strong and stock market valuations are reasonable. We like that rationality! It brings to mind a popular Wall Street reminder: Bulls make money and bears make money. It’s only pigs that get slaughtered.

Sara J. Walker, CFA is the Senior Vice President & Investment Officer at Associated Bank.
 

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